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This column originally appeared in Forbes.

Dexter Roberts wrote recently in BusinessWeek that more than 25% of this year's university graduates in China have failed to find a job. Meanwhile executives at nearly a hundred multinationals recently told my firm that their biggest challenge for growth is recruiting and retaining talent. At more than one-third of the big businesses we talked to they said their annual employee turnover is 30%. In the U.S. 11% turnover is considered too costly because of the expense of recruiting and training; 9% is just right for getting new ideas into an organization and getting rid of dead wood.

Citigroup (NYSE:C) has announced that it wants to triple its number of Chinese employees to 12,000 within the next three years. Businesses from Goldman Sachs (NYSE:GS) to Intel (NASDAQ:INTC) to Microsoft (NASDAQ:MSFT) are trying to add workers at a furious pace--and they are having problems doing so. How can that be, when so many Chinese university graduates can't find jobs? How can there be such a disconnect?

Nearly every aspect of Chinese society has undergone meaningful reform in the last three decades, from freedom to work anywhere in the country and open a business and marry by choice to individual human rights, but higher education (and health care) lag woefully behind. Class sizes are too big, teachers teach by rote, and students are not given the interdisciplinary liberal arts education they need, as I wrote in "Where China Most Needs to Improve." Rather, students typically focus on a single discipline, like accounting, for their entire four years of college, leaving them unable to adjust to a global business environment that demands flexible thinking. They are bright and eager, but unprepared to work effectively for a global corporation.

My own firm, the China Market Research Group, is actively hiring but simply can't grow as fast as we want and as the market is demanding. For every thousand résumés we receive, we find perhaps two candidates who are qualified. Our standards are extremely high, but many multinationals are facing the same problem.

China's education system needs to change and change fast if China is going to prevent social instability and ensure a steady transition from low-cost manufacturing to a more service-oriented economy.

Most analysts point to China's growing income gap and the rural-urban divide as the main causes of social instability in the country. We certainly should be concerned about poor people from a humanitarian standpoint, but if China starts to suffer from real social instability, it will most likely come from a disenfranchised middle class unable to realize its dreams. From the French Revolution to the Chinese one, most revolutionary leaders have been university-educated, middle-class people who were marginalized by society and had their hopes thwarted. The truly poor rarely cause massive instability. They don't have the means to stop working--they work to eat--and they don't have the ability to rally large groups.

Although the number of university graduates in China has risen from 1 million a year a decade ago to more than 6 million this year, the number of people entering the labor pool with great expectations yet without proper training is, if anything, growing even faster. Young Chinese under the age of 32 have watched their country emerge as an economic superpower, and they feel they deserve to share in its economic success. They want to be able to buy BMWs, iPhones, Estée Lauder cosmetics and homes of their own.

What happens if they can't? Getting them good jobs, not just any jobs, needs to be a major priority. As more underqualified university graduates hit the labor pool, they'll pose a growing stability risk if they can't get good jobs.

The situation is not yet dire. Most graduates do eventually find decent jobs, but the problem will increase as more of them hit the labor pool or if the economy stalls.

Furthermore, if China is to transition to a more service-oriented economy, as it wants to do, it will have to have better-trained workers for that. The country cannot and does not want to remain a low-cost hub for manufacturing. More and more younger workers are no longer willing to work for low wages in blue collar positions, and the high costs of real estate are pricing low-cost manufacturing out of China.

Moreover, the government is getting serious about pollution and is shutting down or pressuring high-polluting and high-water-usage industries. Observers in the Western world get it wrong about why the government is consolidating industries like mining, steel and dairy. Westerners think that means the government wants the state to take more control over the overall economy. In fact, consolidation is happening because the government believes it can ensure better pollution oversight, labor conditions and quality control of production processes in large state-run enterprises than in the multitude of tiny private businesses that cut corners in pollution controls and make mistakes like getting melamine into the dairy supply chain.

For China to truly transition to a service economy and produce products high up the value chain with real innovation--as the government has made a priority in fields like aircraft, and clean technologies--it must have the business minds that can lead the way there. That all starts with reforming the educational system by adopting more interdisciplinary thinking. If China's workers are to realize their dreams, and if China is to become what it wants and needs to become, the country needs to make drastic changes to its education system, and make them soon.

Disclosure: No positions

Source: China's Surprising Unemployment Problem