By Wenjing Duan and Prof. Pedro S. Martins

China’s recent emergence in the world economy was underpinned by a massive process of labour reallocation delivered by the country’s nascent labour market. After several decades in which labour was allocated and rewarded centrally, according to communist principles, a number of market-oriented reforms led to greater flexibility and responsiveness to demand and supply. Given the large pool of underemployed workers eager to increase their incomes, in particular in rural areas – over 150 million people according to some estimates –, the potential for growth from industrialisation and exports was considerable.

This blog summarises the findings of our recent CGR working paper, ‘Rent sharing in China: Magnitude, heterogeneity and drivers’, in which we contribute towards a better understanding of the Chinese labour market. Specifically, we provide empirical evidence on how China’s growth was shared between capital and labour. We focus our analysis on the critical period of 2000-2007 – including China’s WTO membership in 2001 and the resulting massive increase in exports. Moreover, we examine comprehensive firm-level panel data covering virtually all manufacturing firms in the country – an average of 200,000 firms and 54 million workers per year – as well as additional information on rural employment and minimum wages.

We focus on the analysis of ‘rent sharing’ (RS), when workers are paid not only depending on the market rates for their skills – as in ‘competitive’ labour markets, as described in neoclassical economic models – but also as a function of the profitability of their firms. RS can be driven by many factors, in particular the bargaining power of workers, especially when enhanced by labour market ‘institutions’ common in many countries such as trade unions, collective bargaining, employment protection law, unemployment benefits and unconstrained labour mobility.

As in the case of most other studies for developed economies, we find evidence that RS is also a relevant dimension of wage determination in China. For instance, according to our econometric results, workers that would hypothetically move from low- to high-profit firms in the same province, industry and year would see their wages increase by at least 45%.

These results are particularly interesting as many of the labour market ‘institutions’ mentioned above are still in an early stage of development in the case of China (for instance, trade unions are in many cases led by management, not blue-collar workers; collective bargaining agreements are relatively rare). At the same time, notwithstanding their significance, our rent sharing estimates are at the lower bound of similar studies in the case of developed economies. Moreover, rent sharing is lower or even not significant in particular types of firms, including those with large shares of women or low-education workers, foreign-owned firms, and non-unionised firms.

A number of additional results that we present in the paper highlight the different nature of RS that we find in the case of China compared to other countries, reflecting the country’s unique labour market and institutional framework:

1. RS tends to be smaller in regions that have larger numbers of rural workers. This relationship is consistent with the bargaining dimension of wage determination as the availability of substitute workers appears to influence negatively the degree to which employers share their profits with current employees.
2. There is an important degree of symmetry in the RS process – while workers benefit from higher wages when profits increase, they are also subject to wage cuts or lower wage growth when profits fall or become negative. This finding is consistent with ‘risk sharing’ and is in contrast to the significant levels of wage or risk insurance provided by firms in more developed countries.
3. Despite their small (relative) values, minimum wages – introduced gradually during the period of our analysis – tend to reduce RS. This can again be explained by the ‘risk sharing’ result above: higher minimum wages will reduce the scope for firms to cut wages at times when profits fall.
4. Employers’ relative weight in local labour markets tends to depress wages, a result that can is consistent with ‘monopsony’ power. At the same time, as firms gain labour market power, when they become the single or increasingly most important employer in their region, they are able not only to pay lower wages to their workers but also to make those wages more variable.

In conclusion, despite the still emerging nature of many formal labour market institutions, workers in China already see their wages respond positively to the profitability of their firms. At the same time, while workers’ bargaining power plays an important role in shaping the wage distribution in China, rent sharing is much lower than in developed economies. Moreover, we find evidence of relevant ‘risk sharing’ dimensions in China’s labour market, which further underlines the significant but comparatively small degree to which workers benefit from their firms’ success.

In future research, we plan to examine to what extent this significant but limited extent of rent sharing in China played an important role in the country’s fast absorption of underemployed labour from rural areas and the resulting high economic growth rates.

Read the Chinese version of this post here.