China confronts its next growth hurdle

06/21/2011 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

On Sunday, June 19, in Athens 8,000 people protested the government’s plan to raise taxes, cut public sector jobs, and sell off state assets. The city’s Syntagma Square has become a permanent tent city with a steady diet of protest speeches, protest street-theater, and protest music. Employees at the country’s electric power plants will begin rolling 48-hour strikes next week. Unions are planning a 48-hour general strike to coincide with a vote on Parliament on a new austerity package.

Meanwhile in China the anniversary of the June 4 attack by Chinese army units against demonstrators in Beijing’s Tiananmen Square has passed without coordinated large-scale protest. Somewhere between several hundred and several thousand protesters were killed in 1989 when the army moved in, firing live ammunition at the crowd. The events in the capital kicked off a massive crackdown on protests outside the capital city and a purge of any party official who had even hinted at support for the protesters’ demands.

The lack of a coordinated, large-scale protest, however, doesn’t mean that China has been peaceful. The country is seeing an increase in uncoordinated protests over seemingly local problems. Last week a protest against lead poisoning in Zhejiang province resulted in one of the largest group petitions for redress this year. Three days of riots in Zengcheng broke out after a pregnant migrant worker was roughed up by government security guards trying to stop her from selling goods outside a supermarket. Elsewhere in Guangdong a stabbing of a worker at a ceramics factory allegedly ordered by his boss after the worker went to ask for unpaid wages prompted clashes between workers and police. On June 12 a man set off a bomb outside a local government headquarters in Tianjin. That followed hard on the heels of three explosions in Fuzhou “protesting” the illegal removal of a building in 2002. The most recent figures on what China calls “mass incidents,” a category that includes petitions, demonstrations, and strikes, dates from 2010. It shows mass incidents hitting 180,000 in 2010, up from 87,000 in 2005, according to the Ministry of Public Security.

These incidents are only seemingly local, however. There may not be anything coordinated about this and the scale may be small for China—600 workers here, 800 protestors there—but Beijing does have a national problem, nonetheless. The same festering social problem underlies most of these protests and it’s not going away.

I’m talking about the anger of the150 to 240 million migrant workers who have helped fuel China’s extraordinary growth with their cheap labor but who have not shared in the country’s new wealth. I think it’s safe to say that China’s leaders are facing the most serious challenge yet to the mix of economic and political policies that has fueled the country’s dynamic growth over the last three decades.

The root of the problem is China’s hukou system of household registration. Migrant workers, because they aren’t considered residents of the cities where they live, aren’t entitled to healthcare, pensions, housing subsidies, or education for their children. To educate their children, for example, migrant workers either have to find the money to pay for schooling in the cities where they work or send their children back to the rural areas where they officially still live. With migrant workers earning so little—the average is about $250 a month--sending children back home is often the only option.

The hukou system is nothing new so why the increase in protests now? Three reasons, I think. First, the contrast between the country’s newly wealthy and this vast migrant underclass has fed anger at the unfairness of the system. Second, because China’s growth has produced labor shortages in many parts of eastern, export-oriented China and because Beijing has pushed growth into lagging western provinces, migrant workers have increased bargaining power. They can find work closer to home if they don’t like how they’re treated in the country’s traditional fast-growth provinces. And third, China’s increasing inflation rate has come down particularly hard on the country’s poorest residents. The annual overall inflation rate was 5.5% in May, but food inflation is running at well over 10% annually. If you make just $250 a monthly—and remember that’s the average so some migrant workers are making much less—and spend 35% of your family budget on food, then 10% food inflation is pushing you to the wall.

Beijing knows it has a problem. A government report from the Development Research Center of the State Council, republished last week, warns that if migrant workers “are not absorbed into urban society and do not enjoy the rights they’re entitled to, many conflicts will accumulate.” The report projects that 9 million additional migrant workers will join the urban workforce each year between now and 2015.

The government’s traditional response to social protest is a mixture of repressive force and selective payoffs. The recent treatment of foil workers from Yangxunqiao protesting that they and their families had been poisoned by lead emitted by these factories is a good example of how the mix works. In the hours before workers had planned to set off to petition government officials in the provincial capital of Hangzhou, local officials visited their homes offering cash if they gave up their trip. When workers gathered to board buses to go to Hangzhou, hundreds of riot police stopped most of them from getting on. Only 400 out of an original group of 1,000 made it to Hangzhou to present their petition. The government initially offered $309 to the most severely affected and then raised the offer to almost $1200 after further protests. The offer doesn’t include all the workers poisoned—any worker without the proper work permit gets nothing. And it doesn’t deal with the larger nationwide problem. China is the world’s largest consumer of lead. National data is sketchy but a 2006 review of the existing data suggested that one-third of Chinese children suffer from elevated blood-lead levels. Part of the problem is enforcement—local officials are reluctant to clamp down on local businesses that provide jobs. But national environmental standards are also woefully inadequate. By U.S. regulations lead levels of 40 micrograms per deciliter of blood are considered poisonous for adults. Chinese rules call 400 micrograms per deciliter, a common reading for lead workers, “moderately elevated.”

Tightening national standards and then enforcing them would require closing marginal factories, mandating expensive environmental upgrades for every company that worked with lead, including the countries increasingly large battery industry, and providing compensation and treatment to affected workers. All that would disrupt local economies and be incredibly expensive. It’s much easier to treat each outbreak of the national problem as a local event and address it with force and limited payments to part of the affected group.

The government’s approach to the migrant worker problem so far seems more national in scope and more tilted to payments than force. The preferred solution of the moment is to raise the minimum wage in province after province so that all of China’s lowest paid workers have more money in their pockets. The country’s latest five year plan would raise national spending on health care, pensions, and education too. But without an end to hukou such increases in social spending won’t do much to help migrant workers.

Part of the problem is that extending social benefits to migrant workers, so that they have equal access to education, healthcare, and pensions in the cities where they live to those granted to “official” residents would be incredibly expensive. The report from the Development and Research Center puts the cost at $12,000 per migrant worker. Multiply that by estimates of 150 million to 240 million migrant workers in China and you’re talking $1.8 trillion to $2.9 trillion. That’s roughly 20% of China’s annual GDP.

The escalation of the migrant worker problem couldn’t have come at a worse time for the government. This year (July 1 is the official date) marks the celebration of the 90th anniversary of the founding of the Chinese Communist Party. It also marks the beginning of a transition to a new leadership that will take office in 2012 and 2013.

Stability and harmony are the goals for both the anniversary celebration and the leadership transition. I wouldn’t expect any significant changes in policy during this period.

At the same time the country is in the midst of a fight to reduce inflation—increasing wages won’t make that battle easier.

Longer term I can see policies that offer a way out. For example, greater social spending on health care and pensions—not just for migrant workers but for everyone in China--would gradually reduce the country’s huge savings rate—when people feel more secure, they save less—and that would give the boost to consumer spending that is exactly what China is looking for. And at the same time less saving and more spending would reduce the cash sloshing around the financial system that is a big driver of speculative price increases in the real estate sector.

But there is no doubt that over the next decade China faces an extensive economic challenge. The country has received a huge economic boost from the supply of cheap labor provided by migrant workers moving off the land and into the cities. That’s similar to the supply of labor created in the nineteenth and twentieth centuries in countries such as the United States by workers moving off farms and into factories and by external immigration.

Economic history says, however, that countries hit a bump in their growth once that supply of cheap labor starts to fall in size as a growing economy soaks up more and more of the excess. The task then, for a developing economy, is making the transition from growth driven by cheap labor to growth driven by productivity and spending by workers who are growing wealthier. In the United States it’s the transition that Henry Ford forecast when he saw that it made sense to pay his assembly line workers enough so they could afford to buy his cars.

As with everything about China, this transition has come up faster than in the development story of other countries. Now it’s up to China to figure out how to handle the challenge. Force, the labor history of the United States shows, is a tempting solution. But ultimately the pitched battles in the Colorado mine fields or at the Homestead steel works didn’t work. Can China do better?

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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