Structural Transformation and Its Implications for the Chinese Economy

Abstract

This working paper was written by Gaofeng Han (Hong Kong Institute for Monetary Research).

This study applies a two-sector model to examine the conditions under which the excess labour force can be reallocated from the tradable to the nontradable sector during structural transformation. We find that to maintain employment stability, output in the nontradable sector should be 1.9-to-3.5 percentage points higher than in the tradable sector, if labour shares in the two sectors approach the level of major developed economies in the next one and a half decades. Such output differentials mean the productivity increment in the nontradable sector should reach as high as 1.5 percentage points at the start, if job loss in the tradable sector is associated with negative investment shocks, or 1 percentage point if job loss is associated with an improvement in efficiency. In the absence of technological progress in the nontradable sector, the government could increase its consumption of nontradables by as much as 4 percentage points to help maintain employment. While the pure labour reallocation has a small effect on aggregate output, the shrinking working population and an improvement in efficiency in the tradable sector have larger effects on aggregate output. Price falls only slightly and the real exchange rate change is small during structural transformation. Although the structural transformation goal seems achievable, it is important to revive high-end tradable industries through product innovations to reduce employment pressure on the nontradable sector.

Keywords: Structural transformation, Tradable, Nontradable, Real Exchange Rate, Employment, Fiscal Policy, Switching cost

JEL Classification: F31, F32, J11, O11, O14, O23