Job creation in China - the role of cities and services sector

Felix Salmon has a superb post which highlights the critical role played by urban areas in sustaining economic growth and job creation in China. He points to two less-discussed facts about the Chinese economy.

1. Services sector employs more people than the manufacturing sector. The graphic shows that manufacturing sector, in terms of total jobs in the sector, actually declined for some part of the nineties but recovered slowly in the last decade.



Examining China's jobs growth over the past twenty years, Felix Salmon writes,

But it is surprising to see that if you take out the services sector, total Chinese employment has been going nowhere, and basically falling... Meanwhile, the services industry — tertiary industry — has been on fire: it now employs 263 million people, more than are employed in secondary industry (218.4 million), and has doubled since 1992... Of course it’s hard to find work in the services industry if you’re a rural peasant: tertiary industry is a fundamentally urban thing.

2. The growth in jobs has been coming mainly from the urban areas though rural China provides more employment than its cities. Apparently 13.7 million urban jobs were created in China in 2010 alone.



Felix Salmon makes the important point that unlike the US, where the construction boom was confined to the real estate sector, the Chinese construction boom "is building cities and roads and crucial infrastructure, which allows the service economy to keep on growing at a torrid place".

Both these graphics highlight the important role played by the services sector and cities in boosting China's labour market. Felix Salmon points to the closely inter-twined nature of cities and services sector job creation,

How do you create service-industry jobs? By investing in cities and inter-city infrastructure like smart grids and high-speed rail. Services flourish where people are close together and can interact easily with the maximum number of people. If we want to create jobs in America, we should look to services, rather than the manufacturing sector. And while it’s hard to create those jobs directly, you can definitely try to do it indirectly, by building the platforms on which those jobs are built. They’re called cities.

Will policy makers in India, obsessed with a rural-centric public policy paradigm, take notice and emulate China?

Do small firms underpin economic vibrancy and create major share of jobs?

One of the recurrent themes in the debate about the problems facing the US economy has been the relative weakness of small enterprises who are traditionally believed to have provided the labor market firepower in the aftermath of recessions and also underpin economic vibrancy of any economy. However, this conventional wisdom has been questioned by Jared Bernstein and Tyler Cowen in different contexts.

Tyler Cowen points to an interesting possible structural cause for the economic weakness in Italy and some of the peripheral economies - the over-sized role of smaller firms in their economies. Referring to Italy's vibrant clusters of family-owned niche businesses, he writes,

"With the advent of modern communications and information technologies, arguably the return to 'small family firms' has fallen. The return to 'largish projects consummated over large distances' has gone up. For Europe, the big winners here are the Nordic countries, which have worked very effectively with information technology and which do not rely so much on family ties to get efficient, non-corrupt management. The losers are Italy and Greece and Portugal too... Portugal is cursed by being stuck with all these small firms, inefficiently small for legal and regulatory reasons. These countries seem to be locked out from some of the major sources of contemporary economic growth."

He also points to Serguey Braguinsky, Lee Branstetter, and Andre Regateiro, who studied the transformation of Portugal's firms and found,

"For decades, the entire Portuguese firm size distribution has been shifting to the left... Portugal's shrinking firms are linked to the country's anemic growth and low productivity. We show that the shift in the Portuguese firm size distribution is not reflected in other advanced industrial economies for which we have been able to obtain comparable data."

Matt Yglesias has an excellent graphic that clearly refutes the small-firms-cause-economic vibrancy thesis.



I cannot but not agree with his broad assessment of firm growth in any economy. He writes,

"The way a healthy economy works is that you start with a bunch of firms and then it turns out that some of those firms are better-managed than others. The well-managed firms expand while the poorly-managed firms go out of businesses. At the end of the day, then, you wind up with the majority of workers working for relatively well-managed firms. Because the firms are well-managed, the workers are more productive and earn the well-known-in-the-literature large firm wage premium. Alternatively, you can have an economy like Italy’s with lots of barriers to competition so that poorly managed firms stay in business with low productivity."

Jared Bernstein writes about the role of small businesses in the US economy,

"It’s not small businesses that matter, but new businesses, which by definition create new jobs. Real job creation, though, doesn’t kick in until those small businesses survive and grow into larger operations."

Bernstein's assessment and the findings from the study of Portuguese economy has important lessons for India, where small businesses and policies favoring them are seen as holy cows. Braguinsky et al write about the distortionary role played by Portugal's uniquely strong protections for regular workers,

"Drawing upon an emerging literature that that attributes much of the productivity gap between advanced nations and developing nations to the misallocation of resources across firms in developing countries, we develop a theoretical model that shows how Portugal's labor market institutions could prevent more productive firms from reaching their optimal size, thereby constraining GDP per capita."

Their assessment of the Portuguese economy would also apply to India which too has similar tight labor market restrictions aimed at protecting smaller enterprises,

"Portugal's policy commitment to employment protections for regular workers in the formal sector is extreme, even by Western European standards. We present a model in which high levels of employment protection e ectively operate as a tax on wages, and can produce a shift in the rm size distribution, relative to the distortion-free benchmark, that reflects, in some ways, what we have seen in Portugal. An immediate implication of our model is that the same policy regime that shrinks firms also lowers aggregate productivity. Even a uniform tax tends to hit the most productive enterprises disproportionately hard, causing a degradation of the allocation of resources across enterprises. More resources are tied up in smaller, less protective enterprises and fewer resources are allocated to the most productive firms, relative to what we would see in a distortion-free economy."

In simple terms, the major share of job creation happens when small industries which started recently consolidate and start their expansionary phase. Public policy should accordingly facilitate this expansion. Unfortunately, both public policy and pervailing socio-economic institutions and conditions, both hinder such expansion.

Catch-up growth and global convergence

Citigroup economists Willem H. Buiter and Ebrahim Rahbari, who earlier identified 11 global growth generating (3G) economies for the first half of this century, have another paper investigating the likely future sources of global economic growth between 2010 and 2050.

They use 40 year economic forecasts by Citi economists, historical GDP data for the most recent 10-year period, and available economic research on the drivers of long-term growth, to examine national-level global growth generators. They assume United States as the technology frontier country and draw the distinction between growth at the technology frontier (productivity growth at the frontier) and catch-up or convergence growth (mainly through adoption and importation of best-practice technology and know-how from the frontier countries). Naturally, they foresee most of the global growth to come from the latter source.

Their earlier 3G index aggregates some key growth drivers - gross fixed domestic capital formation; gross domestic saving; a measure of human capital (which aggregates demographic, health and educational achievement indices); a measure of institutional quality; a measure of trade openness; and the initial level of per capita income. Their final analysis and prescription about how a country grows fast

"1. Start poor
2. Start young
3. Open up to trade in goods and services and to foreign direct investment
4. Achieve reasonable political stability (the absence of significant external and internal conflict)
5. Create some semblance of a functioning market economy
6. Boost the domestic saving and investment rates
7. Invest in human capital (educate and train both boys and girls, focusing on pre-school, primary and secondary education and on vocational training)
8. Invest in infrastructure
9. Don’t be unlucky. Avoid war-like neighbours and natural disasters
10. Don’t blow it. Avoid internal conflict and populist assaults on the incentives to work, save and invest; avoid macroeconomic mismanagement, premature capital account
liberalisation and financial regulatory disasters.

Catch-up and convergence will do the rest."

If we examine the Indian economy with respect to these ten attributes/tenets, the picture is indeed encouraging, especially if point 9 is taken care of. Points 1, 2, 4, and 5 are inherent and historical advantages. Points 3 and 6 are true reform achievements. Even point 7 is being addressed. This leaves us with the real concerns - points 8 and 10.

All our immediate (inflation) and long term (growth prospects and convergence growth pace) macroeconomic challenges are closely linked with infrastructure. This is all the more so since infrastructure forms the basic platform that underpins the growth of the modern economy. We need to plan, design, raise resources and execute massively in all infrastructure sectors. And even if we mobilize the resources and show the requisite commitment to conceptualize and create infrastructure, the greater challenge is to ensure that we do not blow it up.

Here I am not worried about macroeconomic mismanagement nor financial market problems nor even corruption or internal conflicts. All these dangers always lurk around the corner and will even explode once a while, but when seen in historic perspective and when analyzing growth prospects over half-century, they are all surmountable, especially for a continental economy like India. A real worry will be with picking up the pieces from the "populist assaults on the incentives to work, save and invest". I will come back and post on this in the days ahead.