A Tale of Two Economies


Nov 10, 2004

This commentary originally appeared in Asian Wall Street Journal on November 10, 2004.

Despite their huge differences, the Chinese and American economies share one common characteristic that is both a short-run problem and a long-run opportunity: rising labor productivity.

In the U.S., election-year political rhetoric was directed at the so-called “jobless recovery” but ignored the fact that this problem, insofar as it exists, is largely due to rising labor productivity rather than to “outsourcing” of jobs abroad. Similarly, much of the criticism of China's limited ability to create sufficient new job opportunities has ignored the fact that these limits are due largely to rising labor productivity.

Both the Chinese and American economies have generated rates of growth in labor productivity (measured as output per employed worker, or per hour worked), substantially above their previous performance. In China, for the period from 1998 to 2003, increases in labor productivity have been nearly 7%, the highest among the world's major economies. In the United States, annual increases in labor productivity in the same period have averaged between 3% and 3.5%, the highest among the major industrialized economies, including Japan and Germany.

Rising labor productivity is a powerful contributor to economic growth and social progress. It drives the demand for labor, tending to boost wages and to raise profitability of capital. In the process, business investment and consumer spending are stimulated, and these in turn contribute to economic growth.

At the same time, rising labor productivity reduces the amount of new employment created by economic growth. For example, if gross domestic product in the U.S. grows at an annual rate of 4% (the current U.S. growth rate) while labor productivity increases at an annual rate of 3%, then the rate of new job creation in the U.S. will not exceed 1%. This 1% increase amounts to approximately 1.4 million net new jobs annually, which is about 500,000 fewer jobs than the normal increase in the number of new entrants into the labor market each year. Higher labor productivity thus reduces the capacity of aggregate economic growth to generate new jobs.

China has an analogous problem. While China's annual rate of GDP growth has averaged between 8% and 9% in the 1998-2003 period, annual growth in labor productivity has also been extraordinarily high: nearly 7%. The result has been to cap creation of new jobs at 1-2% of existing employment, about 10 million new jobs annually. This figure, although substantial, pales when compared with the total number of China's unemployed and underemployed labor. According to China's official statistics, registered unemployment rose to 4% from 3% of the urban labor force in the past five years, rates that are remarkably low compared with other countries. But these figures conceal as much as they reveal. When proper allowance is made for “unregistered” urban unemployment (for example, the number of itinerant migrant workers from rural areas has been estimated as over 100 million) and “disguised” rural unemployment (labor that, while nominally employed, does not add to output), China's actual unemployment soars to 23% of the labor force, about 168 million workers.

In the short run, there is a tension between the goals of raising GDP growth, creating additional jobs, and increasing labor productivity. Notwithstanding the many and major differences between the U.S. and Chinese economies, rising labor productivity in both countries means that fewer new jobs result from any realized rate of economic growth than would result if productivity growth were slower.

In the midterm and long run this tension is mitigated by the self-corrective effects of competitive markets: higher labor productivity generates additional demand for labor, boosting employment and economic growth. Yet these long-term effects provide limited comfort for policymakers and households anxious for employment to be expanded here and now.

While bearing in mind the long-run prospects, both China and the U.S. should formulate policies that reflect the complex interactions among economic growth, labor productivity and new employment opportunities. Although the public-sector bureaucracies of both China and the U.S. — especially those of China — are swollen and should be streamlined, it probably makes sense in the short run to moderate reductions in these relatively low-productivity public-sector jobs. Investments by China in health-services delivery, in preventing and controlling epidemic disease, and in countering the country's serious air- and water-pollution problems can contribute to advancing economic growth and improving quality of life without appreciable effects on labor productivity in the near term.

What is best in the short run may not be best in the long run, and vice versa. This point carries with it a particular message for China's policymakers: a higher rate of aggregate economic growth may not always be preferable to a lower rate. Annual growth of 7%, together with labor productivity growth of 3%, may be preferable to aggregate growth of 9% with accompanying growth in labor productivity of 7%, because the former combination will generate more new employment.

Mr. Wolf is a senior economic advisor and corporate fellow in international economics at the RAND Corporation and a senior research fellow at the Hoover Institution.

More About This Commentary

Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.