Unemployment and SMEs: Two Worries For 2009 (CKGSB Part III)

Last Wednesday, I attended a discussion of China’s economy in 2009, sponsored by the Cheung Kong Graduate School of Business (CKGSB) in Beijing and featuring Jing Ulrich, managing director and chairman of China equities for J.P. Morgan, and Yijiang Wang, professor of economics and human resource management at CKGSB. In a lively discussion, the panelists expressed somewhat different views on what we might expect to see in 2009. Jing is optimistic that China’s economy will begin to recover in the second quarter, due primarily to the aggressive fiscal and monetary measures being implemented by the government. Prof. Wang isn’t so sure. He worries about growing unemployment and labor unrest; is skeptical about large infrastructure spending; and does not believe that China is doing enough for the country’s small and medium-sized enterprises (SMEs).

Prof. Wang’s assessment of China’s current economic situation is based on his analysis of what he describes as China’s four fundamentals: a huge labor force; a very high savings rate; a vibrant SME sector; and a powerful government.

In terms of labor, Prof. Wang believes that the “employment situation is severe.” China has a total workforce of 800 million that is 40 percent urban and 60 percent rural. Approximately 150 million migrant workers work in the cities, with another 150 million expected to move from the countryside over the coming years. As many as 10 million people enter China’s workforce each year, and 10 million college graduates are currently in need of a job. Yet, China’s economy only creates six to eight million new jobs every year. That is why China watchers always say that China needs at least 8 percent growth to maintain social stability.

In view of this daunting employment challenge, Prof. Wang is concerned that the country’s SMEs, which in his view are the backbone of China’s economy, are not receiving sufficient support from the government. According to his research, SMEs account for 99 percent of the total number of firms in China; 60 percent of the country’s GDP; 70 percent of employment; 65 percent of the patents filed each year; 60 percent of exports and 50 percent of tax revenues. Despite this large contribution to the Chinese economy, SMEs only use 20 percent of China’s financial resources. Per yuan of investment, they are eight to 10 times more efficient than China’s large companies in creating jobs and four to six times more efficient in generating GDP. (Although there is no precise definition of what exactly constitutes an SME, Prof. Wang said that companies with less than 20 million yuan of revenues and 200 employees would certainly fall into this category.)

Of China’s much publicized 4 trillion yuan (US$586 million) stimulus package, almost 90 percent is dedicated to infrastructure investments. 45 percent will be spent on railways, highways, airports and power grids; 25 percent is allocated to post-disaster reconstruction; 9.3 percent to rural development and infrastructure projects; and 8.8 percent to the ecology and the environment. Prof. Wang believes that the principal beneficiaries of this large amount of infrastructure spending will be China’s large companies, not the country’s SMEs.

Moreover, Prof. Wang argues, SMEs have been hit particularly hard recently by tight money, heavy taxes and fees, a new labor law and international shocks like the global economic crisis. As a result, SMEs are closing in large numbers, causing lower class migrant workers to lose their jobs and return to their homes in the countryside, and middle class managers and workers to lose income. Apart from the potential for labor unrest, the loss of jobs and income are not positive for China’s efforts to increase consumption.

In Prof. Wang’s view, China’s high savings rate and the increasingly larger share of GDP being taken by government also work against increasing consumption. He estimates that China’s savings rate is 45 percent; notes that the Chinese do not live on credit; and worries that China’s government is already too big. In 1990, government tax revenues were only 10 percent of GDP. Today, they are approaching 25 percent.

In 2009, Prof. Wang believes that we should worry about jobs and the SMEs, and that we should watch government policies. He is not so sanguine that large infrastructure spending will produce the number of jobs required and he would prefer to see more support for the country’s SMEs. One policy he is advocating, for example, is to exempt SMEs from the new labor law.

Although I believe that Prof. Wang highlights some very important issues, I’m more positive about 2009. I believe the fiscal and monetary measures that the government is implementing will have a “trickle down” effect, benefiting both SMEs and large companies alike. For example, I picture thousands of companies making components for the wide range of machinery that will be used in the infrastructure projects, or, thousands of enterprises providing services to the workers as they help residents in Sichuan province rebuild their economy after the earthquakes of 2008. I also believe that it is in China’s best long-term interests to move away from its heavy dependence on exports and the labor-intensive, low value-added products that many SMEs manufacture. Unlike Prof. Wang, I would not advocate exempting SMEs from the new labor law. China needs to move to higher value-added products that can properly reward its workers and not pollute the environment.

However, I agree with Prof. Wang that the country needs to focus more on its SMEs. As he correctly points out, small companies are the largest sources of job growth in many economies, not just China’s. China’s capital markets need to develop to the point where they can recycle the country’s large savings pool more effectively and get more capital to the smaller, vibrant, fast-growing companies in its economy, not just the country’s large state-owned enterprises. Unfortunately, this is a long-term proposition that will take years to implement. In the meantime, China needs to rely on traditional fiscal and monetary measures to stimulate growth in the near term.

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