7 Social Protection, Labor Market Rigidity, and Enterprise Restructuring in China

Ke-young Chu, and Sanjeev Gupta
Published Date:
April 1998
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Zu-liu Hu

An unpleasant trade-off facing policymakers in economies in transition is how to reconcile market efficiency and social protection. These economies have inherited from the central planning era a large, inefficient state-owned sector, which employed the bulk of the total labor force. During the process of transforming these state-owned enterprises into competitive, efficient, profit-oriented firms, many of the existing workers, who have been taking lifetime employment for granted, have suddenly confronted the risk of losing their jobs. In the absence of an adequate social safety net, high unemployment can cause enormous economic hardship to the vulnerable, as well as a strong backlash against market-oriented reforms.

China started its economic reform in the late 1970s.1 The initial phase of the reform, which abolished collective agriculture—the People’s Communes—and reestablished the family farming system was remarkably successful. At the beginning of the urban industrial reform, however, China realized that it was a far more difficult task than rural reform. A key difference between rural and urban areas was the different labor market structure. The family farming system granted farmers complete freedom in job choice, labor supply, and decisions concerning saving for old age. Responding to market signals, farmers could move freely from traditional farming to rural-township and village industries, or to construction and other tertiary sectors in cities. They were outside China’s formal social safety nets even before they were liberalized from collective farming, so they were not bound by the cradle-to-grave socialist welfare system that applies to the urban, state-owned sector. By contrast, there was no such labor market flexibility in China’s state-owned sector. China’s state-owned sector played a dominant role prior to reforms, especially in China’s highly centralized urban economy, accounting for 77 percent of China’s gross industrial output, and employing 78 percent of the total urban labor force in 1978 (Tables 7.1 to 7.3). If the government was to impose the same kind of market discipline and hard budget constraint on state-owned enterprises, some enterprises would have to be closed down and their employees would lose their jobs. The government, although committed to market-oriented reforms, was not prepared to accept massive unemployment and the associated social and political risk. In the end, China took a cautious and gradual approach to enterprise reforms. The objective was to strike the right balance between improving enterprise efficiency and minimizing the social cost of restructuring. Over the 1980s China introduced, in a piecemeal fashion, measures to reform its labor market and social security system. It is only in the early 1990s, however, with appropriate market and social infrastructure already in place, and with the accumulated experience of more than a decade of trial and error with urban reform, that China began to launch full-scale enterprise reforms. While these initiatives have yet to demonstrate their full impact and effectiveness, the outcome so far has been encouraging.

Table 7.1.China: Role of the State Sector in Urban Employment(In tens of thousands of workers)
YearTotal Urban Labor ForceState SectorCollectivesIndividual Businesses
Source: Chinese authorities.
Source: Chinese authorities.
Table 7.2.China: The Evolving Role of the State and Nonstate Sectors(Percentage share of total gross industrial output)
YearState-Owned SectorNonstate Sector
Source: State Statistical Yearbook of China (Beijing, 1993).
Source: State Statistical Yearbook of China (Beijing, 1993).
Table 7.3.China: Changing Distribution of the industrial Labor Force in State and Nonstate Sectors(Percentage share of total industrial workers)
YearState-Owned SectorNonstate Sector
Source: State Statistical Yearbook of China (Beijing, 1993).
Source: State Statistical Yearbook of China (Beijing, 1993).

China’s experience, consistent with those of other reforming economies, suggests that, without removing rigidities in the labor market, the social and economic costs of necessary enterprise restructuring in terms of unemployment may be too high to be politically sustainable. Reforming the social safety net is crucial to increase labor market flexibility and to pave the way for transforming the state-owned sector.

Barriers to Enterprise Reform

The literature on economies in transition tends to emphasize that the main problem with state-owned enterprises in these economies lies in their public ownership and the associated inefficiency, and thus advocates rapid privatization as the panacea. A closer examination of China’s prereform conditions and experience, however, suggests that the traditional labor market structure and social security system may be even more important barriers to enterprise reform.2

Wage Setting and Employment in the State-Owned Sector

Under the traditional employment system in China, the state simply assigned workers to enterprises. Since state-owned enterprises were obligated to provide jobs, and hiring decisions had no relation to their labor demand, firing was virtually nonexistent. The result was over-staffing in most enterprises. Similarly, potential job market entrants had no need to look for jobs. Although the state attempted to match a worker’s skills to his job assignment, this administrative matching, like the rest of central planning, did not work well. Wages, like commodity prices and interest rates, were set by the state and usually fixed for long periods of time. There was little sectoral variation in compensation across industries and professions. Base wages were entirely determined by seniority, and total compensation did not correspond with work effort. Since pay was not linked to performance, workers had little incentive to increase productivity.

Enterprise as Provider of Social Protection

State-owned enterprises were obligated to provide their workers with a range of social services, including housing, pensions, and medical insurance. Unlike in the developed market economies, the social security system in China was based on individual enterprises. There were three pillars of social protection in China: guaranteed job security, subsidized housing, and pension benefits.

Guaranteed job Security

Once a worker was assigned to an enterprise, from day one he was guaranteed lifetime employment. The system of lifetime tenure may have achieved an important social function, but it also had adverse consequences on enterprise efficiency. Instead of encouraging corporate loyalty, synergy, and greater work effort, as, arguably, occurred in Japan, the system of lifetime employment in China may have actually distorted work incentives and decreased work effort, owing to the so-called iron rice bowl effect. What was lacking was a competitive external environment and a rational wage structure. In China, the fixed, uniform wage-setting policy severed the link between pay and performance. Extreme egalitarianism failed to motivate workers.

Guaranteed Housing

Enterprises were responsible for providing their employees with accommodation, usually at subsidized rents. Since housing was constructed and owned by the firm, it was impossible for a worker to keep his house should he, in the unlikely event, switch jobs to a different firm. Based on survey data, a study by this author shows that in China’s big cities, housing was the single most important determinant for a worker, given a choice, to accept one job over another.3 Since housing constituted such an important part of a worker’s remuneration package, he had an aversion to losing it. Therefore, nonportable housing benefits offered to a worker may also have forced him to get stuck with a particular firm. It is estimated that the annual job turnover rate in Chinese cities is less than 1 percent, and the mobility of nonagricultural households is estimated to be less than 4 percent, compared with an annual mobility rate of 10–20 percent in Korea.

Pension Benefits

Enterprises were also responsible for income maintenance for their own retirees. The expenditure on retirement benefits was financed by the firms’ current revenues rather than by past or current contributions. China’s older industrial firms tended to have a much heavier burden of retirement outlays because they had more retired workers to support. Like housing benefits, pensions were paid by individual firms and were therefore nontransferable.

Other social benefits provided by China’s state-owned enterprises included:

  • free medical benefits;
  • liberal sick and maternity leave policy;
  • day care and schools;
  • library, sports, and entertainment facilities; and
  • subsidized food and other consumer goods.

The traditional system of social protection had, therefore, tied workers to the firms that employed them. Enterprise-based, nontransferable social security benefits, together with fixed wage setting and a system of permanent employment that relied on administrative job assignment, created substantial labor market rigidity in China. These characteristics of China’s employment and social security systems discouraged labor mobility by adding fixed adjustment costs, and led to a substantial loss of efficiency in the state-owned sector.

China’s unique “city residence registration” (Hu-Kou) system effectively eliminated labor mobility between rural and urban areas. Millions of well-educated rural youth had been denied opportunities to work in the modern industrial sector, leading to underutilization of a sizable stock of China’s human capital. Within the state-owned sector, the lack of labor mobility may also have caused further efficiency costs because of widespread mismatch between workers and jobs.

Although the social benefits offered by state-owned enterprises to their workers were both extensive and generous, a critical program was missing from the old system—there was no unemployment insurance. While it was not needed in China’s old system of guaranteed job security, the lack of such insurance has become the major obstacle to enterprise restructuring. Without this important social protection system, market-oriented reforms would inflict poverty and human suffering on the jobless, resulting in the loss of public support for economic reform.

Linkages Between Labor Immobility, Social Protection, and Enterprise Reform

The surge of rural industry and private business in China during the last decade has put strong competitive pressures on the state-owned sector. In recent years, a third of state-owned enterprises (SOEs) have been loss-making. Financially troubled SOEs have suddenly found themselves facing the threat of bankruptcy and reorganization. Public enterprises are struggling to shoulder the social responsibility for their workers, and at the same time to survive competition from a fledgling but dynamic private sector.

Why does the labor market matter for enterprise restructuring? Is not a change of ownership and control, say, through privatization, all that is required to revitalize China’s ailing state sector? Clearly, in China’s new competitive environment, a leading reason for SOEs to lose ground is that they have high costs. With gradual price decontrol and increased autonomy in making production and investment decisions, the profitability of SOEs becomes increasingly dependent on their cost structures. There is no noticeable difference in the net cost of capital between SOEs and China’s rural and township enterprises (TVEs).4 SOEs, however, have substantially high labor costs caused by overstaffing and the heavy burden of providing social benefits to their workers. To improve the economic performance of China’s state-owned sector, a first step would be to relieve SOEs of the burden of social services and to increase labor market flexibility.

A comparison of SOEs and TVEs illustrates the importance of labor market reform. Like SOEs, and contrary to the misconception held by some Western economists, China’s TVEs are not strictly privately owned; rather, most are owned and controlled by local governments or collectives. While there exist a host of factors that can help explain the success of TVEs, a chief advantage enjoyed by them is the flexibility of the rural labor market. Almost all TVE workers are short-term contractual employees or seasonal laborers who receive no permanent job guarantee. Wages are flexible and market-determined. There is a close link between pay and performance, so workers are well motivated and productivity growth is high. Firms’ hiring decisions depend entirely on their demand for labor. They can readily adjust the size of the workforce to changing market conditions. Unlike SOEs, these TVEs provide few social services directly to their employees. In particular, the provision of housing is optional because workers of TVEs are ex-farmers and already own their homes. By contrast, the traditional social security system inhibits enterprise restructuring because it prevents labor mobility and produces a lock-in effect on employment.

The external factors faced by China’s SOEs and TVEs—taxes, regulations, and macroeconomic conditions—have gradually converged over time since economic reforms began. One area that remains strikingly different, however, is the labor market structure. The differences in employment, wages, and social security system may be among the factors that help explain the contrasting economic performance of the state-owned sector and township and village enterprises.

Enterprise-based, nontransferable social security benefits, guaranteed lifetime employment, and the absence of a public unemployment insurance program have presented substantial risks and large opportunity costs associated with adjustments in the labor market. This system of social security has led to overstaffing and high labor costs in most state-owned enterprises, and adversely affected their profitability. If excess labor in the state-owned sector cannot be released and absorbed into the private sector, then China’s strategy of commercialization without privatization for reforming SOEs will stand little chance of success.

Chinese Experiments with Social Security and Labor Market Reforms

In contrast to the sweeping rural reforms introduced and implemented in 1978 and 1979, and the dramatic foreign trade and investment reforms of 1983 and 1984, China’s enterprise reforms have been slow and late. The stop-and-go pattern was indicative of the hesitation of the Chinese leadership about reforming the state-owned enterprise sector. Although the government may have been reluctant to give up its commitment to the dominance of public ownership in China’s economy, a more important reason for the delay has been the deep concern about massive unemployment and social instability likely to be caused by drastic enterprise reform measures. Apparently, the government has concluded that the social and political costs were too high to attempt a “shock therapy” approach to China’s state-owned sector.

This cautious, gradual approach to enterprise reform may have brought about some unexpected benefits. For one thing, China has had ample time to experiment with and carefully evaluate various reform proposals in a few selected enterprises and several designated cities. Through slow-paced trial and error, valuable lessons have been learned and experience gradually accumulated. Without guidance of any formal theory, a practical strategy has nevertheless emerged—to start with labor market reform and social security reform—so that the necessary conditions, including legal and institutional requirements, can be created to support full-fledged enterprise reforms.5

Reform of the Wage System and Employment

An area identified as one of the first targets of reforms was the irrational wage system in the state sector. The Chinese authorities were convinced that some changes in the rigid, egalitarian wage policies were long overdue and making these changes could generate immediate efficiency gains without incurring big social risks. The reform measures emphasized improving work incentives within state-owned enterprises. Wage policies were allowed to be more flexible, and bonuses, once condemned as capitalist, were introduced in 1978 as a component of workers’ total compensation. SOEs were granted discretion in determining the amount of bonus to be paid to individual workers, and were encouraged to link pay to workers’ performance. Wage gaps were permitted to widen, reflecting job performance differentials as well as workers’ seniority. Concerned about general wage inflation under the more flexible wage system and the weak relation between firms’ wage growth and productivity growth, the government introduced in 1984 a system of aggregate wage controls, which linked the total sum of wages and bonuses an enterprise is entitled to distribute to its employees to certain performance indicators such as gross profits or sales volume. Recently, the Chinese authorities have attempted to further liberalize direct control over total wages. The goal is for the government to play only a supervisory role in the future.6 Trade unions, which traditionally have been inactive in the wage-setting process, will be given a role as the workers’ representative in negotiations with SOE management over remuneration and work conditions.

Since the mid-1980s, SOEs have been gradually given more hiring autonomy. An important step leading to greater labor market flexibility was taken in 1986 when the “labor contracting system” was introduced, under which all new employees in SOEs would be hired on a contractual basis for a period usually lasting from three to five years. The introduction of labor contracts marked a shift from permanent jobs to more flexible “contracting,” breaking away from the tradition of lifetime tenure. In contrast to the obligated permanent job offers in the past, these hiring contracts do not guarantee automatic renewal or job extension when they expire. With a finite duration of employment, workers face the risk of joblessness and tend to work harder to stay on the job. Managers find it easier to monitor workers’ performance, and appropriately reward or punish workers according to their performance. SOEs are, therefore, given considerable discretion in selecting employees and in making retention decisions upon expiration of labor contracts.

By 1992, the number of contract workers (He Tong Gong) in the state-owned sector had risen to 21 million, accounting for 19 percent of the total workforce in the state-owned sector (Table 7.4). The proportion was larger for state-owned industrial enterprises, with contract workers accounting for 27 percent of total workers in 1992. In Shanghai, contract workers accounted for 33 percent of total workers in the city’s combined state-owned sector. As a complement to the labor contracting system, a labor arbitration system is being developed to resolve labor disputes. To replace gradually the old system of administrative job assignment by the government bureaucracy, numerous employment agencies, such as labor service companies, are being established in Chinese towns and cities to help place first-time job seekers in the labor force.

Table 7.4.China: Percentage Share of Contract Workers in Total Workers
YearTotal Urban Labor ForceState SectorCollectivesIndividual and Foreign Businesses
Source: Chinese authorities.
Source: Chinese authorities.

Even more significantly, managers of SOEs have been granted the legal authority to lay off redundant or incompetent workers. In practice, however, it is rare for managers to exercise their power to dismiss workers. Rather, they tend to feel morally obligated to keep unsatisfactory workers employed, and make efforts to reassign workers with poor performance to less important or lesser-paid positions. Instead of laying off all redundant workers, manufacturing enterprises have sought to create service-oriented subsidiaries to reemploy those workers.7 In general SOEs still have the social responsibility to maintain jobs. Laying off workers is considered only as a last resort to improve efficiency and profitability. It remains to be seen how far China is willing to go to accept more unemployment as market forces may dictate.

Introduction of a Bankruptcy Law

In 1986, China enacted a bankruptcy law, the first ever in the history of the People’s Republic, which came into effect in 1988.8 The bankruptcy law has just begun to play a significant role in providing a set of incentives to managers to improve enterprise performance and allocate business risks among interested parties. In the immediate ensuing years, however, few actions were taken to apply the bankruptcy law to financially troubled state enterprises. Mainly because of concern for the implication for unemployment, the government was reluctant to allow the bankruptcy law to be fully implemented. Instead, the government intervened to bail out troubled firms by injecting cheap credit and subsidies, writing off or assuming their debt liabilities, in cases where losses were caused by policy factors, such as price controls. For those unprofitable firms whose financial losses were mainly due to poor management, the government would reshuffle management and force a reorganization by arranging a merger with another better-performing state enterprise.9; As more SOEs became unprofitable and debt-ridden, which demanded huge increases in government subsidies and widened the government fiscal deficit, the Chinese authorities have become more willing to let loss-making state-owned enterprises go bankrupt. In 1992, the People’s Courts handled 2,685 bankruptcy cases nationwide, a 365 percent increase since 1991. A large number of those that failed were state-owned. In the coming several years, the Chinese government plans to lift subsidies and all the special protection measures for SOEs so that SOEs become fully responsive to market forces. At the same time, measures will be taken to ensure management autonomy and rights of state-owned enterprises. While some SOEs may eventually succeed in adapting to China’s increasingly competitive, market-oriented economy, other SOEs are expected to fail the test, and more bankruptcies are likely to follow.

A constraining factor in China for applying the bankruptcy law, protecting enterprises’ autonomy in both hiring and firing decisions, and imposing hard budget constraints on SOEs was the lack of an adequate social safety net for displaced workers. As noted above, the traditional social protection system in China was enterprise-based, which locked workers into their workplaces. Over time, this constraining factor has become a severe obstacle to the restructuring of China’s state-owned enterprises. Increasing labor market flexibility, a necessary condition for the transformation of the state-owned sector, entails overhauling China’s social security system. With the introduction of the labor contracting system, provisions had to be made for the transfer of retirement benefits, because a worker could no longer rely on being attached to one enterprise throughout his or her working life. Provision also had to be made for income support for those workers whose contracts were denied renewal and who were unable to find new jobs quickly.

Establishment of Unemployment Insurance

To facilitate the needed trimming of the redundant workforce in the state sector, and implementation of the bankruptcy law, the role of social unemployment insurance is critical. The package of labor market reforms introduced in 1986 included the establishment of an unemployment insurance (UI) scheme as a natural complement to the labor contracting system. The main elements of the unemployment insurance legislation are closely linked with the proposed labor market reform measures. The legislation addresses eligibility criteria, benefit levels, funding, and administration. Workers eligible for unemployment benefits include (1) workers of bankrupt enterprises; (2) workers made redundant by near-bankrupt enterprises during reorganization; (3) contract workers whose contracts have expired or been canceled; and (4) workers dismissed for disciplinary reasons. The eligibility criteria are thus compatible with the structural changes in China’s labor market and overall economy. The UI legislation sets a two-year duration for benefits and a nominal replacement ratio of up to 75 percent of standard earnings.10 Enterprises are required to contribute 1 percent of their payroll to UI funds. The UI scheme has the feature that the funds may be used to finance job training and job creation programs administered by local labor bureaus and their affiliated labor service companies, which have the mandate to assist new entrants, and more recently, job losers, in identifying employment opportunities.

Since the unemployment insurance is established as social insurance rather than an employer-liability program, it is mainly administered at the city- and county-government level, not at the enterprise level. There have been several attempts in China to establish pooled unemployment insurance programs at the provincial level, further moving away from enterprise-based social protection. The regulations on Unemployment Insurance for State Enterprises Employees were enacted in April 1993, and provide for the establishment, management, and operation of unemployment insurance funds. The UI program, as contained in the existing regulations, covers only the state-owned enterprise sector. In some cities, such as Shengzhen and Qingdao, which have moved furthest on reforms, UI has been extended to cover temporary and self-employed workers and workers in joint ventures and foreign-funded enterprises. The government’s goal is to expand the coverage of the unemployment insurance system in the near future. In particular, unemployment benefits will be provided to all the involuntarily unemployed regardless of cause, and coverage will be extended to employees in collectively owned and foreign enterprises nationwide, It would be most desirable for China to extend the UI coverage to employees of TVEs and private businesses as well, whose share in the total workforce has surged over the last decade.

The timely introduction of unemployment insurance has introduced a critical program into China’s social safety net, facilitating the release of “excess workers” from the overstaffed state sector, and helping to contain the social and economic costs associated with transformation to a market economy. During the first three years since the inception of the UI programs, there were annually an average of 30,000 workers who claimed UI benefits. This number more than tripled in 1990 and 1991, with the deepening of labor market and enterprise reforms. About 200,000 SOE workers in 1992 benefited from UI programs. The number of UI recipients have been so far quite small relative to the total workforce in China’s state sector. But this number may start to rise in the next decade, depending on the current extent of “surplus labor” in the state sector, the proposed extension of UI coverage, and the growth prospects of the Chinese economy.

Housing Reform

Transforming state-owned enterprises into autonomous operating economic entities also requires development of alternative means of providing for the housing of their employees. The obligatory provision of employee housing by SOEs has not only created labor market rigidity, but also added a heavy social burden to SOEs in comparison to their private sector counterparts, such as township and village enterprises and foreign-owned enterprises. Since the late 1980s, China has made some limited progress in housing reform. A consensus has been reached that the provision of housing is not an essential function of state enterprises or government and that it could be better carried out by the private sector. The initial reform measures comprised upward rent adjustments aimed at reducing the housing subsidy in the state sector. More recently, the focus of reform has shifted to privatizing the public housing stock by selling housing units to state employees. Several legal developments, including the 1988 amendment of the Chinese Constitution, the revision of the 1986 land law, and national regulations concerning urban land use, land transfer, and property rights, have had a positive impact on the development of the real estate market in China. As widely recognized, these legal developments are necessary to replace enterprise provision of housing to workers with a market-based delivery of housing. Real estate development companies have been forming rapidly in the past several years; and have been involved in constructing and selling residential property to Hong Kong residents and Taiwan investors. Although the number of domestic customers who purchase residential housing has been growing, these buyers tend to be China’s nouveau riches—prosperous private businessmen. Selling housing units at market prices to SOE employees has proven more difficult because of their low wage income and the lack of home financing. In some cities municipal housing funds have been set up—to be funded from the issue of savings bonds and proceeds from the sale of the existing state-owned housing stock—for the construction of affordable housing for urban residents in general and SOE employees in particular. Mortgage financing companies are also being established, with the pension funds as the primary source of funding.

Development of the Service Sector

China’s rapidly expanding private sector has in fact presented opportunities for restructuring the state-owned enterprises through the creation of new jobs and the development of a housing market. These factors help to mitigate the lock-in effect in China’s labor market because released surplus labor is quickly absorbed into the fast-growing private sector and housing becomes better available to new employees and transferred or relocated workers.

As part of the solution to the problem of excess workers in SOEs, the government has attached great importance to the development of the tertiary sector, which in 1992 employed fewer than 20 percent of China’s total labor force and accounted for about 28 percent of GNP. This sector is generally more labor intensive than manufacturing and is viewed as having great potential for absorbing surplus labor in the state sector. In July 1992, the government published its “Decisions on Expediting the Development of the Tertiary Industry,” which spell out a set of policy measures to boost the service sector, including transforming state-owned tertiary enterprises into profit-oriented businesses, decontrolling prices and offering credit and tax incentives. A policy measure of special importance is to encourage civil servants in government organizations and workers in SOEs to resign and establish private businesses in the service sector.11 The government hopes that in the remainder of the 1990s the service sector will generate a large number of new jobs, essentially playing a role similar to that played by the township and village enterprises in absorbing the surplus labor in the rural area during the past decade.

Relaxation of Restrictions on Migration

Other initiatives to increase labor market flexibility in China include relaxation of restrictions on migration of rural labor to cities. Temporary city residence permits are issued to allow rural labor to provide a wide range of services in urban areas. Restrictions on regional mobility are being gradually lifted for university graduates and professionals. In recent years the government has also emphasized the role of training. The Ministry of Labor and its local labor bureaus, as well as enterprises themselves, have established numerous training centers, retraining programs, and technical and vocational schools to improve workers’ skills and adaptability to the changing labor market.

Pooling of Pensions

A key objective of social security reform in China is to relieve individual enterprises of full, direct responsibility for their workers’ retirement pensions by establishing funds that pool resources and risks among enterprises and across regions. Experimentation with pension pooling began in 1986 in several cities, including Shanghai and Shenzheng. In recent years, retirement funds have been established at the municipal level in most cities and some at the provincial level. Employers and employees are required to contribute a certain percentage of the payroll toward these funds.12 These mandatory retirement funds are generally modeled on the Central Provident Fund of Singapore. Retirement pension pooling has eased the financial burden on many state enterprises of supporting the growing number of retirees. Pension pooling has also helped maintain workers’ retirement benefits when changing jobs and, hence, improved the conditions conducive to greater labor mobility.

Table 7.5 suggests that the transition to a market economy in China has not sparked high unemployment. The officially measured urban unemployment rate stood at 2.3 percent in 1992, and the number of the unemployed in urban China actually declined from 5.3 million in 1978 when the reform was commenced, to 3.6 million in 1992. First-time job seekers, consisting mainly of recent secondary school graduates, accounted for about 80 percent of the total urban unemployed. While a variety of factors, including strong economic growth and budgetary subsidies to keep unprofitable SOEs afloat, have so far prevented massive urban unemployment in China, increased labor market flexibility has also clearly played a positive role in keeping the unemployment rate low.13

Table 7.5.China: Economic Growth and Unemployment
YearTotal Urban Unemployed (10,000)In Which: First-Time job SeekersShare of First-Time Job SeekersGNP Growth RateUrban Unemployment Rate
(In percent)
Source: Chinese authorities.
Source: Chinese authorities.

As China’s social security reform continues, it is important to establish a system of social protection for all employees regardless of the ownership structure of their employer, hence achieving greater social equity and a “level playing field” among enterprises of different ownership in China’s socialist market economy.

The Chinese authorities have noted the necessity of transferring social responsibility from enterprises to the government. The new fiscal reform measures, introduced at the beginning of 1994, aim at enhancing the role of the government in social protection and other social services such as education and health care. However, the tack of clear assignment of fiscal responsibilities among different levels of government in China presents risks to transferring government functions from enterprises to the appropriate levels of government.14 Currently, for instance, it is the subnational governments—provincial and, most important, municipal—that are responsible for the financing and administration of both retirement funds and unemployment funds. The stated goal, however, is to establish a unified national social security system encompassing old-age pensions and unemployment insurance at the central government level.


Labor market rigidity induced by traditional social protection mechanism creates barriers for enterprise restructuring and privatization in economies in transition. Lessons from many of these countries’ experience suggest that increasing labor market flexibility through social security reform is necessary to meet the challenge of making a smooth transition to a market economy.

In the past decade, China has made some important progresses in reforming its social security as well as the wage and employment systems, These developments have substantially facilitated labor mobility, helped protect workers’ well-being, and helped sustain social support for economic reforms. China still faces formidable risks and challenges, however. Much more remains to be done to transform China’s state-owned sector and to deal with the threat of potentially large unemployment in rural as well as in urban areas. Nevertheless, with the emergence of a strong, dynamic private sector, and the gradual creation of conditions favorable to reforms, China should now be relatively well poised to launch full-fledged enterprise reforms.

Note: Originally issued as IMF Paper on Policy Analysis and Assessment 94/22 (Washington: International Monetary Fund, 1994).


For reviews on China’s experience with economic reforms, see Perkins (1988), Blejer and others (1991), and Bell, Khor, and Kochnar (1993).


For a survey on China’s evolving social security system, see Ahmad and Hussain (1989).


SOEs in China do face higher nominal tax rates than TVEs. The effective tax burden on SOEs, however, is unlikely to differ substantially from that on TVEs, considering SOEs’ easy access to soft “policy loans” and to government budgetary subsidies.


Most of the enterprise reform initiatives to date have aimed at improving the incentive structure for both SOE managers and workers and removing labor market rigidities. The reform measures in China are vividly characterized as smashing three “irons”: (1) “iron rice bowls” (guaranteed job assignments, pay, housing, pension, medical, and a host of other benefits for SOE workers); (2) “iron chairs” (permanent job positions in permanent state enterprises, with no layoff or bankruptcy risk); and (3) “iron wages” (uniformly distributed, fixed wage payments that are not linked with job performance and productivity).


In July 1992, the Chinese government issued the “Regulations on Transforming the Operating Mechanism of State-Owned Enterprises,” with the intention of putting into effect the “Enterprise Law” enacted in 1988. These regulations specify 14 management rights that would henceforth be exercised by the state enterprises. Three of these clearly defined rights pertain to the labor market: the right to assign labor, the right to have personal management, and the right to set wages and bonuses.


China Daily (July 12, 1993) reported that China’s giant state-owned metal company, China National Nonferrous Metals Industry Corp., planned to slash 330,000 jobs over the next several years. However, few if any of the workers to be laid off will actually end up jobless because they will simply be transferred from the company’s core business, metalworking, to other newly established, job-creating service subsidiaries.


For an excellent summary of the evolving legal framework for enterprise reform in China, see Lichtenstein (1993).


Leasing and privatization have also played an increasingly important role in recent years. Many state-owned department stores and other stores, for example, have been leased out to private individuals. In many cities, foreign investors are allowed to bid and restructure existing unprofitable state-owned enterprises.


Standard earnings are defined as the claimant’s average monthly standard wage over two years before his or her unemployment.


The Chinese press describe the voluntary exodus out of the state sector to the private sector by using a colorful phrase, “Xia Hai,” meaning “plunging into the sea (of commerce).”


In Shanghai, for example, the contribution rates by both enterprises and workers are set at 5 percent of the wage bill.


Paradoxically, in spite of the rapid development of rural TVEs, the problem of rural unemployment may have become more acute. The fast growth in agricultural productivity and relaxed restriction on migration of rural labor to cities have produced a large pool of rural unemployed labor.


For a discussion on issues and options for reforming social expenditure assignment in China, see Hu (1995).


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