After three decades of fast economic expansion, China’s labor market has gone through significant changes. While the dwindling supply of young migrant workers has been widely reported for several years, the growing skills shortage is now attracting more attention. The potential talent pool appears to be enormous and so the talent shortage challenge seems puzzling.
Based on the annual business climate survey conducted by the American Chamber of Commerce in China, management-level human resources constraints were the top operational challenge in 2012 as reported by more than 300 U.S.-based companies (Figure 1). This issue matters for both multinationals and Chinese companies with global ambitions.
A McKinsey survey found that 44 percent of executives at Chinese companies with activities abroad ranked insufficient talent as the biggest barrier to their overseas expansion. The severe shortage of highly qualified professionals—from senior executives to highly skilled professionals—has led to stiff competition among rival firms. The staff turnover rate in China has been on an upward trend over the past decade and now surpasses the rates of all other major countries in Asia.
Insufficient Supply and Fast-Rising Demand for Qualified Talent
China has made significant progress in expanding its higher education sector over the past two decades, and a college education has become more accessible; the number of new graduates increased from less than 1 million in 1990 to more than 6 million in 2010. In total, more than 40 million new college graduates entered the labor force in this period, and the percent of the total population with at least some tertiary education increased from 2 percent to 9 percent.
Despite this large pool of potential talent, companies have been complaining that the skills shortage is worsening at all levels. For entry-level positions, the main challenge is that few graduates have the necessary qualifications and skills to meet business demands.
The field of engineering helps illustrate this problem. China has traditionally rewarded more than half of its first university degrees in science and engineering (S&E) fields, and the number of graduates with a first degree in this area more than tripled between 2000 and 2008 (Figure 2). In several other major countries, this number remained relatively flat. Based on a 2005 McKinsey survey, however, less than 10 percent of China’s applicants were qualified for engineering work in multinationals, mostly because of their lack of experience in practical projects when compared with engineering graduates in Europe and North America. Language, overall communication style, and cultural fit were also frequently cited as the major reasons to reject Chinese applicants.
Although some traditional aspects of China’s education system—such as favoring theory and rote memorization over practice and critical thinking—are believed to have contributed to the skills mismatch, the higher education reform starting in 1999 that intended to quickly expand tertiary enrollment also played a role in the deterioration of educational quality. In the single-minded pursuit of size and revenue, many universities became less responsive to the changing demands of the labor market, leading to a large gap between the knowledge structure of college graduates and the skills needed in China’s increasingly complex economy. In recent years, 20-30 percent of college graduates failed to secure a job upon graduation, and many have lowered their expectations and taken jobs that high school graduates would qualify for.
The market for experienced hires is even more challenging. On top of the limited supply of talent with the right skills, the rapid growth of China’s domestic companies represents an additional hurdle for multinational corporations (MNCs). In the past, jobs at foreign firms, which usually paid more and offered better career opportunities than domestic firms, were viewed as a preferable career option by ambitious Chinese professionals. An interesting shift in attitude is occurring since the recession, however, as more Chinese companies—such as Lenovo, Haier, and Huawei—have risen to global prominence and recruit top talent aggressively. Western firms took a significant hit during the economic downturn and responded with a decrease in recruiting efforts. A report by the Harvard Business Review found that in 2007, 41 percent of highly skilled Chinese professionals preferred working for MNCs while only 9 percent preferred working for domestic firms. By 2010, the inclination for MNCs inched up to 44 percent, but the preference for Chinese employers soared to 28 percent, decreasing the gap from 32 points to 16 points. The report pointed out that factors of this change include the appeal of remaining in one’s own city and the perceived glass ceiling for local workers at MNCs (where senior positions are usually held by expats).
Prospects and Future Trends
China’s talent challenge will very likely continue and even intensify. On the one hand, the supply of tertiary-educated workers can be constrained by the slower labor force growth. On the other hand, the demand for highly skilled workers is expected to rise at a faster pace as China tries to climb the value chain, relying more on high value-added, knowledge-intensive manufacturing and modern service industries for economic growth.
Based on patterns of demographics, educational attainment, and demand growth, McKinsey projects that China’s shortage of college-educated workers will reach 23 million by 2020—or 16 percent of the demand—even though the number of workers with tertiary education will rise by 50 million over the next decade, raising the proportion of the labor force with higher education from the current 9 percent to 14 percent.
The manufacturing sector will experience a sharp drop in employment growth over the next two decades, adding just 18-20 million jobs, down from the 33 million jobs added just in the past decade. The share of the college-educated in the labor force, however, is estimated to double from 10 percent in 2010 to more than 20 percent in 2030.
The service sector will see accelerated job creation, adding 64 million jobs over the next decade in moderately and highly skill-intensive industries such as finance, business services, education, and health (Figure 3).
For multinational companies hoping to compete in China, getting the right talent strategy can represent a new source of comparative advantage. It is essential to have a deep understanding of how China’s labor markets and skills pools are evolving, and to engage in the business community’s efforts to collaborate with government and universities to create innovative ways of delivering education and training to help align the supply of talent with future demand.
 2012 China Business Climate Survey Report, AmCham China, http://web.resource.amchamchina.org/cmsfile/2012/03/26/c46fc22667c5eeb231748808a9244027.pdf.
 For details, see Investing in An Accelerating Asia? Asia Business Outlook Survey 2013, The Economist Corporate Network.
 Diana Farrell and Andrew J. Grant, “China’s looming talent shortage,” McKinsey Quarterly, November 2005, www.mckinseyquarterly.com/Chinas_looming_talent_shortage_1685.
 For detailed discussion, see Litao Zhao and Yanjie Huang, “Unemployment Problem of China’s Youth,” East Asian Institute, National University of Singapore, Background Brief No. 523, April 2010, www.eai.nus.edu.sg/BB523.pdf.
 Keith Bradsher, “Chinese Graduates Say No Thanks to Factory Jobs,” The New York Times, January 24, 2013, www.nytimes.com/2013/01/25/business/as-graduates-rise-in-china-office-jobs-fail-to-keep-up.html.
 Conrad Schmidt, “The Battle for China’s Talent,” Harvard Business Review, March 2011, http://hbr.org/2011/03/the-battle-for-chinas-talent/ar/pr.
 Richard Dobbs et al., The world at work: Jobs, pay, and skills for 3.5 billion people, McKinsey Global Institute, June 2012, www.mckinsey.com/insights/mgi/research/labor_markets/the_world_at_work.