Are Wage Increases in Chinese State Industry Efficient? Productivity in Nanjing's Machine-Building Industry

I. INTRODUCTION Do real wage increases in Chinese stateowned industrial enterprises simply reflect productivity improvements, or are other factors at work? Recently published data for 1997 (SSB, 1998), show that since 1978, during the start of the post-Mao economic reforms in the People's Republic of China, wages in state industry have risen by an average annual rate of about 12.3%. This is faster than the 8.6% average annual increase in the official urban retail price index over the same period, and considerably faster than the 4.3% average annual increase in the output prices for state industry. Meanwhile, the traditional state sector's share of industrial output has fallen from 78% to 26%, and there are mounting financial losses in the state sector. The answer to this question is crucial to addressing the long-run survival of stateowned enterprises, the intended cornerstone of China's emerging Shehuizhuyi Shichang Jingji (Socialist Market Economy). Some scholars, most notably Kornai (1992), argue that rising state sector wages result from "wage drift" as economic reforms expand the autonomy given to state firms with soft-budget constraints and inappropriate managerial incentives. Lacking the fear of bankruptcy and personal loss faced by private owners, state managers prefer to keep their labor force pacified with higher wages, even though worker productivity may be stagnant or declining. However, the erosion of monopoly power previously held by China's state-owned enterprises in the manufacture of industrial goods can also explain the state sector's relative decline (Naughton, 1992). Competition should lead to falling relative prices, rising output, and falling economic profits. Since state firms have significantly higher social overhead than do entering firms, competition may lead to losses even if productivity is improving. Since the hypothesis of monopoly erosion helps to explain falling profits but not rising wages, this paper extends this argument to consider whether reforms may have also cost the state its monopsony hiring position in labor markets; as non-state enterprises compete with state firms for skilled labor, the state firm may be forced to pay its workers more simply to retain them. This paper examines the behavior of wages relative to the marginal product of labor in order to understand state firm responses to reform incentives. Using data collected from a sample of 20 enterprises in the machine-building industry of Nanjing, a large Chinese city, the relationship between wages and the value of labor's marginal product is examined using a CES production function model. Both interview and econometric results strongly support the hypothesis that rising real wages reflect neither productivity improvements nor wage drift, but the loss of the state industrial labor monopsony. II. THE STATE ENTERPRISE'S INEFFICIENCY Despite the dramatic economic transformation and improved performance of the Chinese economy since reform began, by now it is widely recognized that state-owned industrial enterprises have been more of a drag than a vanguard in this evolutionary process. Though the deflated value of the state sector's gross output in the industrial sector (including mining, manufacturing, and utilities) rose by over 7% per year, the non-state sector grew much fasten Collective firms, mostly including rural township and village enterprises (some of which may be quasi-private), now produce a larger share of industrial output than does the state sector. Production from firms under private, foreign, and joint-venture ownership has grown from less than 0.5% in 1980 to almost 20% by 1997. According to Parker (1995), average labor productivity in the non-state industrial sector was rapidly catching up to the state sector by the early 1990s, and by 1992 may have even surpassed it in real terms, in spite of the fact that the state sector continued to receive the lion's share of capital investment through the state's monopoly on banking. …