Wage hike is not at odds with innovation

Column by Sébastien Lechevalier, Professor at Ecole des Hautes Etudes en Sciences Sociales (EHESS, Paris), Senior Researcher at Maison franco-japonaise (UMIFRE 19, Tokyo) and at the Canon Institute for Global Studies (CIGS, Tokyo).

Two economists show that rising wages in China have helped its industry move upmarket.

Column. Wages have risen sharply in China for more than two decades: the average nominal wage of urban workers increased 13-fold between 1998 and 2020. On average, it is now higher than in most non-OECD countries, which raises the question of the current and future drivers of Chinese growth, which until the 2000s was based on low labour costs.

However, it appears that this wage growth has encouraged innovation, which suggests that innovation is now one of the drivers of the country's growth (Wage increase and innovation in manufacturing industries: Evidence from China, Junwei Shi and Hongyan Liu, Journal of the Asia Pacific Economy, September 2021). There are several competing theories about the impact of a wage increase on innovation.

In short, wage increases can be a barrier to innovation by reducing firms' profitability and their ability to invest in new technologies. But, alternatively, innovation can be an effect of higher wages, through at least two channels: on the one hand, firms can introduce technologies to substitute for labor, which has become too expensive; on the other hand, they can seek to maintain employment but increase its productivity through new technologies.

China is no longer a low labor cost country

The two economists, Junwei Shi and Hongyan Liu, analyzed 37 manufacturing sectors between 2002 and 2019, showing that on average there is a positive link between wage growth and innovation (measured by the annual number of patents filed at the sector level). However, this result varies strongly over time and across sectors.

Thus, the measured effects became significant and positive only after 2008 and the entry into force of the new law on employment contracts, which, after a period of deregulation of the labor market in the 1990s, made the wage ratio more uniform. Moreover, the strongest effects are measured in resource-intensive industries (mining and energy) and, to a lesser extent, in labor-intensive ones (textiles) on the one hand and technology-intensive ones (chemicals, electronics) on the other. On the other hand, they are not significant in industries based on capital accumulation (steel).

Finally, this study shows that the main underlying mechanism is the increase in labor productivity thanks to technologies, and not a substitution of one by the other. These results indicate that China is no longer a low-cost labor country and that wage growth has led to a transformation of China's mode of development from "Made in China" to "Designed in China" based on technological advancement.

Employees themselves are at the heart of the innovation process

Above all, what is true for a still developing country like China is also true for OECD countries: higher wages are not an impediment to innovation, quite the contrary, especially when there is a real investment in human capital. In many countries and companies, investment in technology has been at the expense of employees, in a context of highly competitive goods markets and pressures to lower prices.

This research confirms that employees themselves are at the heart of the innovation process, which is not limited to technology. It is by training and motivating them that companies will succeed in innovating in a sustainable way, in China as in Europe.