It is well known that China faces an ageing problem. The popular narrative has it that China surged up the growth league tables on the back of its giant population, reaping years of demographic dividends to become the world’s second largest economy. In this narrative, China’s population is now ageing and so the growth story must come to an end.
We explain why we think this is only partly right; there is no question that China is ageing, but we disagree that this necessarily spells a disaster for growth or investors.
China’s working age population has peaked
As the chart below highlights, the peak in China’s working age population has come and gone. From here the workforce will shrink.
A look at the median age over time reveals how rapidly China has aged, and will continue to age. On this measure, China will become older than the US in 2021, and will be as old as Japan is today by 2045. Meanwhile, current GDP per head is a little under $10,000 in China, against $40,000 in Japan, and $60,000 in the US. To reach US levels of GDP per head by 2035, China would need a herculean 13% annual growth rate. But just because a country is old before it is rich does not mean it can never become rich.
Maintaining growth momentum
Looking at the elements that contribute to economic growth – labour, capital (e.g. investment in machinery) and productivity – it seems that an increase in the labour force made a sizeable contribution to Chinese GDP in the past. More recently, its contribution has lessened with advances in productivity and investment in new machinery having more of an influence.
This suggests that just because the labour pool enters decline, it does not mean growth has to stand still or fall. China can still rely on capital growth and technological progress to grow richer.
A boost to productivity from urbanisation
One boost to labour productivity over time has been the urbanisation process. Urban workers are typically much more productive than their rural counterparts, with manufacturing a more productive sector than agriculture in terms of contribution per head to GDP. Official data estimates the primary sector (including agriculture) contributes around 19,000 renminbi (RMB) per head to GDP. Meanwhile the secondary (manufacturing) and tertiary (services) sectors contribute around 177,000 RMB per head. If urbanisation continues and more labour is directed towards manufacturing and services, GDP per head could be considerably boosted.
The chart below shows the urbanisation experience of the US (which has a similar geographical scale to China) and Korea (a more recent example). If China follows theses trends and its population continues to migrate to towns and cities, support for higher economic growth could come from this source.
Adding more people, and machines, to the workforce
In 2013 the International Monetary Fund forecast that China’s surplus labour will be exhausted between 2020 and 2025. Boosting labour force participation could push back this date.
Taking China as a whole, labour force participation is reasonably high. However, looking at the over 50s, comparisons with Korea and the West are unfavourable. Complete convergence would see an addition of around 50 million workers in 2030, or 5% of the forecast workforce.
Adding to the capital stock (i.e. the plant, machinery, equipment and other assets) to raise productivity is also equally feasible, up to a point. To give a hugely simplified example, more machines mean workers can produce more goods. There is currently a $110,000 per head gap between Chinese and US capital stocks. Assuming these converge, this would imply there is still scope for a great deal more investment.
Apparent from our analysis is that China has managed to grow, and can continue to grow, at a robust pace independently of changes in the size of its labour force. The ageing of the workforce will take time to become a noticeable drag and can be partially offset by labour market reforms aimed at boosting participation rates amongst older workers. Far more important for the Chinese growth story is the productivity of the workforce, not its size.
Reforms are of key importance. The Made in China 2025 policy is an attempt to move up the value chain of production, in doing so greatly boosting the productivity of both capital and labour. The goal is for China to be a dominant manufacturer in high value, high tech, industries such as robotics, AI (artificial intelligence), aviation and new energy vehicles.
Land reform is another key imperative. In our view, agricultural productivity is held back in part because of state ownership of farm land which means farmers cannot sell or borrow against it. Stronger ownership rights might foster investment or allow farmers to join up smaller land holdings to create larger, more efficient, farms. However, the concept of private land ownership clashes with Communist Party ideology.
Allowing the free market to allocate labour and capital on the basis of the returns they can generate, could be another game changer. This was much discussed, to great global optimism, in 2013, but the impetus has since faded.
In conclusion, we believe investors should worry less about the supply of workers and pay closer attention to reform of China’s markets. Given the right policy mix, China’s demographic decline should be less of a problem than it appears. The challenge is achieving that policy mix under a leadership that sees part of the solution as politically unpalatable.
This article was previously published by Schroders on 16th April 2019.