Demographics Is Destiny - The Big Picture In China

by: Simon Daly


- China benefited from one-off historical demographic trends that are now beginning to work against it.

- China’s mission to transition its economy from fixed asset investment to a consumption-driven model are as much driven by necessity as from design.

- The west’s confidence that China can quickly regain or surpass its historic growth is misplaced.

August Comte famously said that 'demographics is destiny' and there is no greater corollary of this today than China. In recent years, China has been nearing the completion of a 35-year mass migration policy that was the largest rural-to-urban migration ever to take place in history. This policy began in the early 1980s with the aim of transitioning the country from a largely rural agrarian society to become an urban-based manufacturing and export-led economy.
By 1990, urban dwellers represented 26% of China's total population rising to 36% by 2000 before jumping to 51.27% over the next decade. China's National Bureau of Statistics reported in January 2016 that the migrant population had a net migration of 5.6m people in 2015 - the first such number in 30 years. Below is an infographic from the Financial Times showing migration on a county and city level, based on data from China's 2010 census. It shows the % difference between the registered population of an area, and how many people the census takers found in 2010.
The End of Surplus Labour
The change in net migration marks the ending of surplus labour in China and this will have a profound impact on the economy. The transition is tied to an economic theory called the Lewis Turning Point, which China likely reached in 2004. The effect of passing the turning point is seen in the slowdown in the flow of low-paid migrants into urban factories. This fundamental shift in the supply and demand of the labour force leads workers to demand higher wages.
As a result, low-cost manufacturers are forced to raise prices or are forced out of business, ultimately slowing export growth and investment. China has benefited enormously from the social dividend that surplus labour and urban migration brought about. This new reality will be a powerful macro trend in China's future and is likely to be the dominant effect of China's rising middle class. So while many observers discuss China's transition to a consumption model has been a largely centrally-designed process, it is also strongly borne out of the necessity of this economic reality. Take note of China bull Ha Jiming (Goldman Sachs' Chief Asia Strategist) comments that:
"The economy will rebalance as exports slow due to rising factory prices. Investment will have to slow. That's exactly what we're seeing in real estate and manufacturing." So while the mainstream view is that China's centrally planned system's control over the economy's factors of production gives it much leeway in the transition towards consumption driven demand it is clear that rising factory prices causing exports to slow will force local government administrations to reduce fixed asset investment".
Powering an Infrastructure Boom
This 30-year period of mass migration coincided with the largest and fastest infrastructure development program in history. China built cities, roads, railways, ports and houses at breakneck speed. Mckinsey estimates that between 1990 and 2011, China invested on average 8.5% of GDP into infrastructure development, more than Europe or the US combined. Below is a graphic from Mckinsey comparing China to the global average.
China 'doubles-down' after 2008
By the time the global financial crisis hit in 2008, China's urban housing stock value to GDP ratio stood at 217%. As part of the central government's response to the crisis, real estate investment was prioritised. This had the effect of turning the previous boom in construction development into a bubble. Mortgage and down-payment rates were reduced and local government revenues were made dependent on land sales. By 2013, the urban housing stock value to GDP ratio had increased to 248% with total housing stock more than doubling. The below chart shows data from the CEIC showing residential gross floor area under construction (k sqm).
Systemic Externalities
China could not have experienced such a rapid rate of growth in such a short space of time were it not for its authoritarian system. The prevailing view in the west is that the system 'gets the job done' and allows China to circumvent many of the problems that western democracies face during expansionary periods. However, China's economic system has created massive excess, waste and corruption. After 2008, the regulatory system incentivized loose lending policies and allowed development permission to be based on political influence.
As a result, China's construction boom didn't wait for demand to catch up. By 2011, The Economist's Intelligence Unit calculated that only 44.9% of China's population lived in urban areas, but the construction boom had already created per-capita residential space that approached that of the UK, which had 90% urbanization and an average disposable income level many times greater than China.
This excess led to China's 'ghost city phenomenon'. In 2007, then Premier Wen described the situation in the country as "Unsteady, unbalanced, uncoordinated and unsustainable." Research by investment firm Kynikos Associates showed that by 2011, China had 30bn square feet of office space under construction, which equated to a 5ft x 5 ft office cubicle for every man, woman and child in the country.
China's migrant population had grown to 221m by 2011 (expanded further to 247m by 2015).
The central government policy of decentralising urban development to local administrations created excess and waste with planning policy failing to keep pace with the social and economic realities of urban life for migrants. Under the Hokou residency system, migrants are categorised as second class citizens and generally their social protection entitlements are tied to their home towns. In many cases, migrants are forced to move to cities to escape land grabs.
The resulting poverty, lack of access to education and affordable accommodation has created divides in China's society and led to social unrest despite strict control over the internet.
China's Great Demographic Challenge
One-Child Policy
China's one-child policy, originally introduced in the 1970s has been one of its greatest policy missteps. After seeing little early effect, strict family planning programs were introduced and by the early 1990s, the policy had taken hold. China's birthrate dropped from 4.77 births per woman in the 1970s to 1.64 in 2011 before falling to 1.41 in 2013. A level of 1.3 is often referred to as the 'low fertility trap' below which it has historically been very difficult for countries to return to replacement levels of fertility.
Through this period, the policy had the effect of accelerating China's economic transition by increasing the working-age population and lowering China's dependency ratio (the ratio of the population aged 65 and over to the working age population). This had the effect of adding to the demographic dividend gained through mass urban migration. The lower dependency ratio increased the rate of capital formation and the growth of the working-age population. Between 15% and 25% of China's growth since the 1970s is attributable to this. Below is a chart from the FT showing historical and projected population growth rates in comparison to India.
Peak in Working Age Population
China's working age population (aged between 15-64) peaked in 2010. According to the UN's 2015 World Population Report, the median age of the Chinese population will increase from 37 years in 2015 to just under 50 years by 2050. As a result, the working age population will decrease from slightly more than 1 billion in 2015 to about 800 million by 2050. This will produce a profound change in China's old-age dependency ratio - from 0.13 to 0.47 over this period. Below is a chart from the Financial Times showing the projected decline as a % of total population.
Policy Response
To address the effects of this shift, China will need to develop a comprehensive national social care system. A move in this direction was made with the drafting of the National New-Type Urbanization Plan, 2014-2020. The plan emphasizes community-based old-age care facilities, consolidated around a family-based old-age care system. To lower the financial burden on the economy, the plan proposed gradually increasing the retirement age, but such a move is unlikely to have a lasting impact.
Overall, the plan faces a structural problem in China's population. China's urban population consists of those who possess urban household registration and those who don't (termed 'Hokou'). China's migrant population was 247m in 2015, the majority of whom are considered Hokou. This system is designed to prevent migrants from settling permanently in cities to prevent the build-up of large slums. Hokous are condemned to a 'floating life' for decades in many cases, unless they can afford to bribe the local administration for residency status.
Under the plan, the government has stated its intention to register 40% of the current migrant population by 2020. However, this is a real catch 22 situation for the central government. By depleting the floating population by 40%, it will be removing a massive tool from its economic arsenal. Having the ability to migrate its population en masse to regions that were designated for economic growth was a major advantage in China's explosive growth.
China benefited from a uniquely favourable demographic context that allowed it to expand exponentially over the past two decades. However, this is an unrepeatable historical phenomenon. Its young and productive work force made China the world's factory and booms in the west (first with the dot-com boom and then the housing and stock market booms) provided ready markets for China's export industries. China was uniquely fortuitous that this demographic transition was in place just as it break-neck growth was about to take off. In the future, these trends will be significant burdens on China's economy.

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