This article from Economist magazine offers some good counter-arguments to the misguided view that China is running out of it's surplus labor (or cheap labor in mass media) as reports spread that factories in coastal China were finding it difficult to find workers even with wage increase (this was before the current global economic slowdown):

WHAT is the single most important price in the world? Popular answers are the price of oil, American interest rates or the dollar. Yet Chinese wages are, arguably, more important. China has by far the world’s biggest labour force, of around 800m—almost twice that of America, the European Union and Japan combined. Thus recent claims that it is running short of cheap labour would, if true, have huge consequences not just for China, but also for the rest of the world.

A seemingly unlimited supply of cheap workers has been one of the main forces behind China’s rapid economic growth. But over the past couple of years, factory owners have complained of labour shortages and wages have risen more rapidly, leading some to conclude that China’s “surplus” labour has been used up. The country’s one-child policy, introduced in 1979, has caused the growth in its labour supply to slow sharply (see chart). After rising by 1.3% a year during the decade to 2005, the population of working age is expected to increase at an annual rate of 0.7% until 2015, and then shrink by 0.1% a year until 2025. At the same time, the shift of workers from agriculture to industry, which has been an important source of productivity gains, will also slow. Jonathan Anderson, an economist at UBS, reckons that these two trends will reduce China’s sustainable growth rate from 9-9.5% today to 7-7.5% by 2025.

But as well as boosting growth, the flow of workers from farms to factories has held down manufacturing wages—not only in China, but also throughout the world. The theory behind this was first expounded by Sir Arthur Lewis, an economist from St Lucia, who won the Nobel prize for economics in 1979. He argued that a developing country with “surplus” (ie, underemployed) rural labour could expand industrial employment for many years without causing wage inflation, because employers enjoy such a large supply of labour. During the first 50 years of Britain’s industrial revolution, real wages remained more or less flat while profits soared. Likewise in China, as millions of migrants have quit the countryside for urban factories and construction sites, the real wages of low-skilled workers barely rose during the 1980s and 1990s, despite big productivity gains; only recently have they increased rapidly.

This acceleration of wages has prompted some to conclude that China’s surplus labour in the countryside has been used up. Last year Cai Fang, the director of the Institute of Population and Labour Economics at the Chinese Academy of Social Sciences, argued that China has reached the “Lewis turning point”. By 2009, he predicted, there would be a widespread shortage of workers, pushing up industrial wages. Does this mean the death of China’s growth model?

As so often in China, this debate is clouded by the poor data. Until recently, most estimates of surplus labour varied between 150m and 200m people. But the true figure is probably much smaller, because government figures for the rural labour force include millions of migrants who have already moved to cities and others who work in rural industry, not farming.

In addition the population is ageing: the number of workers aged between 20 and 29 fell from 233m in 1990 to 165m in 2005. Many textile and electronics firms hire only young women in their 20s, as they are thought to be less troublesome and more willing to work long hours. Construction firms favour young single men. Older people are not only less employable, but they are also typically less willing to migrate if they have children. After taking account of this, Mr Cai estimates that China’s surplus labour has been virtually exhausted.

But Stephen Green, an economist at Standard Chartered, thinks that talk of China’s vanishing labour surplus is premature. In a report this year he argued that the surplus would not run out for another decade. Although the number aged between 20 and 29 fell over the past decade, their ranks are now rising again. Using the 2005 census, Mr Green estimates that the 20-something group will increase by a third in the ten years to 2015, as baby-boomers’ children join the workforce (see right-hand chart); only then will it start shrinking sharply.

What is more, the recent spurt in urban wages is not necessarily proof that the surplus has gone. Mr Green argues that to attract migrant workers, urban employers have to pay more than rural income, which has increased in recent years, thanks to government policies and higher food prices. The temporary increase in the age group between 20 and 29 over the next few years will also ease the upward pressure on urban pay.

The World Bank agrees that China’s labour surplus has not yet run out. Even when the number of young people drops, the labour supply is determined by more than demographics. Migrant workers are usually excluded from urban social-security schemes and have to pay more for education and health care. The bank suggests that phasing out the household-registration system would encourage more people to move to the city. Vocational training for rural residents aged over 30 would equip them better for jobs in industry. And financial incentives to encourage workers to retire later could also boost the labour supply: only 60% of men and 30% of women aged over 50 have jobs.

Moreover, Mr Cai’s estimate of China’s labour surplus assumes that 180m workers, or 24% of total employment, are needed for farming. But that is based on today’s agriculture. Mechanisation and the consolidation of land plots will boost productivity, meaning that fewer farmers will be needed. That will in turn release more workers for industry. In developed countries only 3% of workers till the land.

China’s surplus labour will eventually dry up, but it still seems some years away. In any case, that moment should be cause for cheer not fear in China and elsewhere, because it will lead to bigger gains in income and consumption. That, after all, is the whole point of development.