With much wisdom and foresight, Chairman Deng Xiaoping introduced sweeping reforms that turned China from a centrally-planned economy to a market economy in 1978. By allowing farmers to keep their own crops for sale, the Chinese leadership provided incentives to farmers for increasing yield and freed up rural labor to move to the cities. In half a century, 277 million migrant workers left the villages to work in the cities for better-paying factory jobs. The almost unlimited supply of workers drove labor costs down and allowed companies, both foreign and domestic, to expand and produce at an unprecedented pace. Foreign investment and government-sponsored infrastructure projects rebuilt China from decades of ravaging war and Mao-era mismanagement. This was the Chinese Miracle – a country on the brink of starvation became the world’s giant.
A country hits the “Lewis Turning Point” when all available rural labor has been converted to more-valuable factory labor. Companies must then raise wages to attract workers which in turn cuts profits and slows down economic growth. In China, decades of urbanization have left villages empty except for children and their elderly caretakers. Companies in China are now experiencing labor shortages after decades of endless supply of labor. The One-Child Policy, designed in the 1980s to prevent overpopulation, left the new generations with a fertility bullwhip effect that will drastically decrease the ratio of working-age adults to retirees. It is estimated that in 2040, the ratio will have declined from 5 workers per retiree to 1.6. With a shrinking workforce and an increasing number of dependents, China may never see its GDP grow at double-digits again.
Another significant driver of growth came from years of government infrastructure spending that connected the vast landscape and brought economic opportunities to previously undeveloped provinces. So, to maintain the GDP growth during economic slowdown, the Chinese government accelerated its infrastructure spending and pumped trillions of dollars into the economy. But the success of an infrastructure project depends on whether the it creates net economic benefits, not by how many workers it kept on payroll during its construction. Unlike the U.S., China’s infrastructure has already been modernized and its salient needs addressed during the economic boom. To call the latest round of infrastructure projects wasteful is an understatement – entire cities were built without any occupants. With China’s debt-to-GDP ratio approaching U.S. levels at 250%, the government must stop relying on stimulus spending to maintain the image of growth.
Party leaders have now recognized that China will no longer grow at the scale and speed as it had before. In its most recent 5-year plan, the government signaled a pivot from investment to consumption as the primary driver. Instead of building new railways and factories, China is to become an innovation based economy like Japan and Germany, designing products instead of producing them for another country. Although the shortage of labor prohibits companies from expanding like before, increased wages will provide billions of working-class families with more money to spend and an increased appetite for luxury goods that can be produced by their own country. The Lewis Turning Point is in fact the opportunity for China to climb the food chain of global economies and join the ranks of the rich, developed countries. The coming years will be crucial as China begins its transformation, along with the rest of the world.