Segmentation of the labor market and inter-sectoral income inequality
Although the market plays an increasingly important role in resource allocation in China (Nee 1989, 1991, 1996), the state has never stopped to shape the market. How the state influences the market varies from time to time (Bian and Logan 1996; Rona-Tas 1994). China’s market-oriented reform takes a gradualist approach, and the introduction of the market mechanism varies largely according to factors such as geographic region, form of ownership, and industry (Xie and Hannum 1996; Li et al. 2016; Wang and Cui 2010; Luo and Li 2007; Wu 2011).
Yet, existing research neglects the current wave of economic globalization. These studies have not addressed how the global market influences the trajectory of Chinese reform. Given that China’s transition to a market economy unfolded in tandem with the country’s insertion into the global economy, it is critical to examine the mechanisms through which the economic globalization shapes China’s transition. As will be discussed later in this article, the current globalization sets a boundary for—and reshapes—what is considered as national interests. This will further influence government policies for the finance and the manufacturing industries, as well as their sectoral income level.
What is economic globalization?
Trade and investment are the most important and common economic activities. Economic globalization means that such activities are more frequently carried out across national borders (Lim and Tsutsui 2012). After the dissolution of the Bretton Woods System in the 1970s, the international financial regime has been characterized by the Dollar Standard System and the floating exchange rate system. These two systems constitute the foundation of the current global economic system. They also generated two important consequences, namely, global reorganization of the manufacturing sector and liberalization of the financial sector. Previously, under the Bretton Woods System, countries usually keep their manufacturing sector within their national boundary, because manufacturing exports were critical for balancing the country’s current account and controlling trade deficits. In contrast, currently, under the Dollar Standard System, countries must hold dollars and the US economy runs with debts. The USA seeks to manage its deficits by employing a variety of financial tools to finance from abroad. As a result, it became unnecessary to keep the manufacturing industry inside the USA territory.
The liberalization of the financial sector has not only generated huge profits for the financial capital but also created potential risks for open economies like China which heavily depend on the global market. First, if the country runs a trade deficit, its demand for US dollar will increase; hot money from the international financial market will flow in and out of the country and make huge profits. This can worsen the country’s deficit of US dollar and cause a liquidity crisis. Second, a trade surplus will push a country to purchase a large amount of debts and bonds denominated in US dollar, in order to maintain the value of its assets in foreign currency. When the bonds mature, a large amount of currency will enter the domestic financial market, which can increase financial speculations and generate huge risks. Third, international hot money can flow into China’s domestic market, disguised as foreign trade or FDI, which becomes another source of financial risks for the country. Fourth, China has accumulated an FDI stock of 1 trillion US dollars over the past decades. A withdrawal of the FDI may cause a liquidity crisis for the country.
The global competition in the manufacturing sector and the high risk of the financial sector are not only the basic characteristic of the current economic globalization; they also constitute the external condition for China’s market transition.
Monopolistic and competitive industries under economic globalization
China’s economic reform is characterized by its capacity to utilizing the resources and opportunities generated by globalization. Now China ranks No. 1 in the world in international trade. It is also the largest destination of foreign investment and the second largest source of foreign investment. Foreign trade, including exports and imports, represents China’s participation in the global market and competition. Foreign investment often pursues long-term interests in the economy of its receiving country and tends to produce for the local market. The size of FDI is a useful indicator to measure the competition and collaboration between foreign investors and Chinese enterprises, as well as its impacts on income distribution.
The economic globalization has expanded global competition and to a certain extent reduced the advantage of the income level of monopolistic sectors. Although monopolies are not totally free from competitions (e.g., the competition among China Mobile, China Unicom, and China Telecom), they are largely protected by their monopoly status. Notwithstanding, foreign trade and FDI introduced at least some pressure of competition from the international market to these monopolies. First, in the export industries, monopolies tend to suffer lower productivity and higher costs, and exporting companies must reduce labor costs in order to make their products more competitive. Second, the competition from imported goods affects the production and sales of the domestic industry and will reduce the wage rates in these industries. Third, some foreign or mixed capital companies are fortunate enough to enter a few monopolistic sectors, and their productivity and administrative capacity will also affect local state enterprises and lower the income level of those sectors.
For these reasons, this article proposes the following hypotheses:
Hypothesis 1: the degree of participation in economic globalization has a negative impact on the sectoral income level.
Hypothesis 1a: the larger the volume of foreign trade, the lower the average income level of the monopolistic sector.
Hypothesis 1b: the larger the volume of FDI, the lower the average income level of the monopolistic sector.
For competitive industries, the effects of economic globalization are often not significant. This is because although wages in some industries such as manufacturing may be suppressed by global competition, for many other competitive industries (e.g., food catering, the service sector), as their productivity is high, the global competition has minor effects on their average income level.
China’s manufacturing industry in the context of economic globalization
Foreign trade and FDI can often substitute each other (Zhang and Guo 2004). Foreign investment and foreign trade in China are largely concentrated in the manufacturing sector, particularly the labor-intensive industries (Jiang and Li 2010). Although machinery and electronic products have increased their share in the exports of the country, most of these goods are only assembled products with no original intellectual property right (Yuan 2010).
Two opposing positions exist among scholars regarding the relationship between foreign trade and the income level of the manufacturing sector. The first one, which is based on the theory of international trade, underscores the positive relationship between foreign trade and the income level of the manufacturing sector. According to this view, both parties involved in foreign trade can harness their comparative advantages and benefit from the trade. As China is labor-abundant but faces a scarcity of technology and capital, the country should export labor-intensive products and import capital-intensive goods. Because the Chinese manufacturing sector is still predominantly labor-intensive with a low technological level, non-skilled labor will see an increase in their wages, which will further raise the average income level of the manufacturing industry. Based on this idea, Xu (2003) predicted an improvement in income distribution after China’s admission into the World Trade Organization. Wei (2002) found that participation in the global economy particularly benefited the low- and middle-income groups, which would lead to an improvement in income distribution.
The opposing side contends that foreign trade is more likely to benefit skilled labor, technicians, and male workers, and thus will augment the income inequality between these groups and the non-skilled workers. Given that the manufacturing workforce in China is predominantly non-skilled labor, it is expected that foreign trade will hinder the wage increase for this sector (Feenstra and Hanson 1997).
The bulk of existing research on China identifies a positive relationship between income inequality and foreign trade and attributed this to the higher return on foreign trade to skilled labor and technicians. Empirical evidence suggests that foreign trade expands the income gap between skilled and non-skilled labor (Zhao 2003), technicians and non-technicians (Bao and Shao 2008), and between male workers and female workers (Liu and Li 2012), as well as urban residents (characterized by higher level of education and human capital) and rural residents (Zhao and Zhang 2013).
Scholars who focus on income find that the effect of foreign trade on wages varies with time. In recent years, foreign trade has a negative impact on the income level of the manufacturing industry, as well as the income level of the low- and middle-income population. In the late 1980s and early 1990s, foreign trade in the coastal region once created a large number of job opportunities and attracted migrant workers from the rural area of the interior provinces. The transfer of the redundant labor from the rural area to the urban area significantly raised the wage level of the manufacturing sector (Wang 2001). Data from recent years, however, suggest that this trend has been reverted. Data between 1998 and 2011 show that exportation did not significantly improve the wage level of the manufacturing sector (Bao et al. 2011). Another household survey (1998–2001) reveals that foreign trade has widened the income inequality in China since the country’s admission into the WTO (Han et al. 2012).
Students of globalization argue that wages in the manufacturing sector are suppressed due to the competition among developing countries in the global market. In the context of economic globalization, enterprises in these countries not only have to compete with domestic companies but also with those in the global market. The pressure of international competition urges companies to reduce labor costs and to engage in the so-called race to the bottom (Guan 2002). Following China’s admission into the WTO in 2001, Chinese companies compete in the global economy in a broader and deeper way. As a result, wages in the manufacturing sector are suppressed, as cost control became particularly important for manufacturers which seek to export their products to the global market.
Importation also has a negative effect on income. Since the country’s admission into the WTO, China has significantly reduced its trade restrictions, such as tariffs, import quotas, and other non-tariff trade barriers. These factors combined to increase the country’s imports. As many of the previous trade restrictions aimed to protect the products that advanced industrialized countries had advantages over China, such as automobiles and electric equipment, an increase in imported products was a heavy blow to these industries and caused widespread bankruptcies and massive layoffs (Hai 2001). The increase in the unemployment rate also has a negative impact on the wage level of the manufacturing sector.
In sum, researchers who focus on comparative advantages tend to emphasize the positive effects of foreign trade on the wage level of the manufacturing sector. Those who focus on human capital (skilled versus non-skilled workers), technological innovation, and market competition tend to agree that foreign trade suppresses the wage level of the manufacturing sector. Based on these viewpoints, this article proposes the following hypotheses:
Hypothesis 2: the level of foreign trade has a significant impact on the average income level of the manufacturing sector.
Hypothesis 2a: Based on theories of comparative advantages and international trade, the higher the level of foreign trade, the higher the average income level of the manufacturing sector.
Hypothesis 2b: Based on theories of competition and human capital, the higher the level of foreign trade, the lower the average income level of the manufacturing sector.
As scholars disagree over the nature of foreign capital, they also have different views over the effect of FDI on wages.
The mainstream economist argues that “capital is capital,” which is free from the influence of power structure or social relations. Thus, whether the capital is national or foreign should have no effect on income distribution. It is expected that the influx of foreign capital can create jobs and increase the wage level of the manufacturing sector. Data from Mexico in the period 1990–2000 show that foreign capital raised the income level of the working class (Jensen and Rosas 2007). There are two mechanisms through which foreign capital affects wage level: first, foreign enterprises will bring a large amount of capital, which makes capital less scarce. This will reduce the economic return on capital and raise the return on labor. Second, labor-intensive enterprises harness the comparative advantages of the developing countries, create jobs for non-skilled workers and raise their income level.
Modernization theories also agree that, in general, foreign capital from developed countries can raise the wage level of various economic sectors (including the manufacturing industry) and promote modernization in underdeveloped countries. Even though developing countries must suffer some temporary pain during their transition to modernity, they are expected to eventually achieve the same living standard of developed countries (Kentor 2001).
Most sociologists oppose to this viewpoint. They disapprove the argument of capital is capital, contending that the inflow of foreign capital is carried out in a set of power relations. The inflow of foreign capital alters the industrial structure of the receiving country and suppresses wage level. In opposition to economists’ argument on the positive relationship between foreign capital and wage level, dependency theorists distinguish the short-term and long-term impacts of foreign capital. They argue that although in the short term, foreign capital can create jobs and reduce the scarcity of capital, in the long term, the influx of foreign capital can distort the economic structure of the receiving country, often in favor of external sectors such as mining and manufacturing (Dixon and Boswell 1996). These external sectors may have achieved a certain level of development. However, as the foreign capital seeks to maximize profits, it has little incentive to expand investment or contribute to tax revenues or infrastructure development in the host country. Moreover, it has a strong incentive to maximize profits by reducing labor cost (Curwin and Mahutga 2014).
The world system theory underscores the geographic division of labor between developing and developed countries. This theory views the domination and exploitation of developing countries by developed countries as the source of low wages in developing countries. In this system, whereas developed countries (referred to as “core countries”) are specialized in producing high-tech products, developing countries (referred to as “periphery countries”) are specialized in providing raw materials and labor-intensive products. Developing countries are forced to remain at the lower end of the global production chains (Wallerstein 1974). The fact that foreign capital is only interested in maximizing profits leads to the low wage level of the external sectors in developing countries.
In theory, FDI may have some positive externalities and stimulate technological innovation in China, which may further lead to higher productivity and higher wages. However, empirical research shows that the main effects of FDI in China are capital accumulation. The industrialization in China is still mainly driven by the simple expansion of investment (capital-driven, instead of technology-driven). The role of FDI in technological progress in China is only marginal (Li and Zeng 2009).
In sum, economists who focus on the economic nature of capital tend to underscore the positive relationship between foreign investment and the income level of the manufacturing sector. On the contrary, sociologists pay much attention to the political nature of foreign capital. They argue that the inflow of foreign investment can suppress the wage level of the manufacturing sector in host countries. Based on these contrasting viewpoints, this article proposes the following hypothesis:
Hypothesis 3: FDI has significant impacts on the income level of the manufacturing sector.
Hypothesis 3a: Based on modernization theory, the higher the level of FDI, the higher the average income level of the manufacturing sector.
Hypothesis 3b: Based on the dependency theory and the world system theory, the higher the level of FDI, the lower the average income level of the manufacturing sector.
China’s finance industry in the context of economic globalization
Against the backdrop of economic globalization, the finance industry enjoys a high level of income and profit globally. The financial sector is the highest-paying industry not only in developed countries such as the USA and France but also in developing countries such as China. Most economists attribute this phenomenon to the market mechanism, such as the expansion of the financial market, the increasing demand for financial services as the result of expanding international trade, the scarcity of talents in the financial sector, and the high productivity of the financial sector (Manova 2012).
In opposition, sociologists focus on the power structure in which the market is embedded. The market equilibrium is not natural, nor does it happen automatically. On the contrary, the market consists of a set of institutional arrangements, and reflects the power relationships among various stakeholders (Fligstein 2001). Based on this understanding, scholars attribute the high wages in the financial sector to two processes: the generation and the distribution of economic rent. Here, economic rent refers to the extra revenues generated beyond the perfect competition of the market (Sorensen 2000). The primary goal of capitalists is to maximize profits. To achieve this goal, rather than engaging in market competition, capitalists manage to avoid competition by creating favorable market conditions and maintaining the monopoly. In this process, capitalists in the financial sector become increasingly powerful and occupy an advantageous position over the industrial capitalist. Financial capitalists can persuade national and state governments to forgo its previous rigorous monetary policy to deregulate the financial sector and financial activities, to relax regulations over speculation, and etc. All these preferential policies generate enormous profits for the financial sector in the short term. Meanwhile, the distribution of economic rent is a negotiated social process (Carruthers and Kim 2011). As the financial sector becomes increasingly powerful, it also occupies a favorable position in the redistribution of economic rent. This is particularly the case for institutional investors, commission-based employees, and bankers (Tomaskovic-Devey and Lin 2011). In sum, sociologists focus on how the growing power of the finance industry leads the government to implement preferential policies in its favor.
The high wage level of the financial sector in China, on the other hand, has much to do with how the challenges of economic globalization have reshaped government policies. The importance of the financial sector in the current wave of globalization, as well as the high risk and profitability of the financial sector, combine to shape government financial policies. The Chinese government not only consolidates the monopolistic character of the financial sector but also helps the sector to repay its debts, to improve its efficiency, as well as to learn innovative financial tools from Western countries. All these factors contribute to the high-income level of the financial sector in China.
While the financial sector is characterized by its high risk, it should be noted that the financial sector in China has only recently undertaken its transition from the planned economy to the market economy. Its performance is not optimistic. According to the statistics from the China Banking Regulatory Commission, the non-performing loan (NPL) ratio of the four major state-owned banks in China reached as high as 40%; these banks were technically on the verge of bankruptcy (Xie and Yin 2002). The current Chinese financial sector was created as the result of the country’s insertion into the global economy. Prior to economic reform, the financial sector in China only assumed the role of banking. The People’s Bank of China was the only bank in the country.Footnote 1 The banking system at the time did not have to face the risk of loans, nor to operate on the principle of profit maximization. The monetary supply and interest rates were established by the People’s Bank of China; the monetary demand was determined by the planned economy. Bank branches were required to remit their revenues to upper-level branches. The financial market was non-existent. In sum, the banking system in the pre-reform era served no more than an instrument to fulfill economic plans. Banks had little autonomy in decision-making, and they did not play an independent role in adjusting the economy (Song 2008). From the beginning of the economic reform and opening up to the 1997 Asian Financial Crisis, the development of the financial sector in China centered around establishing and consolidating the three major finance industries, namely, the banking system, the stock market, and the securities industry, so that the financial sector could serve the purposes of economic opening and economic development. The Chinese finance industry took an extensive mode of growth, which heavily relied on the expansion of financial institutions and personnel, with very little regard to risks. Between 1989 and 1997, the volume of the loans issued by the four major state-owned banks increased by 4.63 times, but the profit decreased by 63%, from 24.24 billion Yuan to 8.51 billion Yuan, and the administrative costs increased by 8.7 times.Footnote 2
The 1997–1998 Asian Financial Crisis, the admission of China to the WTO, and the US Financial Crisis in 2008, were external shocks to the Chinese financial sector. The Chinese government had to face seriously the challenges imposed by the economic globalization on the financial market. The government became aware that the chronic low competitivity and high risks combined to make China’s financial market vulnerable to external shocks. Thus, following the 1997 Financial Crisis, the Central Committee of the Communist Party and the State Council held the first national meeting on the financial sector, in which much emphasis was placed on “effectively avoiding financial risks” and “accelerating the establishment of a modernized financial system.” Soon after China’s admission to the WTO, the Central Committee of the Communist Party held the second national meeting on the financial sector in which various policies were established to enhance the competitivity of the country’s financial sector.
First, measures were taken to maintain and reinforce the monopolistic character of the financial sector. People’s Bank of China enhanced its role as the central bank. Four major state-owned, specialized banks were founded, together with 12 commercial banks in which state enterprises or local governments owned the bank’s outstanding stock.Footnote 3 Meanwhile, barriers to entry were raised against foreign banks and more restrictions were imposed on their activities in China.Footnote 4
Second, the banking sector exercises firm control over interest rates in order to maintain its high profitability. Banks take up to 85% of the profits generated by the entire financial sector, and 70% of their profits come from the interest rate spreads. In China, interest rates have always been under government control,Footnote 5 and banks obtain profits from the gap between interest rates for savings and those for loans. As a result of government control, interest rates in China cannot correctly reflect the scarcity of the resources, and loans and savings are not subject to market forces. Meanwhile, due to the barriers to entry, Chinese banks maintain their monopolistic position. Companies find very few options when they seek loans. They are usually in a weak negotiation position with loan agencies and must passively accept the terms and conditions of the loan.
Third, the Chinese government uses its own resources to help banks to repay their debts. The Basel Accords established a minimum capital adequacy ratio of 8%. To help the Chinese banks to meet this requirement, between 1990 and 2005, the government recategorized 243.75 billion Yuan of debts of the four major state-owned banks as government debts. Between 2003 and 2005, the government injected 60 billion US Dollars from the country’s foreign reserves to Bank of China, China Construction Bank, and Industrial and Commercial Bank of China. Nevertheless, China still has one of the highest ratios of non-performing loans in the world (Xie and Yin 2002; Zhou 2007).
Fourth, the government actively promotes the stockholding system in the four major state-owned banks and listed them on the stock market. This attracts an enormous amount of funds for these banks and improves their administrative capacity. More importantly, the introduction of foreign equities—in this case, Bank of America and Scotia Bank—allows the national banks to learn advanced technology, administrative experience, and innovative financial tools in a more direct and in-depth manner. This has a positive impact on the profitability of China’s banking sector.
Fifth, control over exchange rates and capital accounts are rigorously enforced, with the purpose of reducing risks and improving the profitability of the banking sector. As the Chinese economy is highly dependent on the global market, the international financial capital pressures the Chinese government to marketize the exchange rates and to liberalize capital accounts for foreign investors. Currently, China has a “controlled” floating exchange rate regime, which establishes that the fluctuation of the dollar-yuan exchange rate should not exceed 2%. This is essentially a fixed exchange rate regime. The control over capital accounts imposes restrictions over transnational transactions and transfers of funds. These two regulatory mechanisms, to a certain extent, insulate the financial sector of China from the international financial market, which reduces risks and fluctuations of the economy.
It is obvious that consolidating the monopolistic character of the financial sector is consistent with the national interest. This differs sharply from the era of planned economy, when the financial sector was a regular economic sector and it was the heavy industry that enjoyed preferential treatment from the government. Currently, the Chinese financial sector enjoys not only a higher income level compared to other sectors, but also additional preferential policies, as the government intends to improve its productivity and competitivity. The high wages in the financial sector are the result of its monopoly, high efficiency, advanced technology, and low risk. In sum, as China becomes increasingly inserted into the global economy, it will face increasing potential financial risk. This will further raise the importance of the financial sector, and the government preferential policies will be more effective to increase the income level of the financial sector. Accordingly, this article proposes the following hypothesis:
Hypothesis 4: the higher the degree of economic globalization, the higher the income level of the financial sector.
Hypothesis 4a: The higher the level of foreign trade, the higher the income level of the financial sector.
Hypothesis 4b: The higher the level of FDI, the higher the income level of the financial sector.