Sign of economic upgrading

The investment in agriculture, industry and construction has peaked, so it is no longer as easy as it was before to raise labor productivity through high capital accumulation, while boosting productivity through human capital accumulation is relatively slow. Also, the transition of the economy from agriculture to industry has been slowing, and the shift from industry to services has begun, which means the growth rate of general productivity will decline given the relatively higher productivity of the industrial sector. This is a common phenomenon among higher-income economies.

What drives the rapid growth of labor productivity? First, it is the "catch-up effect". The wider the gap between an economy's average personal income and that of the advanced economies, the larger room it has to improve its technology, management and mechanisms to catch up with the advanced economies, and thus the greater space it has to raise its labor productivity.

The room for improving productivity varies across sectors. Latecomers have larger room to improve their productivity and catch up with advanced economies in sectors such as food, capital goods and equipment, and construction, whereas the gap is smaller in consumer goods manufacturing, and even smaller in the service sector. In the early stage of development, an economy can quickly improve its labor productivity through massive capital accumulation and achieve economies of scale in sectors where the room for improving productivity is bigger.

Second, it is the structure effect. As an economy of lower average personal income grows, its industrial and service sectors tend to attract more investment and expand quickly, with the demand for agricultural products being gradually satisfied. Compared with agriculture, more human capital and financial capital is invested for each worker in the industrial and service sectors. Generally, labor productivity is highest in the industrial sector, followed by the service sector, and then the agricultural sector.

Due to the two effects, when the focus of economic activities shifts from agriculture to industry and services, labor productivity will grow at a faster pace.

In the first decade of the 21st century, China's annual average economic growth rate stood at 9.7 percent, among which the structure effect accounted for 2 percentage points, and the catch-up effect contributed 7.7 percentage points, according to our study. During this period, massive investments poured into the steel, energy and chemical industries, as well as equipment manufacturing and construction, and consequently, labor productivity rose fast. The same period witnessed the large-scale transfer of agricultural workers to the industrial and service sectors, which contributed to higher labor productivity.

Accordingly, there are two reasons behind the slowing growth of labor productivity.

First, the catch-up effect diminishes. With personal incomes rising and the industrial structure changing, a latecomer's space for productivity improvement shrinks after rapid growth in the agricultural, industrial and construction sectors, particularly after the capital accumulation in these sectors has passed its peak and productivity has increased fast thanks to the rapid accumulation of material capital and economies of scale. This leads to a declining growth rate of productivity.

In the service sector, the room for latecomers to improve labor productivity is smaller. In labor-intensive service industries, such as catering, hospitality, tourism, retailing, wholesale, and transport, developing countries have a relatively narrow gap to close with the developed countries and therefore smaller room for improvement. In comparison, in knowledge and technology-intensive sectors, such as scientific research, education, healthcare and finance, it is more difficult to realize the accumulation of human capital. Therefore, human capital accumulation is slower, and thus the growth of productivity is slower in these areas.

Second, the structure effect wanes. Global experience suggests that when a country's average personal annual income reaches 8,000 to 9,000 international dollars, the shift of the economic center of gravity from the agricultural sector to the industrial and service sectors will slow down, and the economic focus will start moving from the industrial sector to the service sector. During the process, even if the growth rate of labor productivity remains unchanged in each sector, the total productivity growth will decelerate nevertheless.

China saw a marked deceleration in the growth of labor productivity in the second decade of this century, when it dropped from an annual average of 9.7 percent in the first decade to 6.1 percent during the period from 2011 to 2018, among which the catch-up effect contributed 5.1 percentage points and the structure effect was responsible for 1 percentage point.

Compared with the first decade, the contribution from the catch-up effect decreased by 2.6 percentage points and that from the structure effect fell by 1 percentage point. During this period, the investment growth in capital-intensive sectors passed its peak. As a consequence, capital accumulation and labor productivity growth dropped dramatically.

At the same time, the shift from the agricultural sector to the industrial and service sectors slowed down notably, which, coupled with the transfer of the labor force from the industrial sector to the service sector, led to the reduced growth rate in labor productivity.

The author is deputy director of Institute of World Economics and Politics at the Chinese Academy of Social Sciences. The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.