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Labor laws and regulations in China


China Economic Review 14 (2003) 426 – 433

Labor laws and regulations in China
Belton M. FLEISHER a,*, Dennis T. YANG b
Department of Economics, Ohio State University, 1945 North High Street, Room 410, Columbus, OH 43210, USA b Department of Economics, Virginia Polytechnic Institute and State University, Blacksburg, VA, USA Accepted 19 September 2003
a

Abstract We discuss how economic reform has highlighted labor-market imbalances and disequilibria both within and between the rural and urban sectors. We show that these disequilibria can be resolved only through massive reorganization of legal restrictions on population movement and revisions of wage, welfare, and social insurance, which have been only partially accomplished and in some cases hardly begun. Dealing with these major remaining legislative and regulatory gaps is a major challenge the ingenuity and, more so, to the will of the Chinese government at the national, provincial, and local levels. Neglect of these reforms will damage China’s prospects for continued economic growth and political stability. D 2003 Elsevier Inc. All rights reserved.
Keywords: Labor laws; State-owned enterprises; Rural – urban markets; Rural – urban migration

1. Introduction More than two decades into an era of sustained reform, China’s labor force has experienced fundamental transformation. In 1978, an overwhelming majority of the labor force was either employed in rural communes or in urban state-owned enterprises (SOE). During the reform, dramatic changes have taken place in the distribution of jobs: rural nonfarm jobs and urban employment in the nonstate sector have grown rapidly; by the end of the 1990s, about one third of the rural labor force was engaged in nonagricultural activities and about three fifths of the urban labor force was employed outside of the state sector, in urban collectives, joint ventures, and private enterprises (Fleisher & Yang, 2003).
* Corresponding author. Tel.: +1-614-292-6429; fax: +1-614-292-3906. E-mail address: fleisher@economics.sbs.ohio-state.edu (B.M. Fleisher). 1043-951X/$ - see front matter D 2003 Elsevier Inc. All rights reserved. doi:10.1016/j.chieco.2003.09.014

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Connecting the rural –urban labor markets, there were about 77 million rural migrants working temporarily in cities in 2000 (Cai, 2003b). Prior to reform, job changes were either prohibited or controlled by appropriate government agencies. The fundamental shifts in the distribution of employment across sectors and ownership categories that have occurred under reform require an allocative mechanism far more flexible and sensitive than any nation has ever achieved with administrative controls. The emergence of a functioning labor market has been essential to this transformation, and the government recognized this fact. The uneven institutional evolution of labor markets and their regulation has profound social and political consequences for China. Dealing with this labor market transformation is one of the most challenging tasks facing the government and Chinese Communist Party, and the way in which laws, regulations, and institutions evolve under this challenge raise a series of questions of great academic and policy interest. In this essay we address some of the legal and regulatory issues related to this process. For well-known historical reasons that still affect general economic and labor market conditions today, we discuss rural and urban labor markets separately, with an additional section on the connection of rural –urban markets.

2. Rural Labor Markets At the end of the Cultural Revolution, on the eve of economic reform in 1978, rural labor was governed under the commune system. The two key features of this system were the following: (1) the pervasive labor incentive problems, and (2) the central allocation of labor through the commune administrative system. Given the privations of the Great Leap famine between 1959 and 1961 and the disruptions of the Cultural Revolution 1967 – 1977, the government recognized the need for radical reform of the rural labor system, which at that time employed 76% of the nation’s labor force. China’s economic reforms fundamental to both the rural and urban economies started with labor market reforms in the rural sector, with the emergence of the Household Responsibility System (HRS) in Anhui province, which aimed to solve labor incentive problems in the communes. The success and significance of the HRS led to its nationwide adoption and the abolition of communes by 1985 (Lin, 1992; McMillan & Zhu, 1988). Households became decision makers in allocating their labor. In addition to the replacement of production teams with households as units of basic production, other rural reform included official increases in agricultural product prices, and the liberalization of markets for rural products. These reforms provided the necessary conditions for the emergence and subsequent boom in rural industrial development starting in the mid-1980s. The increased productivity that resulted from rural reforms led to reduced demand for workers on small Chinese farms. This labor released from farming actively sought new employment, but legal restrictions on labor mobility constrained farmers to jobs in nonagricultural activities. There is little question that by 1985, the marginal productivity of capital and labor in the nonfarm sector of the rural economy exceeded the levels in the cropping sector, indicating overallocation of resources in agriculture (Yang, in press).

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The catalyst for the rapid expansion of nonfarm production that could absorb labor released by the increasingly productive farming sector was a series of government regulations in the 1980s that loosened restrictions on labor mobility and the operation of rural enterprises. These are described below in chronological order. In 1983, Document No.1 of the Central Committee of the Chinese Communist Party (CCP) provided general guidelines that encouraged the emergence of specialized households and praised their effectiveness in making the best use of limited funds and labor. Skilled workers and craftsmen were permitted to leave farming and engage in a variety of nonagricultural activities, including long distance transport and the marketing of commodities. In addition, the document allowed cooperative ventures, as well as rural industrial and commercial households, to employ labor (Ash, 1988). In 1984, the Central Committee of the CCP and the State Council issued the ‘‘Report on Creating a New Situation in Commune and Brigade-run Enterprises,’’ which outlined a new development strategy that targeted industry as the focus of future rural development. Industrial development was expected to provide inputs for agriculture, absorb rural labor, and help raise rural earnings (Findlay, Watson, & Wu, 1994). This strategy sharply contrasted with the old policy of local grain self-sufficiency in which rural industries had only a subsidiary role to agriculture. In 1985, Document No. 1 of the CCP permitted farmers to seek employment and establish businesses in nearby towns, if they could provide their own food grain and were financially capable to run a business. This deregulation officially relaxed the controls on labor mobility within rural regimes; in the past, farmers had to live and work in villages where they held household registration. These labor market deregulations, coupled with the change in grain procurement policy from mandatory production to contract negotiation (Lin, 1992), prompted farmers to reallocate their labor to the more profitable nonagricultural activities. In 1985, the number of TVEs more than doubled, and their total labor force increased by more than 30%, following a year of strong growth in 1984. These dramatic changes in policies and in farmers’ responses marked the beginning of sustained expansion in nonagricultural activities and growth in rural household earnings (Yang, in press). Despite significant improvements in the regulatory environments, there still exist serious barriers that prevent an efficient operation of labor markets in rural China. Although land rental markets have began to emerge (e.g., Kung, 2002), under the HRS, farm families have land-use rights but not rights of alienation. If permanently leaving agriculture, farmers must return the land to local authorities and consequently give up a stream of potential land earnings in the future (Yang, 1997). This pecuniary cost reduces labor mobility, as it raises the expected future wages that rural families require from their prospective destination when moving away from agriculture. Moreover, China’s farmland arrangements under the HRS obligate the farm household to deliver a part of its grain output to the state at quantities and prices specified by the government, which has an effect of restricting family labor allocation to alternative employment (e.g., Brandt et al., 2002). Local protection is also a significant issue. For instance, a rural worker currently employed in the enterprise of another village does not receive the allocation of homestead or other housing arrangements, even if the job is permanent, thus incurring

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high costs to the migrants. In addition, workers from a village often earn much higher wages than outsiders after controlling for productivity related characteristics (Yao, 1999). Hence, further regulatory and legal reforms in the property rights of rural land, grain procurement, and incentive structure of local government could improve labor market efficiency.

3. Rural – urban migration In the prereform period, the central government vigorously pursued a heavy-industryoriented development strategy, which caused severe segmentation between the rural and urban sectors in China (e.g., Knight & Song, 1999; Yang & Cai, 2003). The main mechanisms for enforcing this strategy included unified procurement and sale of agricultural commodities, the People’s Communes, and the Household Registration System (hukou). This strategy led to massive distortions in the factor market with an excessive concentration of capital in urban areas and of labor in rural areas, resulting in a high urban – rural income ratio of about 3 on the eve of economic reform in 1978. The pressure for rural –urban migration was magnified by rural reforms that reduced the demand for farm workers, and it could not be offset, even though it was ameliorated, by the burgeoning TVE sector. When rural reforms abolished the communes and reduced the role of central planning in agricultural production and sales, hukou became the most important legal barrier to rural –urban migration. China has used a household registration system for tax collection and social control purposes for over 2000 years, but its current importance stems from its formal adoption by the Chinese government in 1958, with the issuing of Regulations on Household Registration of the PRC (Wang, 2001). According to the regulation, hukou designates a person’s legal place of residence and work at the time of his or her birth based on the locality of the mother’s registration (Chan & Zhang, 1999). Possession of the appropriate hukou (e.g., agricultural vs. nonagricultural) also determines one’s access to various amenities and social services such as health care, schooling, and until recently rationed or subsidized food products, which were provided only to urban residents. Therefore, although rural labor force had strong desires to seek employment opportunities with better pay in cities, they had to overcome legal barriers to working in cities. Because of the inefficiency associated with labor misallocation, the hukou system has been modified in recent years to permit more flexibility in reallocation of labor between rural and urban markets. In 1988, the central government initiated a major policy reform that relaxed the controls over rural –urban migration—farmers were permitted to work and to carry on business in cities provided they could secure own staples (Forbes & Linge, 1990). This regulation gave new opportunities for rural workers to work temporarily in cities, representing improvements over the old system in which college education and joining the people’s liberation army, not even marriage, were the main legitimate channels to access urban registration (Chan & Zhang, 1999; Wang, 2001). In the early 1990s, the removal of food rationing further reduced the costs of living for temporary rural migrants in cities because they could purchase food directly and no longer

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needed to bring it with them physically or to barter for ration coupons. In 1998, the Ministry of Public Security issued another regulation loosening the control of hukou registration—those who moved to join their parents, spouses and children in cities could also receive urban registration (Cai, 2003b). As of today, hukou reform remains incomplete and its progress varies across provinces and even cities. In general, local situations fall into one of the three models (Cai, 2003b): (1) in over 20,000 small towns, applicants may receive local registration if they have a permanent source of living and housing in the locality, (2) in many medium-size cities, including a few provincial capitals, requirements for gaining hukou status have been significantly reduced; some just require a long-term work contract, and (3) in a few mega-cities such as Beijing and Shanghai, obtaining hukou remains very difficult. It is doubtful that radical liberalization will occur so long as loss of the power to grant or withdraw hukou registration is deemed a threat to the incumbent government’s political power. Here is a clear example of the mixed motives of government in China with respect to economic reform (Clarke, 2003; Ohnesorge, 2003). Rural migrants who lack the possession of correct hukou status are called the ‘‘floating population,’’ and as of the year 2000, totaled about 77 million rural –urban migrants (Cai, 2003b). They subject themselves not only the risk of various arbitrary actions by local authorities carried out in the name of preserving social order, public safety, and so on, but also to significant economic costs in the form of fees, work permits, bribes and so on (see, e.g., Shenzhen SEZ Daily News, 2001; Southern Capital Daily, 1999). Perhaps the most significant example is schooling. Although national and local laws require that the municipality of residence (whether or not one’s hukou grants permanent residence rights) be responsible for providing 9 years of primary schooling for each child. In practice, this right is often denied, with the result that migrant families must pay fees ranging from 3000 to 30,000 yuan per year per child to have their children admitted to the regular school system or cooperate with other migrant families in providing their own schools and teachers. Even so, newspapers often contain reports of migrant schools being torn down by public authorities on grounds that they provide inferior schooling or are safety hazards (which are probably true claims; see e.g., Li, Li, & Liu, 1998; Xie, 1999). None of what has been said is meant to deny that there are in fact costs of providing public services for migrants, and these costs must be paid by the workers themselves, by their employers, by government, or some combinations of them. The main problem at present appears to be that there is an inadequate provision built into current laws and regulations and, where there are such provisions, there are numerous incentives to ignore or pervert them. Determining whether these deficiencies are due to the complexities of adapting to China’s transition from planning or to an unwillingness to forego the political control that the current system provides over an increasingly mobile population is beyond our scope. What is clear from empirical studies is that these institutional barriers to rural – urban migration are largely responsible for the enormous differences in labor productivity and income across the rural and urban sectors, which indicate significant efficiency losses for the aggregate economy (Fleisher & Yang, 2003). The potential output gains from optimal labor reallocation across the sectors call for further legal reforms in the hukou system as well as related areas in the provision of social welfare.

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4. Urban labor markets: wage and employment policy The hallmarks of urban labor arrangements under central planning included labor allocation by labor bureaus; hukou; the dangan (personal file) under the control of the work unit or educational institution, the transfer of which was required for a new job; incentives determined by permanent job tenure through retirement (the ‘‘iron rice bowl’’); and wage determination according to the ‘‘wage grid’’ (Meng, 2000). Full implementation of the hukou system in 1958 as a requirement for urban employment coincided with expansion of the urban welfare system, referred to as the ‘‘big kitchen,’’ because social welfare including health benefits and even schooling were all provided in one package by the work units (Cai, 2003a; Dong & Ye, 2003). All of these institutional arrangements imposed severe limitations on job mobility on the administrative side and reduced incentives to work hard and/or to change jobs on part of the workers. 4.1. Reform of the employment and wage system Step-by-step reform has characterized almost all of China’s transition from planning, and this gradualism has characterized the liberalization of urban labor markets. Wage reforms introducing various profit-sharing arrangements were introduced beginning in the late 1970s. The degree to which various bonus schemes actually provided increased incentives to reduce shirking and increase worker productivity is open to question, though (Meng & Kidd, 1997). The labor contract system was first introduced in 1983 to cover new entrants to the state and collective enterprises. In 1987, regulations calling not only for the hiring of all new workers through fixed-term contracts, but also the extension of contracts to incumbent workers were put into force (Cai, 2003a). These reforms transferred some autonomy in hiring decisions from planners to enterprises and increased the risk of layoff for workers who shirked or otherwise did not fulfill their employment obligations. Even so, these regulations left a large role for planners to influence regional employment targets (Meng & Kidd, 1997). A managerial responsibility system was introduced later and is described by Grove, Hong, McMillan, and Naughton (1995); subsequently, management acquired additional wage discretion (Xu, 2000). 4.2. Job-related social security issues: unemployment, insurance, health insurance, and pensions We discuss the problems of urban unemployment, health, and welfare benefits very briefly here, because these topics as well as pension reform are treated in depth in another paper included in this Roundtable (Dong & Ye, 2003). The urban reforms described above, when effective, have had their obvious costs in terms of temporary and long-term unemployment of laid-off workers. As emphasized by Appleton, Knight, Song, and Xia (2002), mass unemployment is a relatively recent phenomenon in China. While not directly comparable, the Great Depression of the 1930s created social disruption and unrest associated with mass layoffs and involuntary unemployment which was poorly accommodated under a variety of state programs. Just as Federal legislation leading to establishment of national coordination of state unemployment policies dates to that era in

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the United States, the unemployment crisis in China is forcing the government to formulate policies to deal with this explosive issue. This is an example of the ‘‘crashthen-law’’ development of legislation emphasized by Chen (2003) in this Roundtable. As is much more thoroughly discussed by Dong and Ye (2003), unemployment insurance as a portable right available to all workers under clearly specified conditions does not exist in China. There is a hodgepodge of local and provincial arrangements that are provided in varying degrees primarily for those holding hukou in the community providing the insurance. The principal burden of providing benefits falls on a combination of semiprivate insurance companies funded by enterprise payments, the enterprises themselves, and local governments. Ironically, the central government opted out of guaranteeing unemployment benefits to most workers in the mid-1980s, as urban reforms began to take off. It is well known that China faces an immense challenge in balancing the fiscal burden of paying the government’s share of unemployment benefits while at the same time fostering the continued movement toward efficiency among government enterprises and dealing with the social unrest attributable to laid-off and retired workers whose nominal claims on unemployment compensation and pensions are disappearing due to financial inability and/ or lack of will to fund them (Appleton et al., 2002).

5. Conclusion Labor market reform has been both the source and a major limitation—perhaps the major limitation—of China’s economic transition since 1979. Beginning with the household-responsibility reforms in agriculture, which freed the immense power of incentives to power an unforeseen leap in productivity and economic growth, it spread gradually to wage and managerial reform in urban enterprises. These changes not only highlighted immense imbalances and disequilibria both within and between the rural and urban sectors, they require massive reorganization of legal restrictions on population movement and revisions of wage, welfare, and social insurance that have been only partially accomplished and in some cases hardly begun. Dealing with these major remaining legislative and regulatory gaps is a task that will challenge the ingenuity and will of the Chinese government at the national, provincial, and local levels if economic growth and political stability are to be maintained. Acknowledgements We thank Xiaojun Wang for his comments. References
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