China’s Ticking Time Bomb

06/21/2011 8:00 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

The fast-growing economy is fueled by low-paid migrant workers who have watched others profit from their sweat. How much longer will they be willing to do it?

On June 19, 8,000 people in Athens 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, street theater, and 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 in 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 protests.

Somewhere between several hundred and several thousand protesters were killed on that day 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.

However, the lack of a coordinated, large-scale protest 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 who were trying to stop her from selling goods outside a supermarket.
  • In Guangdong, the stabbing of a worker at a ceramics factory—allegedly ordered by his boss after the worker asked 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 has a national problem, nonetheless.

The same festering social problem underlies most of these protests, and it's not going away.

NEXT: A Serious Challange to Leadership

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A Serious Challenge to Leadership
I'm talking about the anger of the 150 million 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 past three decades.

The root of the problem is China's hukou system of household registration. Migrant workers aren't considered residents of the cities where they live, which means they aren't entitled to health care, pensions, housing subsidies, or education for their children.

To educate their children, 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 more bargaining power. They can find work closer to home if they don't like the way they're treated in the traditional fast-growth provinces.
  • 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 month—and remember that's the average, so some migrant workers make even less—and spend 35% of your family budget on food, then 10% food inflation is pinning 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, who were protesting how 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. Then, when workers gathered to board buses bound for Hangzhou, hundreds of riot police stopped most of them from getting on.

Only 400 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 $1,200 after further protests.

The offer doesn't include all the employees poisoned past the point of working—any worker without the proper work permit gets nothing.

NEXT: The Scourge of Lead Poisoning

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The Scourge of Lead Poisoning
And settling with 400 workers from Yangxunqiao doesn't deal with the larger nationwide problem.

China is the world's largest consumer of lead. National data are sketchy, but a 2006 review of the existing data suggests that one-third of Chinese children suffer from elevated blood-lead levels.

Part of the problem is enforcement—officials are reluctant to clamp down on businesses that provide jobs. But national environmental standards are also woefully inadequate.

Based on US regulations, lead levels of 40 micrograms per deciliter of blood are poisonous for adults. Chinese rules call 400 micrograms per deciliter—a common reading for lead workers—“moderately elevated.”

Tightening and enforcing national standards would require closing marginal factories, mandating expensive environmental upgrades for every company that works with lead—including the country's increasingly large battery industry—and providing compensation and treatment to affected workers.

All that would disrupt local economies and be incredibly expensive. It's easier to treat each outbreak of the national problem as a local event, and address it with force and limited payments.

The government's approach to the migrant-worker problem so far seems more national in scope and more tilted toward payment than force. The preferred solution of the moment is to raise the minimum wage in province after province, so that 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. 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 the same access to education, health care, and pensions in the cities where they live as those granted to “official” resident status—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 gross domestic product.

NEXT: New Leaders Have a Big Challange Ahead

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New Leaders Have a Big Challenge Ahead
However, the escalation of the migrant-worker problem couldn't 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 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—and increasing wages won't make that battle easier.

In the 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. That would give consumer spending the boost China is looking for. 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 a daunting economic challenge.

The country has received a huge economic boost from a strong 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 19th and 20th centuries in countries such as the United States—similarly, by workers moving off farms and into cities as well as by external immigration.

Economic history says, however, that countries hit a bump in their growth once that supply of cheap labor starts to shrink, as a growing economy soaks up more and more of the excess. The task then, for a developing economy, is to transition from growth driven by cheap labor to growth driven by productivity and spending (by workers who are becoming wealthier).

In the United States, it's the transition that Henry Ford forecast when he realized it made sense to pay his assembly-line workers enough so they could 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 Kentucky mine country 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 column in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.

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