A holistic approach to understanding unemployment

Hong Kong’s GDP growth used to be a good predictor of the unemployment rate but this is no longer the case. The unemployment rate has consistently stayed between 3.1 percent and 3.5 percent since July 2011 even though GDP growth has been fluctuating. The main reason why Hong Kong’s unemployment rate has stayed low while GDP growth has been weak is that demand for Hong Kong’s labor has come from both local demand and explosive demand derived from China’s mainland.

To compare, Hong Kong’s labor supply growth was rather stable and predictable over the years, averaging 1.1 percent in the past 10 years. On the other hand, “derived” labor demand — for example, that coming from neighboring parts of the mainland — has grown exponentially.

To put this into perspective, the number of mainland visitors coming to Hong Kong in 2013 is 4.8 times to size of that in 2003, when the Individual Visits Scheme was first introduced, but total labor supply was only 1.1 times larger over the same period. In the retail sector, retail sales volume growth averaged 13.4 percent annually over 2009-2012 while the sector’s labor force growth averaged just 2.1 percent annually over the same period (labor force data for the retail sales sector only available since 2008).

Derived labor demand impacts more than the retail sector. Closer integration with the mainland has increased demand for labor in almost all sectors, the more obvious ones being retail, catering, accommodation and property.  In fact, any corporation that is doing business with the mainland would have more derived labor demand. Recently, even the demand for educational and medical services has risen due to integration between Hong Kong and nearby regions. In the past, when Hong Kong was less integrated with the mainland, labor demand was a simpler function of local demand.

Besides the impact from rapid growth in derived demand for labor, supply-side factors can also explain Hong Kong’s consistently low unemployment rate. Many sectors face chronic labor shortages regardless of the state of the economy.

According to a recent report by Manpower Group, some 57 percent of Hong Kong employers are having trouble finding the right staff, the most since 2008. Demographic factors, such as an aging population, could be one of the reasons. The percentage of male employees aged below 50 have now decreased to 64 percent from 77 percent back in 2005, and this may have caused labor shortages in some sectors requiring intensive manual work.

Fundamental changes in the labor demand-supply equation explain why low unemployment rates have been consistently seen in the past two and a half years.  As Hong Kong integration with the mainland grows, the unemployment rate will likely remain at low levels for a prolonged period. Nevertheless, one must be careful not to equate this with a healthy labor market.

The behavior of unemployment in retail and real estate sectors

To further explore this peculiar phenomenon, we focus on two sectors: retail and real estate.

In the retail sector, the unemployment rate behaves differently compared with previous cycles. The uptick of unemployment coincided with the drop in retail sales growth in the past, but the unemployment rate practically stayed flat throughout the second half of 2012 even when retail sales growth plummeted.

This is likely attributable to the increasing influence of tourists on the retail sector. Although retail sales plunged in the second half of 2012, tourist numbers did not — mainland tourist arrivals grew 25.5 percent in the second half of 2012 versus 22.7 percent in the first half of 2012.

If many people stop shopping altogether (e.g., in the midst of a financial crisis or epidemic), it would lead to layoffs. However, if shoppers remain active but are simply spending less, retail employees are still required to serve these customers. This is especially true now as the influx of tourists generate high demands on retail employment.

In addition, changing patterns of tourist consumption can also explain the relative stability of retail sector employment. For instance, mainland tourists may visit high-end stores less amid an economic slowdown but spend more time shopping for personal products or clothing, increasing staffing needs in those stores.

In the real estate sector, the unemployment rate runs against intuition even more. The sector’s unemployment rate stood at just 2.5 percent in the fourth quarter of 2012, even though residential flat transactions have fallen by more than 40 percent year on year to 4,000 per month. In comparison, when transactions averaged 9,000 per month or more between the second quarter of 2009 and 2012, the sector’s unemployment rate was 3.2 percent.

The present low rate of unemployment is explainable: large agencies have decided to freeze headcount rather than lay off workers; discouraged agents went to find jobs in other industries; potential entrants into the industry may have been deterred by the poor prospects.

Another reason is that real estate agents only account for about one-third of all real estate employees in Hong Kong.

Real estate developers have been busily launching projects recently, and these companies demand labor. The situation in the real estate sector is a good example of how industry-specific characteristics and microeconomic factors sometimes affect unemployment more than broad macroeconomic indicators like GDP growth.

For now, employment surveys offer more insights

By now it should be clear that there are limits to conventional macroeconomics when analyzing Hong Kong’s labor market. Microeconomic factors are crucial to understanding hiring decisions and job seekers’ aspirations, particularly at the industry level.

Thus, it is worth paying more attention to employment surveys. Over the period the third quarter of 2011 and the first quarter of 2014, when the unemployment rate stayed flat, export/import trade and wholesale was the only sector that experienced notable deterioration in the employment outlook (mostly over the first quarter of 2013 and the first quarter of 2014).

Employers in other sectors consistently expressed intentions to increase staffing levels despite apparent swings in Hong Kong’s growth rate over that period. The results of these surveys are consistent with the prognosis that there is, indeed, a labor supply issue. In the absence of labor shortages, one would have expected hiring sentiment to fluctuate with the economic situation.

Implications for employers and policymakers

The government has started exploring long-term solutions to labor supply shortage, including the possibility of importing foreign labor and increasing female participation in the labor force.

While importing labor can in theory relieve labor shortages, it is not very practical in Hong Kong’s case. High housing and rental costs make significant labor imports too costly.

Firstly, it is unlikely that employers would be willing to provide housing subsidies to imported labor. Without subsidies, however, foreign workers, especially those in low-skilled sectors, would have no incentive to work in Hong Kong. Secondly, even if a significant inflow of workers were somehow made possible, it would ramp up housing demand and property prices much further.

This means releasing local labor supply is the only viable solution to the labor shortage problem.

One way to do this is by increasing female labor force participation. This is complicated by the need for supporting infrastructure such as child care facilities. Meanwhile, to slow down population aging, the government needs to encourage childbirth, which again involves detailed long-term planning. These solutions are viable but visible results would not be seen for years.

For the time being, the widening gap between labor demand and supply will increase wage pressures. This is already happening in the construction sector, where the wages of steel fixers are even higher than white-collar professionals. Wages for menial jobs like dishwashing have also jumped in recent years. To minimize wage inflation and its impact on profits and growth, employers will have to find ways to raise productivity.