Business Spectator (Australia)
October 3, 2012
by John Lee
Talk of the so-called China dominated Asian Century ignores one important factor in the equation: China like the rest of northeast Asia is a rapidly ageing zone. As the grandfather of the region, most of the attention is on Japan. In terms of the implications for the power balance into the future, much more attention should be paid to China. While the fact of China ageing is well known, less appreciated is what this actually means for the future of Asia's largest and most rapid rising power. 'Demography is not destiny' as French sociologist Auguste Comte once said. But it does shape the future prospects for countries gradually but relentlessly, and on this account, China is in trouble.
When China began its reforms in 1979, there were around seven working persons for every retiree. The current ratio is about 5.5 for every retiree. By 2015, more people will formally leave the workforce than enter it. And by 2035, there will be 2.5 working persons for every retiree. Put differently, 40 per cent of the population will be of retirement age in 2035.
The age profile of the working population also matters since workers tend to be at their most productive from the late 20s to their mid-40s. By 2035, there will be 4.5 older workers (50 to 64 years old) for every three younger counterparts (15 to 29 years old) which is the direct reverse of the situation currently.
It is also extremely difficult to reverse these trends. For one, China's ageing population is largely the result of the dramatic increase in average lifespan, which increased from under 65 years old in 1980 to 75 years currently. The declining fertility rate from just under three children per woman in 1980 to about 1.5 in 2011 also represents changes in the rising lifestyle and expectations of many Chinese families. Because of the 'one-child policy' in place since 1979 – combined with the widespread Chinese preference for sons over daughters – the number of child-bearing women is now artificially limited. There will be a surplus of about 40 million men of marriageable age by 2020.
China is far from alone in facing an ageing demographic, even if its one-child policy means that the rapid rate of ageing puts the country in unchartered territory. The certainty that China will be the first major country to grow old before it grows rich (or even moderately so) is a function of its low economic base resulting from the disasters of the Mao Zedong years, and the modern increase in life expectancy.
But one cannot solely blame Mao's terrible legacy or even the three decade old one-child policy for China's looming predicament. The country's policies since the early 1990s have resulted in outcomes that leave the country woefully unprepared for its ageing demographics despite the sustained period of economic growth.
Such pessimism appears at odds with the fact that China's economic expansion has dramatically outpaced population growth since 1979. Per capita income has increased from less than $US200 in 1980 to $US7800 currently. Based on current growth rates, GDP per capita should reach middle-income levels of around $US16,000 in a decade's time.
However, focusing only on dramatic increases in GDP per capita is a highly misleading indicator of economic and social progress in the country for two reasons. First, in China's state dominated economy, revenues of the country's estimated 150,000 state-owned-enterprises have been rising at an average of 20 to 30 per cent each year since the mid-1990s. It is estimated that half of all domestic savings in the country's financial system is by SOEs.
In contrast, mean household incomes have been rising by 2 to 3 per cent over the same period. Worryingly, the accumulated findings of various studies suggest that the disposable income of some 400 million Chinese have actually stagnated to gone backwards over the past decade. Currently, more than half of the population still live on less than $US2 per day.
Second, dividing national output by the number of people each year gives no indication of how wealth is actually distributed throughout the country. In reality, when considering measurements of income distribution such as the Gini-coefficient, China has gone from being the most equal society in all of Asia to the least equal in one generation. Its Gini-coefficient level has deteriorated from 0.25 in the 1980s to 0.38 in the 1990s to over 0.5 currently. As a comparison, India's is 0.37, the US is 0.43, Japan's is 0.38 and Russia's is 0.42. The bottom line is that even though Chinese households have the highest savings rates as a proportion of disposable income of any major economy in the world, the amount saved will not be sufficient for the majority of retirees.
The fact that high growth countries like India have managed to maintained a steady Gini-coefficient throughout the last decade of rapid growth is suggestive that the particular growth model, rather than rapid growth itself, is a major cause of inequality. Indeed, medium household income in the first decade of Chinese reform (1979-1989) was rising at similar rates of economic growth and inequality did not worsen during that period. It was only after state-corporatism took hold in the mid-1990s that income inequality accelerated.
The link between both suppressed household income and dangerous levels of income inequality on the one hand, and the country's state-dominated economy on the other is unmistakable. In a system where around 150,000 SOEs receive the lion share of capital and market opportunity at the expense of tens of millions of private corporations and informal businesses means that a relatively small number of well-placed and connected 'insiders' benefit disproportionately from the current growth model.
The gains of the corporate state at the expense of the household sector are also entrenched through other related policies. For example, the need to provide for oneself in old-age is one reason behind the high savings rate. Since there are no alternatives, savings are deposited into state-owned banks and attract extremely low interest returns (around 1.5 per cent over the past decade.) State-owned banks extend the majority of their loans to SOEs at below market rates, most of which goes into fixed investment. In other words, the country's struggling households are effectively subsidising the investment activity of the country's bloated and inefficient SOEs. These reasons, incidentally, are also the same ones behind the low rates of private domestic consumption in China.
The country's unpreparedness is only exacerbated by the reality that only around 15 per cent of Chinese workers, mainly from SOEs, have some form of pension fund. For the majority without a pension, studies indicate that more than half will depend overwhelmingly on their children in their old age – putting significant pressure on the disposable income of future Chinese generations that could otherwise underpin the transition towards a consumption-led economy. Even now, more than half of the living expenses of the average rural retiree are met by family transfers, with one quarter of expenses met by family transfers for urban residents.
What is the bottom line for China's next generation of leaders?
For starters, growth through ever increasing levels of capital and labour inputs will not do the trick. Capital factor productivity has been declining for a decade, and the seemingly endless supply of young, cheap labour will gradually recede. Moreover, large advances in labour productivity and innovation are extremely difficult to achieve in poor ageing societies – particularly where rule-of-law and intellectual property rights are poor. Across all economies, productivity and innovation (alongside adequate investment in human capital such as in education) tends to continue to improve significantly for workers in the 30s and 40s before levelling off. Even if China increases the retirement age towards 70 years old, the productivity and innovation gains from doing so will be relatively slight.
Second, sustained economic growth based on productivity gains is only one part of the solution. The other is to ensure that across-the-board household incomes increase faster than GDP growth. In other words, there needs to be a massive transfer of assets and opportunity from the state-owned towards the private sector. This would entail an enormous SOE privatisation drive, although such policies will be pointless if well-connected families are the ones snapping up shares in SOEs as occurred during the 1990s and earlier this decade.
Forcing state-owned banks to lend on merit rather than on policy and political considerations will also allow millions of private firms the opportunity to prosper (at the expense of less efficient SOEs). In addition to granting private domestic firms equal access to the most lucrative domestic markets, doing so is the most effective way to maximise the chances that households will have acquired enough wealth to look after themselves in old age.
All these solutions will be bitter pills for the country's future leaders to swallow. The loss of SOE dominance will have uncertain political implications for the Chinese Communist Party. Meaningful economic reforms that would enhance the capacity of Chinese households to provide for themselves in retirement will severely dilute the economic relevance of the CCP, and cause and immediate and dramatic decline in output during the transition.
America, India, and Indonesia have far better age demographic trends than China well up to 2050. China will always be an important strategic and economic player because of its absolute size. But betting on the Asian Century being a Chinese dominated one is beginning to look unwise.
John Lee is a Hudson Institute Visiting Fellow and an Adjunct Associate Professor and Michael Hintze Fellow for Energy Security at the Centre for International Security Studies, Sydney University. He is the author of Will China Fail? (CIS, 2008).
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