Microsoft Word EcRefChina Oct06. doc

importer
of high-
tech components, which are assembled to finished products with the help of low-skilled 
labor, for sales both in domestic and foreign markets. Thus, the value added of Chinese 
export of such products is still mainly low-tech and low-skill.
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Developed countries will 
have an overwhelming comparative advantage, and a trade surplus, in high-tech and high-
skill products as long as China continues its large import of high-tech and high-skill 
components in domestically produced final products. Over time, the situation is, of 
course, bound to change. The value added share of Chinese export would be expected to 
continue to rise as a result of the gradual upgrading of the high-tech and high skill 
components of China’s export production. Trade between China and today’s developed 
countries will then increasingly consist of intra-sector trade based on specialization within 
different kinds of high-tech and high-skill product areas.
Two other characteristics of China’s economic system – not explicitly highlighted in 
Figure 1 – should also be mentioned. One is that
 factor markets
, in particular the market 
for capital and credit,
 
have been reformed less than product markets. There is, however, 
an emerging labor market, with gradually more flexible relative wages and an increased 
return on investment in human capital; see, for instance, the discussion in Zhang et al. 
(2005) and Meng (2005). One background factor is that state firms, which used to 
shoulder the main responsibility for providing and securing jobs, increasingly adjust their 
workforce to what is needed for actual production, and this has resulted in large shedding 
of workers since the second half of the 1990s (Dong and Zu, 2006).
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As a result, 
“lifetime employment” in state firms and truly collective firms is gradually becoming 
replaced by less permanent and more market-oriented labor contracts.
20
But the flexibility 
17
For an attempt to measure this similarity and its development over time, see, for instance Schott 
(2005). 
18
The research on this issue is still rather thin. See, however, Cao (2004); Hsiung (2002); Leydesdorff 
and Ping (2005); and Schwaag Serger and Widman (2005).
19
The number of workers in the SOEs fell from 110 to 66 million between 1995 and 2003, and the 
number of workers in collective enterprises from 31 to 10 million (Ministry of Labor and Social 
Security, 2005). 10-20 percent of those previously employed by state firms were still counted as “laid-
off workers” (
xiagang gong
) several years afterwards; see, for instance, Cook (2000).
20
About half the workforce of SOEs seems to have been on terminable labor contracts in the late 1990s 
(State Bureau of Statistics of China, 1998; Hussain, 2000a). 

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of the labor market is still constrained by the lingering overstaffing in many state firms. 
Workers usually do not voluntarily leave such firms because important social benefits are 
still tied to the individual’s employment contract. Since these arrangements imply that 
employees in SOEs are privileged relative to other employees, the urban labor market has 
a pronounced insider-outsider character. The difference between the situation for state 
firms and private firms is, however, likely to continue receding over time.
As a result of these features of today’s labor market, labor mobility in China is to a 
considerable extent provided by rural-urban migration rather than by labor mobility 
within the group of favored urban residents (Knight and Yueh, 2004). One explanation is 
that the residence registration system in urban areas, 
hukou
, has recently become more 
lenient, so that it does not prevent migration to cities to the same extent as earlier. Indeed, 
the urban share of the total population has increased from about 18 percent in 1978 to 
about 42 percent in 2004 (based on addresses rather than registration). A large number of 
the migrants to cities constitute, however, the so-called “floating” population, without 
residence permits or only with temporary permits to live in the city – a group often 
estimated at about 140 million. Many of these migrants not only perform particularly hard 
and dangerous jobs. They also have much less social protection (if any), and they have to 
pay much more than others in urban areas for human services, such as education and 
health care. Moreover, they are reported to be less rewarded for their effort and for their 
investment in human capital (Maurer-Fazio and Dinh, 2002); however, studies of this 
issue are complicated by the difficulties of identifying migrants with similar 
characteristics as permanent urban residents. This means that the 
hukou 
system 
accentuates the insider-outsider nature of the urban labor market, where immigrants 
without even temporary residence permit are the most pronounced outsiders. 
During a comparable phase of industrialization, today’s developed countries in Europe 
also experienced a huge outflow of labor from agriculture. A considerable share of the 
rural population could, however, emigrate to other continents with ample availability of 
agricultural land and expanding urban labor markets. China’s current agricultural 
population does not have the same opportunities. We would expect this fact, in 
combination with gradually increasing leniency of the 
hukou
system, to retard the rise in 
real wages for low-skilled workers in urban areas, and hence keep China highly 
competitive in labor-intensive products for a long time to come. Another likely result is

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an accentuation of unemployment problems in the future, although high flexibility of 
relative wages could, in principle, mitigate this problem.
21
For some time to come, urban 
labor markets may therefore continue to exhibit characteristics similar to Arthur Lewis’s 
(1954) model of “unlimited supply of labor” in urban areas, although at gradually rising, 
rather than constant, real wages for low-skilled workers (in the connection with higher 
labor productivity).
22
Largely as a result of the huge public ownership of financial assets, it is reasonable to say 
that financial markets in China are less developed than labor markets. In particular, this 
holds for securities’ markets. For instance, only very few non-state firms are listed on the 
Shanghai and Shenzhen stock exchanges, and the bulk of the shares of incorporated state 
firms are not available for purchase.
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The efficiency and flexibility of the stock market 
are also constrained by the poor financial transparency of listed companies, although the 
transparency is higher for SOEs that have recently issued shares (often in the form of 
Initial Public Offerings, IPOs) in Hong Kong and on foreign stock markets (mainly New 
York). Moreover, the bond market is very thin, only constituting about 20 percent of 
GDP, and bond issues by the government and SOEs dominate the market. Indeed, the 
bulk of the stock of bonds is also held by government agencies, partly because of the near 
absence of insurance companies and private pension funds. Moreover, for bonds to play 
an important part in Chinese financial markets, deregulations of the bond market would be 
necessary, including a lifting of interest ceilings and a removal of