A Surprising Threat to China's Economy

Despite recent economic data that somehow keeps surprising to the upside, there are numerous concerns about the sustainability of China's economy.

Some of the major ones include the excessive growth of credit over the past five years, staggering levels of overcapacity in several key industries, heavily indebted local governments, wasteful state-owned enterprises that continue to siphon money away from savers, and the threat of social instability if economic growth were to slow sharply.

But there is another major headwind that is less frequently discussed and may actually surprise a lot of people -- the end of China's so-called "demographic dividend."

The end of cheap Chinese labor?
For decades, China's economy has prospered in large part because of a massive supply of cheap labor. Workers from rural parts of the country migrated to the cities to find employment, mainly in manufacturing. Until recently, manufacturing wages in China remained comparatively low, which attracted multinational corporations in droves.

For instance, Apple (NASDAQ: AAPL  ) shifted many of its manufacturing operations to China starting in the early 2000s to capitalize on the region's much lower labor costs, though CEO Tim Cook recently announced that the company is planning on shifting some of its manufacturing operations away from China this year.

Other electronics companies with manufacturing operations in China are also retrenching lately. For instance, Nokia (NYSE: NOK  ) , which currently has two main factories in China, recently laid off some workers in its Dongguan factory as part of its cost-cutting strategy.

Part of the reason many companies are downsizing their operations in China is that Chinese labor is not nearly as competitive as it was a decade ago. According to Helen Qiao, Morgan Stanley's chief economist in Hong Kong, real wages for Chinese manufacturing workers have increased by nearly 12% per year over the previous decade.

This shouldn't come as a surprise. As in any developing economy, there comes a point where the supply of cheap surplus labor starts to fall and the bargaining power of workers rises. Named after the Nobel Prize-winning economist Arthur Lewis, this point is referred to as the Lewis turning point. It looks as if China has reached -- or is very close to reaching -- this turning point.

And because of the country's unique demography, things are unlikely to get any better on this front.

Fewer new workers
Over the past three decades, China's fertility rate -- defined as the number of children a woman can expect to have if she lives to the end of her childbearing years -- has been in general decline. It has plunged from about 2.6 to around 1.6 currently, which is substantially below the rate required to maintain a steady population.

According to The Economist, the low fertility issue is especially prevalent in the richest parts of the country. For instance, Shanghai registered a fertility rate of just 0.6 in 2010, which places it among cities with the lowest fertility rates across the globe.

Going forward, this looks unlikely to change, irrespective of any future amendments to the country's one-child policy. In fact, the UN projects that the nationwide fertility rate will continue to fall and estimates that it will be around 1.5 over the period 2015-2020.

While this 0.1 decline may seem insignificant, it actually has massive implications for a country's demography, especially for a nation of nearly 1.4 billion people. The Economist notes that even with the optimistic assumption that the fertility rate begins to recover, China's population is projected to decline slightly, from 1.34 billion in 2010 to an expected 1.3 billion by the middle of this century.

And with the more realistic assumption that the fertility rate remains ultra-low, China's population is projected to be less than 1 billion by 2060. That would imply a drastic reduction in the supply of new workers, which -- despite strong improvements in worker productivity -- could greatly hinder the potential of China's economy.

An aging population and its implications
On top of fewer children being born, China is aging rapidly. Three decades ago, The Economist notes, the country's median age was 22, which is common among developing countries. But currently, the median age stands around 35, which is more commonly seen among richer, more developed countries.

The combination of fewer children being born and a rapidly aging populace means that China's median age can be expected to increase to nearly 50 by 2050. That's higher than the projected median age of 40 for the U.S. by that date, and approaching Japan's expected median of just over 53.

This is worrying stuff. Japan's fiscal situation is clearly burdened by an increasing number of pensioners. The country's rapidly aging population is one of the biggest sources of stress on its public finances, which have ballooned out of control over the past couple of decades. In fact, Japan now has the highest debt-to-GDP ratio of any country in the developed world.

But Japan is a rich country and has been for quite some time. The average Japanese worker's wages are more or less in line with wages in other developed countries, coming in at around $34,000 in 2011 according to the World Bank, which places it just below the United Kingdom and France.

China, by contrast, is far from a wealthy country, despite the hordes of fantastically wealthy Chinese businessmen so often profiled in the media. According to World Bank data, China's per capita GDP in 2011 was a little over $8,000, which places it in the company of countries like Jamaica and the Dominican Republic.

At its current level of population aging, where nearly 10% of its population is over the age of 65, China is likely to grow old before it grows rich, making it the first major economy to encounter such a problem. Other rapidly growing Asian countries, such as Japan and South Korea, had income levels twice and three times as high, respectively, when they reached a similar level of population aging.

A lot more boys than girls
The skewed gender ratio is another issue whose impact is likely to be felt sometime soon. Most countries generally have a more-or-less equal share of men and women, typically reporting between 103 and 105 baby boys for every 100 baby girls. But according to official statistics, China had nearly 120 boys for every 100 girls in 2005

Unless current rates of economic and income growth are maintained for the foreseeable future -- an unlikely proposition -- these little boys could very well evolve into tens of millions of low-income, unmarriageable men. That's probably suboptimal, regardless of what country you're in.

Final thoughts
To sum it up, China is undergoing profound demographic changes that are likely to limit the potential growth rate of its economy. In particular, the major changes include a sharp decline in the supply of new labor, a rapidly aging population, and a growing gender imbalance.

Going forward, the combination of a smaller workforce and a rapidly aging population pose a double whammy to China's economy. Not only will there be fewer workers to sustain the economy, but there will also be many more retired persons, which places an additional burden on the Chinese government's already stressed coffers.

Despite these demographic developments that will play out over the next few decades, the rapid growth of mobile and Internet users in China is an indisputable trend. Apple, which calls China its largest market, is at the center of technology's largest revolution ever and has already rewarded longtime shareholders with gains in excess of 1,000%. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple, and what opportunities are left for the company (and your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.


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  • Report this Comment On February 27, 2013, at 6:17 AM, nudnyk wrote:

    About time for the Chinese people to start spending money on good old American chachkes, as they get more free time. Movies, oversized cars, junkfood, beer, Malboro and Coca Cola.

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