Wage Reform, Soft Budget Constraints and Competition
Since the beginning of the Chinese economic reforms in 1978, there has been a series of effort to reform the labour compensation practice in state- owned enterprises to strengthen the link between pay and productivity. Despite the reforms, however, rapid increases in wage rates occurred in state-owned enterprises. Moreover, although state-owned enterprises have much lower productivity gains than non-state enterprises, they pay substantially higher wages and have faster wage growth.
This paper studies the effects of institutional factors on labour compensation in state-owned enterprises. The first factor is soft budget constraints faced by the enterprises, which are proxied by their level of government supervision. The second factor is the intensity of competition from the non-state enterprises. By distorting enterprise incentives, the presence of soft budget constraints is expected to lead to excess in labour compensation. The extent to which competition can discipline enterprises may reflect its success in reforming the Chinese state-owned enterprises.
The results show that soft budget constraints lead to (1) higher wage premiums and faster wage growth, and (2) a wage share of enterprise income inconsistent with the labour inputs of the enterprises. Competition, on the other hand, has not been found effective in containing labour costs and restraining the wage share of enterprise income. This may indicate that the effectiveness of competition in the Chinese economy is compromised by the presence of soft budget constraints.