China's weak social safety net will dampen its economic recovery

May 4, 2020 10:00 AM
Image credit: 
REUTERS/Aly Song

China’s domestic institutions, notably its weak social safety net, are not up to the task of supporting private consumption, which is critically important for its economic recovery from the COVID-19 pandemic.

Household disposable income in China declined in the first quarter of 2020 for the first time ever by 3.9 percent in real terms. The loss of wages and economic uncertainty related to the COVID-19 pandemic combined led to a 12.5 percent fall in real private consumption expenditure. The overall decline in consumption accounted for almost two-thirds of the unprecedented decline in quarterly GDP.

Consumption (two-thirds of which is private household consumption) has been far and away the dominant source of China’s growth in recent years. Recovery, which clearly began in March, will therefore depend largely on the expansion of this source of growth. China’s export surplus is no longer a source of growth and, given the weak economies of China’s major trading partners, there is little prospect that this could change soon. And the investment boom that powered China’s growth through the global financial crisis a decade ago is mostly off the cards given the high existing levels of domestic debt.

One of the weakest elements of China’s social safety net is its unemployment insurance system. Its coverage is limited, its benefits are modest, and only a tiny share of the unemployed receive benefits. Firms employing only 200 million workers, less than half of the urban labor force, participate in the system. Coverage of China’s 290 million migrant workers is even more limited, less than one-fifth. Limited participation of small private firms and individual businesses in urban areas is probably the primary cause for the small coverage of urban employment. In addition, China’s unemployment insurance scheme does not cover several hundred million farm workers and nonagricultural workers living in rural areas.

Benefits of the program, which is administered locally, are usually pegged at 80 percent of the local minimum wages. Since the establishment of the minimum wage system in 1994, local governments that administer the program have raised the minimum wage much more slowly than the increase in the average wage in their jurisdictions.[1] In China’s megacities like Beijing, Shanghai, and Guangzhou, minimum wages have been around 20 percent of local average wages in recent years, which means unemployment benefits are less than one-fifth of average wages in these cities. Aggregate national data show a somewhat higher rate of wage replacement, presumably reflecting lower wage growth outside these major urban centers. Nationally, benefits paid in the first quarter of 2020 were RMB9.3 billion (US$1.32 billion)[2] or RMB1,350 (US$191) per unemployed worker per month, which is the equivalent of 20 and 30 percent, respectively, of the average wage in private and nonprivate urban firms in urban areas.

Finally, only a minuscule share of unemployed workers receives benefits. Official Chinese data show an average unemployment rate of 5.8 percent in the first quarter, implying there were more than 25 million unemployed workers in China. But less than one-tenth this number, only 2.3 million workers, drew unemployment benefits. But unemployed workers are undercounted so the actual share of the unemployed receiving benefits is surely lower. One estimate is that there were 70 million to 80 million unemployed at the end of March, about three times the official number, mainly because of an undercount of unemployed individual workers in small unincorporated family businesses and migrant workers.

Authorities have sought to compensate for the inadequate unemployment insurance system through two mechanisms. First, officials use moral suasion to discourage firms from laying off workers. Ironically this tactic is probably more effective in larger state-controlled firms where participation in the unemployment insurance system is relatively high. Most micro and small firms lack the liquidity or access to bank credit to sustain employment in a major economic contraction. Second, the government has begun refunding up to 100 percent of unemployment contributions paid in 2019 by micro, small, and medium-sized firms if they retain employment at certain levels. As of March 25, the government refunded RMB22.2 billion (US$3.14 billion) to 1.46 million small firms with 49.51 million workers, which translates to about RMB450 (US$64) per worker. These refunds on average amount to less than 1 percent of the wage bill of these firms so it seems unlikely that they will incentivize firms to retain surplus workers.

Without strengthened cash transfers to the unemployed, China’s recovery will be weak.

Notes

1. See Nicholas R. Lardy, Sustaining China’s Economic Growth After the Global Financial Crisis (Peterson Institute for International Economics, 2012), pp. 118–19.

2. The exchange rate used to convert renminbi to US dollars in this post is as of May 4, 2020.

More From

Nicholas R. Lardy Senior Research Staff
Tianlei Huang Research Analysts