What Happened around 1996? The Turning Point in Labor Market Reform

As argued in the previous section, it was in the mid-1990s that the PRC established its growth pattern of low labor costs and high exports. That was the starting point of the large-scale rural-to-urban migration, the radical labor market reform, and the era of an undervalued yuan.

Though restrictions on rural-to-urban migration have been gradually loosened since the mid-1980s, the scale of rural-to-urban migration was modest until the mid-1990s. The significant increase in the number of migrants is shown in Figure 8 [ PDF 35.7KB | 1 page ]. With the process of urbanization and industrialization, migrant workers have been making up an increasingly larger proportion of rural labor. The inflow of rural migrants into cities intensified labor market competition, and therefore, weakened labor's market power and lowered the growth of urban worker wages, compared with the growth of labor productivity.

Another event that deserves our attention is related to the labor market reform which accelerated in 1996. Before the initiation of reform and the open door policy in 1978, the PRC adopted a planned employment system to satisfy the need for a “catch-up” development strategy. To generate revenues for the investment in the SOEs, which were focused on heavy industry, the government interfered in the labor market, and rendered two characteristics of the labor market in the planned economy: distortion of the labor price and segmentation of the labor market. On the one hand, the state compressed wages and assigned employment through the Ministry of Labor. Even if wage disparity existed among different industries and enterprises, such disparity could not be narrowed through labor market competition and labor force reallocation. On the other hand, because of the “catch-up” development strategy, which favored capital-intensive heavy industry, demand for labor was relatively low, but the government attempted to eliminate unemployment by administrative policies. Therefore, enterprises in the PRC ended up with redundant employees. From the initiation of the labor contract system in 1986, up until 1996, the newly-grown labor force was marginally allocated through the market mechanism, but the employment mechanism of the labor stock, i.e. those were already employed, was not marketized. As a result, in this stage, the effect of labor market reform was mainly a gradual adjustment of income structure. More and more laborers earned income from non-state enterprises, and from non-wage sources.

Starting from Shanghai in July 1996, the labor market system reform was officially initiated, and was marked by the establishment of the re-employment service centers for separating surplus SOE employees. From 1997 to 1998, this reform initiative was quickly introduced all over the nation. Laid-off SOE workers were required to leave their original role, and enter the reemployment centers to be reassigned.⁹ Those laid-off workers were not included in the registered urban unemployment rate. As the new century descended, enterprises came to have more autonomy in labor employment. As now, in order to lay off employees, enterprises are only required to pay sufficient compensation. SOEs often carried out the so-called “buy-outs,” with calculations based on the number of years employees had worked. Among those who were laid off, some found new jobs, some became unemployed, whereas others quit the labor market. Many found new jobs in the informal sector. Structural adjustment was actualized mainly as differentiation in terms of various employment statuses.

Figure 9 [ PDF 29.6KB | 1 page ] plots the changes in income structure. We can see that the ratio of total employee wages to total income of urban residents has been steadily decreasing since 1978, as income from sources other than employee wages is accounting for an increasingly larger proportion of total income. Multiple factors could have led to this trend, such as the informalization of employment and the diversification of income sources. Figure 10 [ PDF 29.6KB | 1 page ] depicts the ratio of the number of urban paid employees¹⁰ to total urban employment, which displays a downward trend, especially after 1996. This implies that with the deepening of labor market reform, employment is more informalized. Figure 11 [ PDF 27.6KB | 1 page ] shows the structure of urban workers' employment in organizations with different types of ownerships. As we can see, the share of employment in SOEs and collective-owned-enterprises has declined, while employment in other forms of ownerships has been increasing significantly, especially after the mid-1990s, which indicates a diversification of employment.

The registered urban unemployment rate has also risen after 1997, and the increase was especially rapid from 2001 to 2003 (Figure 12 [ PDF 31.4KB | 1 page ]).¹¹ The trend of a decreasing labor force participation rate is revealed in Figure 13 [ PDF 31.4KB | 1 page ]. The falling labor force participation rate indicates that during the adjustment of the employment structure in the labor market, an increasing number of people chose to quit the market.¹² Obviously, we can conclude from the analyses above that after 1997, the pace of employment restructuring caused by labor market reform accelerated, and led to intense changes in employment and income structures.

Labor protection is insufficient under the current system in the PRC. Although trade unions are nominally organizations through which workers can lawfully fight for their rights, in reality they are subordinate organizations established within enterprises by the Party and government in public sectors and SOEs. In the initial stages of SOE reform in the mid-1990s, chairmen of trade unions in some enterprises were even given incentives as members of enterprise management teams. Therefore, in SOEs, employees did not have an organization that could effectively represent them in wage negotiations. However, employees' disadvantageous market power gave rise to an unexpected favorable condition enabling the smooth progress of PRC labor market reform; namely, maintenance of slow wage growth in the first stage and employment restructuring in the second stage. At the same time, this disadvantage is also a hidden trigger to increasing income disparity within cities. Nevertheless, in private enterprises, leaders of trade unions are primarily paid employees, who do not have powers to bargain with employers.

Regional competition in the PRC is also an important factor in the maintenance of relatively slow wage growth. Interregional competition is considered as an important factor in the success of the PRC's economic reform (Qian and Weingast 1997). When the central government evaluates the performance of local governments, it ranks them in terms of relative performance, and the promotion of local government officials is based on local GDP growth during their incumbency (Li and Zhou 2005). Such a mode of competition, where officials report to their superiors and not their local residents, induces local government officials to care more about local GDP growth by attracting investment, not employees' rights and income disparity.

Rural-to-urban migration and labor market competition are basic sources of low labor costs. Furthermore, the reform of the exchange rate system in 1994 contributed a lot to the export-led growth pattern. Since 1978 when reform and the open door policy was first initiated, and with the gradual marketization of the trade regime, the overvalued yuan faced increased depreciation pressure. Though several adjustments had been made in the same period, the yuan was still overvalued and there was a huge gap between the official and illegal black market exchange rates. This dual system was abolished in 1994, and the official exchange rate was lowered tremendously once and for all. From then on, the exchange rate of the yuan to the USD remained steady until 2005 (see Figure 14 [ PDF 30.9KB | 1 page ]). The great depreciation of the yuan was a starting point of the PRC's export-oriented strategy, and has been responsible for the tremendous increase in exports since 1994.¹³

Massive rural-to-urban migration, urban labor market reform, and the political governance structure have all created favorable conditions for slow wage growth in the presence of surplus labor, which, in addition to the undervalued yuan, have ensured that low labor costs, the main comparative advantage of the PRC, has been made use of.

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