A Looming Crisis

The Brookings Institute’s Feng Wang authored an insightful report on the looming demographic crisis facing China.

In his article, Wang points out that China’s astonishing economic expansion over the past two decades took place within a highly, almost uniquely favorable demographic context. However, the time for reaping economic gains from a favorable population age structure is ending.

Economic growth relies on a number of basic factors, including capital, technology, markets, and labor. Foreign direct investment, especially from overseas Chinese, brought capital, technology and management know-how, and foreign consumer demand, especially from the United States, supplied a ready market for China’s export industries. But the country’s economic boom in the last two decades of the twentieth century relied on another crucial factor: a young and productive labor force.

This labor force was the product of a rapid demographic transition that was present as the Chinese economy was about to take off. The large birth rates of the 1960s and 1970s led to a workforce at peak productive ages when the boom began. This good fortune is estimated to have accounted for 15 to 25 percent of China’s economic growth between 1980 and 2000. But this is a non-repeatable historical phenomenon, and all this is about to drastically change.

The Line to Watch: 160 million

China is today the world’s most populous country, with 1.33 billion people, although in a little more than a decade, it will give up this title to India.  But the magic number to watch is 160 million, which describes 3 important current demographic realities:

160 million internal migrants: China’s internal migrants, in the process of seeking better lives, have supplied abundant labor for the nation’s booming economy.

160 million aged 60 or older. The total populations of countries like Japan and Russia do not reach 160 million, and Bangladesh’s population is roughly equal to that number.

160 million families have only one child, a product in part of the country’s three-decade-old policy limiting couples to one child each.

Dramatic Changes

But the these three Chinese population groups of 160 million are rapidly growing, and this change will redefine China’s position in the global economy.

Loss of Labor: The era of uninterrupted supplies of young, cheap Chinese labor is over. As a result of the country’s low fertility rates since the early 1990s, China has already begun experiencing what will become a sustained decline in new entrants into its labor force and in the number of young migrants.

Growth of Elderly: The size of the country’s population aged 60 and above, on the other hand, will increase dramatically, growing by 100 million in just 15 years – to 200 million in 2015, and doubling to over 300 million by 2030.  The latest numbers based on nationally representative surveys put life expectancy at birth at 74.5 years for females and 70.7 for males, levels that approach those of the world’s more developed countries. Longer life expectancy means more old people in the population and an increasing demand for services and expenditures related to health care.

Decline of Fertility: The number of families with only one child, which is also on a continued rise, only underscores the challenge of supporting the growing numbers of elderly Chinese. For nearly two decades, the average number of children a couple is expected to produce has been less than 2, recently falling as low as approximately 1.5. Such a number is below the replacement level (the level required for a population to maintain its size in the long run). Today the national fertility level is around 1.5 and possibly lower. In the country’s more developed regions, fertility has been even lower for more than a decade—barely above 1 child per couple, a level that rivals the lowest fertility rates in the world.

Although policy implementation has varied over time and across different regions, almost all urban Chinese couples have observed the one-child rule for the past three decades. With the current birth control policy in place amid continued low levels of fertility, by the middle of the current century, half of Chinese women aged 60 are projected to have had only one child, a development unprecedented in world history.

The Alarming Facts

A Rapidly Aging, Urbanizing Society:While China’s mortality rate has dropped to a level not very different from that of the developed countries, its fertility has dropped to a level lower than that of many developed countries, including the United States, Britain, and France and is among the lowest in the world. And the largest flow of internal migrants in world history, has created a population that is rapidly aging and rapidly urbanizing. Increased spending obligations created by the aging of the population will  shift resources away from investment and production, and test the government’s ability to meet rising demands for benefits and services. A declining labor supply and increased public and private spending obligations will result in an economic growth model and a society that have not been seen in China before. Japan’s economic stagnation, closely related to the aging of its population, serves as a ready example.

Gender Imbalance: A projected 20 to 30 million Chinese men who will not be able to find wives, due to the country’s decades-long imbalanced sex ratio at birth, may constitute a large group of unhappy and dissatisfied people.

Decline of Educated Workers: In 1995, primary schools nationwide enrolled 25.3 million new students. By 2008, that number had shrunk by one-third, to only 16.7 million. China had over 750,000 primary schools In 1990, but the number has fallen to about 300,000. In a country where getting into a university has always been a matter of intense competition and anxiety, the number of applicants to universities has begun to decline in the past couple of years.

Political Problems Ahead: Political legitimacy in China over the past three decades has been built around fast economic growth, which in turn has relied on a cheap and willing young labor force. An aging labor force will compel changes in this economic model and may make political rule more difficult.

Little Time to Prepare: The challenges posed by these demographic changes will be more daunting in China than in other countries that have experienced similar mortality and fertility declines. The reason is in the speed with which China has made the transition, achieving in 50 years a life expectancy increase from the 40s to over 70, something that took many European countries a century to accomplish. China completed its mortality-decline transition while per capita income was still at a very low level.

Similarly, the fertility reduction in China took even less time. In just one decade, from 1970 to 1980, the total fertility rate (TFR) was more than halved, from 5.8 to 2.3, a record unmatched anywhere. While in Western European countries, it took 75 years or longer to reduce TFR from around 5 to the replacement level, the decline took China less than 20 years.

Such a compressed process of demographic transition means that, compared with other countries in the world, China will have far less time to prepare its social and economic infrastructure to deal with the effects of a rapidly aging population. The challenge is all the more difficult because the country is undergoing an economic upheaval at the same time, continuing to transform itself from an agrarian to an industrial and post-industrial society and from a planned to a market-based economy. This means it will need to provide health care and pensions for a rapidly growing elderly population that has been covered under government-sponsored programs, and will need to figure out how to expand the scope of coverage to those who were not covered under the old system.

The End of the “Demographic Dividend”

The term “demographic dividend” is used to refer to gains or losses in per capita income brought about by changes in a population’s age structure, expressed as the ratio of the growth rate of effective producers to the growth rate of effective consumers.

According to Brookings, China has exhausted its demographic fortune as measured by the demographic dividend. Between 1982 and 2000, China enjoyed an average annual rate of growth in the support ratio of 1.28 percent. Using the World Bank’s figure of per capita annual income growth during this same period, 8.4 percent, the demographic dividend accounted for 15 percent of China’s economic growth. Today, the net gain due to favorable demographic conditions has declined to only one-fifth of that average level maintained from 1982 to 2000.

By 2013, China’s demographic dividend growth rate will turn negative: the growth rate of net consumers will exceed the growth rate of net producers. This negative growth rate will reduce the country’s economic growth rate by at least half a percentage point per year. Between 2013 and 2050, China will not fare demographically better than Japan or Taiwan, and it will fare much worse than the United States and France.

The Loss of China’s Labor Advantage: As a result of China’s very low fertility over the past two decades, the abundance of young, inexpensive labor is reaching an end. The number of workers aged 20 to 29 will face a precipitous drop will begin in the middle of the coming decade. Over a 10-year period, between 2016 and 2026, the size of the population in this age range will be reduced by about 25%, from 200 million to 150 million.

For Chinese aged 20 to 24, that decline will come sooner and harder, as, over the next decade, their number will be reduced by nearly 50%, from 125 million to 68 million. This shrinking of labor force entrants will have profound consequences for labor productivity, since the youngest workers are the most recently educated and the most innovative.

A Drop in Domestic Consumption: As the young population declines, domestic demand for consumption may weaken too, as young people are also the most active consumers of everything from wedding banquets to new cars and housing units.  And because China is a major player in the global economy, the impact of the country’s demographic changes will not be limited by its borders.

Growing Social Instability:  The size of the labor force, of the elderly population, and of the number of men who will not be able to marry are concerning for the country’s future economic growth and social stability. But the challenges that China will face go far beyond these concerns.

The social costs that China will need to pay as the result of the one-child policy, especially in terms of family support for aging parents, will be exceedingly high. Largely due to implementation of the one-child policy, China by 2005 had accumulated nearly 160 million only children aged 0 to 30. That number has further grown in the past five years. These figures imply that over 40 percent of Chinese households have only one child. That such a huge share of Chinese families have only one child presents serious economic and social risks for individuals, and for the whole society.

Chinese parents in the future will not be able to count on their children in their old age. And many parents will face a most unfortunate reality: outliving their children and dying alone. Given the current mortality schedule, the likelihood that an 80-year-old Chinese man will see his 55-year-old son die before he does is 6%, but because women live longer, the likelihood that an 80-year-old woman will outlive her 55-year-old son is 17%.

China’s Impending Collapse

China’s current TFR of 1.5 implies that, in the long run, each future generation will be 25% smaller than the one preceding it.  Given current mortality and fertility rates, and with a population age structure that is growing increasingly older, the number of deaths will soon exceed the number of births. China’s population is likely to peak less than 15 years from now, below a maximum of 1.4 billion. After that will come a prolonged, even indefinite, population decline and a period of accelerated aging.

Even if China can restore fertility to replacement level within 10 years after the country reaches its population peak, population will still exhibit a decline nearly half a century long, with a net population loss of over 200 million, if not more. The median age of the Chinese population, at its peak, could be as high as 50 years.

Why China is Different: Below-replacement fertility has become a new global reality in the past decade, and for more than half of the world’s population, in Europe, North America, and East Asia, below replacement fertility is now the norm. In the most extreme cases, such as Italy and Japan, population could be reduced by half in as few as 40 years or so if current trends persist.

What makes China unique, however, is that it still has a state policy, unique in human history, that restricts the majority of Chinese families to one child per couple. It was instituted 30 years ago as an emergency measure to slow down population growth intended to last for only one generation,  but the government has not yet shown the willingness to phase it out. This lack of recognition and inaction in the face of an impending demographic crisis persists despite appeals by almost all the country’s population experts to phase out the one child policy quickly.

The Root of China’s Problem: Poor Management: This reflects an entrenched, unrealistic leadership, and resistance from the country’s birth-control bureaucracy, which formally employs half a million people. China’s management.

In the final analysis, it reveals the Chinese regime’s most serious shortcoming, which, according to Brookings, is “relegating difficult, long-term, structural challenges to the back burner, while giving priority to short-term crisis management and concerns about stability.” It seems they’ve learned much from the West after all!

China Watchers See Signs Now

Slowed Growth: Already, the signs of instability appear to be showing. Some economists have raised fears of a so-called hard landing in China, in which economic growth slows sharply. Others believe the government still has plenty of room to act, especially since rapid inflation is not a problem.

As reported in Barron’s, after three decades of annual growth averaging 10%, China’s economy is slowing markedly. As of this post, prices are tumbling in China, and China’s economic growth has started to slow amid weaker global demand. Economic problems in Europe and the U.S. are hurting export growth that has long been the primary driver of China’s economic success. Growth in industrial production has been decelerating for months. This year growth in gross domestic product could slip to 8%—and it may get even worse from there. Though recently announced interest-rate cuts and a ramp-up in the government’s already massive infrastructure spending could keep the economy moving along, many already anticipate that “the Great China Growth Story may be falling apart.”

Barons cites a comprehensive report by Nomura Global Economics issued late last year entitled “China Risks” that provides a scenario in which China’s growth could fall by half to under 4%.

Already cracks are becoming more and more apparent in the seemingly adamantine façade of the Great China Growth Story that may well deter China from surpassing the U.S. in the near future—or ever. One can only remember the triumphalism extant about Japan’s prospects 25 years ago just before its economy went into a two-decade funk.

Barons cites Wall Street short-seller Jim Chanos, who has placed negative bets on the stocks of major Chinese banks, real-estate developers, and international mining concerns that are major suppliers to the Chinese. Chanos holds that China is headed for a hard landing of epic proportions because of its shaky financial system and an imminent collapse in its property market, which undergirds the entire economy. “I’m being conservative when I say that the coming bust in China’s real-estate market will be a thousand times that of Dubai.

According to Barrons, even some of the longtime bulls are concerned about China’s future, including William Overholt, an Asian scholar who worked at Asian investment-banking posts, think tanks, including the Rand Corp., and academia who is now a senior research fellow at Harvard’s Kennedy School.

Poor Governance: Overholt finds that the economic and political reform movement of the Jiang Zemin/Zhu Rongji era (1993-2002) has flagged badly over the past 10 years causing giant state-owned enterprises like energy colossus Sinopec, telecom giant China Mobile, conglomerate Norinco and integrated steel maker Baosteel to become overly dominant in the economy. Due to oligopoly positions, implicit government guarantees, cheap credit, tax breaks, and subsidized access to cheap raw materials, they have been squeezing out small and medium-size companies in the more innovative private economy that caters to the export market.

These firms have close family and financial ties to China’s ruling party clique. Overholt states that unless this favoritism is curbed by the incoming administration of Xi Jinping,  China faces the prospect of long-term stagnation potentially far worse than that of Japan faced 20 years ago. But Japan entered their economic crisis at a time of affluence and greater technological sophistication, with a per-capita annual income that was eight times that of China’s current $5,000. Overholt cautions:

The bulk of Chinese high-tech products and indeed exports that come from foreign companies with plants domiciled in China, and they don’t have to stay there. I’ve been championing the China growth story in various academic papers and publications for 30 years, including a book called The Rise of China in 1993, but I don’t want to be a permabull when a great historic trend may or may not be changing.

Increased government spending on infrastructure is, for now, offsetting a slowdown in household consumption. But as the chart below suggests, a burst property bubble would inflict severe damage on China’s economy.

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What About the Rest of Us?

Regardless of the current economic cycles, the fundamental instability of the Chinese economy is a fact that the rest of the world needs to come to terms with. And China is facing massive, long-lasting demographic changes that portend an inevitable crisis that will affect the entire world economy. The question economies and political systems around the world need to start asking is how they will be affected, and how they need to adjust their own policies in response.

Related Articles:

The Coming Collapse of China: the 2o12 Edition (Foreign Policy.com)

Why China Will Have An Economic Crisis (Time Business)

Chang: Chinese Collapse Coming (Video) (Fox Business)

China Slows Down, And Grows Up (New York Times)

China’s Looming Economic Crisis (Foreign Policy In Focus)

China’s Housing Market is Set for a Hard Landing (CNN Money)

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