China's Demography and Economic Development

By Claus Vistesen

Well Edward's recent post has certainly stirred up a nice batch of interesting and thoughtful comments. Here I would simply like to add my own two cents worth to the general overview. Now as Edward has already noted, back in August 2007 Keith Bradsher had a good article in the NYT in which he makes the much cited connection between rising wage costs and rising import prices from China thus pointing to end of global labour arbitrage and what has been known as the Great Moderation. Of course, the picture is a bit more complex than this or as Scott Peterson notes in a recent comment, it may simply be a question of China trying to move up the value chain;

It seems that now that China has raised the standard of living for a sizable chunk of its workers, the rest of the work force isn't willing to accept the difficult working conditions that gave China its manufacturing cost advantage. This puts China in the same stage of workforce condition as Western countries. By that I mean that holders of capital can't find workers willing to take jobs at the wage on offer, so the country must either import workers willing to work at that wage as the US has done with agricultural workers, or outsource the work to foreign labor. Since bringing foreigners in is politically and practically nonsensical for China, the work goes overseas.

In fact, China may not in fact be lacking labour as such but there does indeed seem to be a lack of young labour with respect to ensuring the continuation of the Chinese growth model where investment and cheap factory capex have been the main driver. It still is of course but now the ill-wanted companion of inflation now seems to be slotted in on the passenger seat threatening to pull the gear lever and the steering wheel to make the car stray off the road. Paraphrasing Edward in his quote of Keith Bradsher the following is a fine summation of the problem at hand ...

"Plant owners’ refusal to hire blue-collar workers over 35 or 40 is colliding with the demographic reality of China’s one-child policy".

The evidence presented so far seems to be confirmed if we move into the world of academic journals. Indeed a recent paper published in 'China and the World Economy' entitled A Counterfactual Analysis on Unlimited Surplus Labor in Rural China precisely starts out by what it terms "debunking" the myth of the unlimited supply of surplus labor from Rural China.

The paper is about more than that however and opens up the very pertinent question as to how China is to integrate the rural regions with its coastal urban counterparts and how to manage the flow from one end of the value chain to other. At the heart of this rapid depletion of Chinese labour resources is then first and foremost the very rapid economic development which in itself has feasted upon the cheap labour supply. However, in the background of all this the one-child policy has surely and steadily exerted its effect and now the curves might just be intersecting.

And the result? Well, there now seems to be mounting evidence that growth is being increasingly accompanied by ensuing effects on wages costs, with inflation grapping a tight hold not least because the composition of China's population is changing at a time where China is thundering ahead at double digit speeds. China's demographic profile and by derivative its fertility patterns are notoriously difficult to get a hold on. In a paper from March 2007 (Population and Development Review) four Chinese scholars embark on the formidable task of extracting an overall pattern from the very heterogeneous nature of Chinese fertility regimes as they vary between provinces ...

At both the prefecture and province levels, policy fertility ranges from the one-child rule to a policy that allows two children and more. At the same time, birth control regulations drafted and implemented by China’s provinces allow numerous kinds of exemptions to the one-child rule, based on considerations ranging from the demographic to the political. These results highlight the complex nature of Chinese birth control policymaking and implementation. Both regional and demographic distributions of policy fertility show that the mode of the policy falls into the category of 1.3 to 1.5 children per couple (38 percent of the prefectures and 53 percent of the population, respectively). The majority of the Chinese population (more than 70 percent) live in areas with a policy fertility level at 1.3 to 2.0 children per couple.

(...)

Based on local fertility policies and corresponding population distributions, we estimate that the overall average fertility targeted by the fertility policies for China as a whole is 1.47 at the end of the 1990s. This level is far below replacement.

The difference between policy and actual action has been frequently cited in a Chinese context as couples have attempted to circumvent the official policies to have more than one child. However, on the other hand it also seems that especially fertility rates in urban are persistently underestimated. The picture we are left with is that the TFR is (and has been for around a decade) in the region of 1.5 (with the pessimists tending towards 1.3 and the optimists 1.7). In the grand scheme of things these numbers are not so important when it comes to pointing out a path for China's population in the immediate future. What we know is that China is now set to age very rapidly and that the composition of the population will undergo a change of historical proportions as China - irrespective of what happens to economic development now - is set to join the league of economies with a steadily rising median age. In fact, China's size here aids us tremendously in our analysis as immigration to mitigate the effects is completely out of the question due to the size of the Chinese population.

All this does not of course spell doom for China but it does mean that China is now entering a new stage of its economic development process. As Edward points out and as is echoed by this piece by one of the blogosphere's main China savants Michael Pettis this means that the number of young workers (aged 15 to 19) is now set to steadily decline as a proportion of China's population. We also know that the demographic changes will come very swiftly now and there do not seem to be many remedies on the table at this point. And those that we have are simply not adequate I am afraid - and to pick (perhaps unfairly) on one - I could refer to Yi Zeng's paper from June 2007 in which he sketches the 'options' for a fertility transition bringing China out of the vice of below-replacement fertility.

(...) the author concludes that China needs to begin a gradual modification of its fertility policy as soon as possible. He proposes a three-stage "soft-landing" strategy for fertility policy transition: (1) a 7-year initial smooth transition period; (2) from approximately 2014-15 to 2032-35 a universal two-child policy combined with late childbearing in both rural and urban areas; (3) after 2032-35 all Chinese citizens would be free to choose family size and fertility timing. This strategy will enable China to have much more favorable demographic conditions and socioeconomic outcomes, as compared to keeping the current policy unchanged.'

If we leave aside the rather dubious point that Chinese women are programmable robots who can actually be submitted to such a transition we also need to consider the speed with with the current process is moving along. The suggestion above simply denotes an understanding of the demographic transition which is wholly out of sync with the way it actually works in the real world. I won't be picking extensively on this paper and if anything we should be acknowledging the fact that this is actually narrated as a problem which needs to be addressed. Yet, we also need to understand that given the trajectory of China's demographics and its rampant growth rates any actions, on this front, taken in a post 2015-2020 perspective will literally be subject to such long term projections before they may have a concrete effect that it does not, in a scientific or policy related context, makes sense to discuss their merits.

So what the hell am I getting at here?

In the main, I have tried to take sketch, or take proprietorship of, the part of the discourse on China's economic development and its role in the global economy which should be specifically related to demographics. But how does it link in with the general narration of China in the global economy? Well, demographics are not destiny and you should not leave this note thinking that this is what I am advocating. However, there is mounting evidence that once fertility (TFR) drops into the 1.5 region and stays there for a prolonged period the forces of demographics steadily and rapidly begin to take center stage as one of the main macroeconomic explanatory variables.


In China's case this becomes rather preoccupying. In this way and if we return to my introductory remarks I would argue that the rapidly changing demographic profile of China quite simply is at odds with all those changes we believe China is to make in order to, as least partially, lead the process of global macroeconomic adjustment. In fact, there may be a rather worrying precedent for the process China is now set to enter. If we consequently peer a bit to the West from the Chinese mainland we run into Russia and then further on the Eastern European economic edifice. What we have seen in this region since the end of 1980s is a process by which these countries have been in a veritable race against time to move up the value chain fast enough to escape the burden of completely lopsided demographics as fertility collapsed in the beginning of the 1990s and outward migration steadily began to drain their labour markets (Russia is an exception here). This process is now set to come to a very abrupt standstill prompted by the simple fact that these countries are now out of road in terms of having qualified labor to continue to process.

Moreover, the process itself has been one which rampant inflation and wage costs have followed in the heels of the build-up of large negative external positions. And what is at the heart of this then? Well, surely it is not all about demographics but in the main I think it is. In essence these countries have quite simply not had the demographic profiles to support the massive expectations of growth opportunities which were vested on them in an external context and whatever importance we ascribe to institutional reform (and nobody can argue that this is unimportant) the speed by which this has happened has left traditional reforms completely helpless in keeping up.

Allow me then to end this piece on a rather ominous note. I don't deny for a minute that China needs to correct, not for a minute and 'yes Virginia, exchange rates do indeed matter'. However, the global economy also has a distinct stake in not allowing China to enter on a road like the one we have seen in Eastern Europe. It takes a strong back bone to act as the global importer of last resort and at the heart of that backbone is a strong demographic profile. Yet, if China now is on the path of engaging in a breathtaking race against time to fulfill the obligations to become the new consumer driven nation of the world we at least need to look at what the potential consequences could be. One common fallacy in this respect would be how an appreciation of the Yuan would have a mitigating effect on inflation and overheating pressures. Of course, this is what theory tells us and I think that everybody can see that a revaluation is badly needed at this point. But such an adjustment process would also require that China invested more of its reserves in the domestic economy as well as foreign money and goods would come pouring in at a pace which itself could stoke a lot of bubbly tendencies. At the end of the day, I may be too pessimistic here.

Recent data out of China show that income is growing and that domestic demand is booming as a consequence. That is good. But if the process is too fast and too abrupt lingering inflation is likely to take hold and that would not be welcome by any standards. In a more immediate context I have this year's Olympic games as a sort of litmus test. There is no doubt that China will race through this at her traditional pace but what happens afterwards?


Post script ...

China and her economy obviously command a lot of attention in the general debate, and as ever it is difficult to find the time to read everything. I therefore suggest you go for quality. Brad Setser and his global imbalances watch is a must and even though Brad and I have our little ongoing "exchange rates v demographics" argument I still think that he is indispensable. Another author you need to read here is Michael Pettis (who recently had a guest posting spell on Setser's blog). Michael writes exclusively on China and you would be hard pressed to find a better one-stop source. Finally, this small space tracks the quarterly journal China in the World Economy and last (and you can decide for yourselves whether it is by any means least or not) Edward and I have our small China Economy Watch which we will be updating on an ad-hoc basis.