China will now allow parents to have three children. The move came shortly after new census data showed that the country’s population growth rate had slowed to the lowest level since the 1950s, when millions of people died in a famine caused by Maoist economic madness. There was also a lot of buzz before official figures were released that China’s population may in fact have declined in the second decade of this century. The relaxation of family planning rules comes just five years after the Chinese government allowed parents to have two children.
The latest United Nations estimates suggest that China will have 112 million fewer people by 2050. Its population will also age rapidly. The median age is expected to drop from 38 in 2020 to 46 in 2050, or where Japan is now. Most demographers say China’s labor force has already peaked, which means the number of people retiring is higher than the number joining the country’s labor force after completing their education.
The demographic change underway in China, the most populous country, is likely to have a profound economic impact in several ways. The most widely discussed of these economic changes is its direct impact on the Chinese development model, and the ripples of that in countries like India. China has used its massive workforce to become the factory of the world, first producing cheap consumer goods, followed by the assembly of more expensive products through global supply chains.
Chinese wages are now rising as the pool of cheap labor shrinks. Numerous estimates suggest that China has already moved from a labor-surplus economy to a labor-shortage economy, or what has been described as a “Lewis turn” according to the author. economist Arthur Lewis, who theorized on how the development process essentially involved the movement of surplus labor from traditional sectors to modern sectors of the economy.
Lewis’ turn in China will be a signal for global supply chains to move to other parts of the world in search of cheaper labor. India is a prime candidate to benefit from it, if it plays its cards well, although competition will be stiff from countries like Vietnam, Mexico, Bangladesh, Indonesia and many others.
The other big change in China’s economic strategy will depend on what happens to the rates at which it saves and invests. At one point, China saved almost half of its national income. This was more than necessary to keep its investment rate high. The difference between the two is the current account surplus, which has sparked a lot of global anger in recent years. What could happen to China’s current account surplus once its demographic transition is complete?
Much will depend on how the two drivers of trade surpluses – savings and investments – evolve in the years to come. China may continue to earn more dollars from the rest of the world than it spends on financing its imports, in case the expected fall in the savings rate is accompanied by a fall in the investment rate, leaving the difference between the two virtually unchanged. However, a sharp drop in China’s investment rate will lead to a parallel decline in its economic growth rate in the years to come, unless its economy becomes more productive in the way it uses its resources. The ongoing technological war with the United States must be seen in this context.
A third possible impact will be on real interest rates, not only in China but around the world. There are three cross trends to watch out for. First, the reality of higher longevity may force workers to save more for decades of retirement. This is especially true in countries like China which do not have adequate social security. This increase in savings is expected to put downward pressure on real interest rates.
Second, the flip side of an aging population is that there will be fewer workers as a proportion of the whole. Such an increase in the dependency ratio will also affect real interest rates, as retirees will spend their savings to maintain their lifestyle. Public savings could also decline should the Chinese government increase its budget spending to provide social security for its growing number of elderly people. It will have exactly the opposite effect. There will be upward pressure on real interest rates.
Finally, investing in new machinery with a declining workforce will lead to a higher ratio of capital per worker. Standard neoclassical theory suggests that the marginal product of capital will decrease in such a situation, or that the output that each new unit of capital can produce will be on a downward trajectory. To the extent that real interest rates depend on the marginal product of capital, they are likely to fall.
China is currently the most populous country in the world, its second largest economy and its largest provider of global savings. The demographic transition that began there can have profound implications for economic growth, global supply chains, financial markets, and even geopolitics. This is something Indian policymakers as well as strategists should pay attention to.
Niranjan Rajadhyaksha is a member of the Academic Council of the Meghnad Desai Academy of Economics
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