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China will now allow parents to have three children. This decision came soon after new census data showed that the population growth rate in that country had slowed down to the lowest level since the 1950s, when millions had died in a famine caused by Maoist economics run amok. There was also a lot of buzz before the official numbers were released that the Chinese population may actually have decreased in the second decade of this century. The relaxation in family planning rules comes just five years after the Chinese government allowed parents to have two children.

The latest estimates from the United Nations suggest that China will have 112 million fewer people by 2050. Its population will also age rapidly. The median age is expected to increase from 38 years in 2020 to 46 years in 2050, or where Japan is right now. Most demographers say that the Chinese labour force has already peaked, which means that the number of people retiring is higher than the number of people joining the country’s labour force after completing their education.

The ongoing demographic shift in China—the most populous country—will likely 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 such as India. China used its massive labour force to emerge as the factory of the world, first churning out cheap consumer goods, followed by the assembly of more expensive stuff through global supply chains.

Chinese wages are now rising as the pool of cheap labour shrinks. Many estimates suggest that China has already shifted from being a labour-surplus to a labour-shortage economy, or what has been described as a ‘Lewis turning point’ after the economist Arthur Lewis, who theorised about how the process of development essentially involved the shift of surplus labour from traditional to modern sectors of the economy.

The Lewis turning point in China will be a cue for global supply chains to shift to other parts of the world in search of cheaper labour. India is a prime candidate to benefit from this, if it plays its cards well, though there will be stiff competition from countries such as Vietnam, Mexico, Bangladesh, Indonesia and several others.

The other big shift in the Chinese economic strategy will depends on what happens to the rates at which it saves as well as invests. China at one point saved almost half its national income. That was more than it needed to maintain its high investment rate. The difference between the two is the current account surplus, which has raised much global anger in recent years. What could happen to the Chinese current account surplus after its demographic transition is complete?

Much would depend on how the two drivers of trade surpluses—savings and investments—move in the coming years. China can continue to earn more dollars from the rest of the world than it spends to fund its imports, in case the expected decline in the savings rate is matched by a decline in the investment rate, leaving the difference between the two largely unchanged. However, a sharp decline in the Chinese investment rate will lead to a parallel decline in its rate of economic growth in the coming years, unless its economy becomes more productive in the way it uses its resources. The ongoing technology war with the US should be seen in this context.

A third possible impact will be on real interest rates, not just in China but across the world. There are three criss-crossing trends to look out for. First, the reality of higher longevity can force workers to save more for their decades in retirement. This is especially true of countries such as China that do not have adequate social security. These higher savings should apply downward pressure on real interest rates.

Second, the flip side of an ageing 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 people who have retired will spend down their stock of savings to maintain their lifestyles. Public savings could also decline in case the Chinese government has to ramp up fiscal spending to provide social security to its growing number of senior citizens. This will have the exact opposite effect. There will be upward pressure on real interest rates.

Finally, investment in new machines with a declining labour force will lead to a higher ratio of capital per worker. The standard neoclassical theory suggests that the marginal product of capital will decline in such a situation, or the output that every new unit of capital can produce will be on a downward path. To the extent that real interest rates are dependent on the marginal product of capital, they will likely decline.

China is currently the most populous country in the world, its second largest economy, and its biggest supplier of global savings. The demographic transition that has begun there can have deep implications for economic growth, global supply chains, financial markets and even geopolitics. It is something that Indian policymakers as well as strategists must pay attention to.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics

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