My Blog

May 13, 2008

TUE 13 MAY

Demographic projections and trade implications By Michael Pettis

With yesterday’s bad April CPI number, the subsequent increase in minimum reserve requirements to 16.5%, and the slowing will-they-won’t-they appreciation of the RMB, it is tempting to stick to monetary topics in this and the next few blog entries, but regular readers know what I am going to say anyway.  First, inflation may get a little better in the next month or two (although I wouldn’t bet on it), but by now it is pretty clear, at least to me, that this is a monetary phenomenon and, given the continued recent expansion in the domestic money supply as reserves pile on, we are going to see non-food inflation surge in the coming months. 

 

Second, as far as the slowing of RMB appreciation is concerned, I bet this is going to be a very temporary phenomenon, and is probably largely a response to the dollar’s appreciation against the euro.  But this new strategy (or revival of a failed old one) is not going to improve the worsening monetary dynamics.  Reserves are going to continue to surge, driven increasingly by hot money rather than the trade surplus, and with inflation rising and still no sign of an economic slowdown it is just a question of time before the monetary authorities throw in the towel and go for the one-off appreciation.  Nothing else will work.  By the way last night I had dinner with a group of Chinese academics, including a very famous and influential finance scholar (who for obvious reasons shall remain nameless), and he said there was little doubt in his mind that a one-off revaluation was the only solution left to the country’s monetary problems.  Our only disagreement was that he said it should be a 10% jump, whereas I think that is too little and is only likely to encourage speculative inflows.

 

Interesting as all this is, however, in this blog entry I want to change the subject to something very different and with much longer-term implications.  I spent the last week going thorough historical and projected population data for China by age group, and the most interesting summary of the data I have put in the table below.  It shows the growth rate of Chinese population by decade (of course these are average annual growth rates for each decade), as well as the growth rate of subcomponents of China’s population.  Given the way the data is presented I am defining “Young dependents” as anyone 19 or younger, and “Old dependents” as anyone above the age of 65.  “Working population”, of course, is everyone else.

 

	1990-00	2000-10	2010-20	2020-30	2030-40	2040-50
Total population	1.00%	0.60%	0.60%	0.21%	-0.05%	-0.21%
Working population	1.72%	1.42%	0.40%	-0.26%	-0.60%	-0.49%
Young dependents	-0.51%	-1.50%	-0.30%	-0.44%	-1.36%	-0.41%
Old dependents	3.34%	2.43%	4.30%	3.51%	3.20%	0.62%

 

To summarize the raw numbers, China’s population is expected to grow from 1.32 billion today to 1.46 billion in 2030, after which it will decline slowly, to around 1.42 billion in 2050.  Its working population is currently around 840 million.  This component of the population will rise in the next ten years to around 910 million and then will decline quite rapidly to around 790 million by 2050.

 

The graph below shows the composition of China’s population by age group.  Needless to say the most dramatic change is the explosive growth of the over-65 population, followed by the decline in the share of the young.  Another way of understanding this is to note that China’s median age basically climbs over this period from 24 to 45 (which, by the way, may have favorable consequence for long-term political stability).

 

 

The graph shows the consequence of these differential growth rates on the age composition of China’s population.  Notice that the Y-axis begins at 50%, so the working population is much bigger than its share of the graph might indicate.  As is nonetheless evident, the real interesting story here is in the age composition, especially in the growth of the over-65 population.  In 1990 China had about 63 million people over the age of 65.  Today that number has grown to around 109 million.  The rate of growth really starts to pick up in the middle of the next decade so that by the year 2050 China is expected to have about 350 million people over the age of 65 – this, for comparison sake, is more than 15% bigger than the total current population of the United States.  The ratio of the elderly rises from 5% of the population in 1990, to 8% today, to an expected 25% in 2050.

 

The graph also indicates that, thanks to the baby boom in the 1950s and the implementation of the one-child policy beginning in the mid-1970s, China has enjoyed a huge demographic dividend beginning around 1970 or so, when people of working age comprised around 51% of the working population (one worker for every non-worker), to 2015, when they will comprise around 65% of the total population (one and one-half workers for every non-worker).  Their share is then expected to decline to around 56% of the population by the middle of the century.  During and after the 1970s, the working population exploded as the baby boomers joined the work force, but with very few children being born, even the very rapid growth among the elderly (thanks, I assume, to significant improvements in health care) meant that China’s working population grew much faster than its total population.  Even if worker productivity were constant (and it wasn’t – it rose dramatically), the consequence would be a sharp improvement in per capita income and living standards.

 

I don’t have the figures yet from before 1990, but looking at other sources I would guess that China’s working population grew by about 2% or more annually during the 1970s and 1980s.  In the 1990s, as the table indicates, the growth rate of the working population slowed to 1.72%, declining further in the current decade to around 1.42% on average.  The number of working Chinese keeps growing until around the middle of the next decade, and then begins to decline by about half a percent a year.

 

Actually these numbers might understate the change, since as China transitions from a largely rural society to a largely urban one I suspect that the definition of the working population becomes more rigid.  In a peasant and rural societies, in other words, the definition of working population is probably a lot more flexible, and many too-young people and too-old people do the same work that the working population does.  As the society becomes increasingly urban, however, young people are expected to go to school and old people to retire, so their contribution to the work force probably declines.  This suggests that the real working population may have grown a little more slowly in the past decade or so and may decline a little more rapidly in the coming decades than the age numbers indicate.

 

All this has important implications both for nominal growth rates and per capita growth rates in the next few decades.  For one thing, a country’s GDP growth rate can be expressed as a factor of the growth rate of its working population and the growth rate of average productivity per worker.  As the growth rate of the working population swings from positive to negative – by a little more than 2%, depending on what periods you compare – this will have a commensurate impact on Chinese GDP growth rates, i.e. all other things being equal (which of course they are not).  China’s equilibrium growth rate should be about 2% lower than the equilibrium growth rate of the past two or three decades.

 

The other thing worth noting is that beginning some time in the next decade, China’s working population will begin to grow more slowly (or shrink more quickly) than its total population, suggesting that the demographic dividend it has enjoyed during the past three decades will become a demographic tax.  Per capita income, in other words, will grow more slowly than the growth in worker productivity. 

 

Since total consumption is a function of the size of the total population and its income per capita, and total production is a function of the size of the working population and its productivity, the demographic relationship between total production and total consumption also will change.  Remember that a country has a trade surplus if it produces more than it consumes, and a trade deficit if it consumes more than it produces.  This implies that over the last three decades China has had a demographic bias towards trade surpluses (working population, a proxy for production, grew faster than total population, a proxy for consumption), but over the next three decades it is likely to have a demographic bias towards trade deficits.  

 

This doesn’t mean, of course, that China necessarily ran trade surpluses during the last three decades (in some years it ran deficits) and will necessarily run trade deficits over the next three decades.  Other factors, including most obviously changes in worker productivity and savings rates, matter too.  But it does mean that since demographic conditions contribute towards the relationship between consumption and production, in China we are going to see a switch in those conditions from a bias towards trade surpluses to a bias towards trade deficits.

 

Three years ago I argued in a Wall Street Journal OpEd piece that because of the aging and declining populations of Europe and Japan (and to a lesser extent China and Russia), compared to the growing population and relatively stable age distribution in the US, it was not unreasonable for the former countries to run large current account surpluses with the US since they would need the accumulated claims against the US to pay for the current account deficits they would need to run to manage their demographic adjustments.  This is why I have never been terribly worried about the sustainability of the US trade deficit.  In the next decade it is likely that demographic changes will create pressures to reverse those US trade deficits.

 

It also suggests at least one extenuating circumstance explaining the very mercantilist trade policies followed by the Chinese government.  As they are probably very aware of the dramatic demographic adjustments China will need to make in the coming decades, it is reasonable for them to want to accumulate claims against the US to pay for these adjustments.  Of course now, I think, their policies have caught them in a monetary trap from which it is very difficult to escape and which is causing balance sheet havoc.  Still, after their upcoming monetary adjustment, however painful, I expect them to continue favoring export oriented policies.  The only certainty about their demographic future is that there will be a difficult adjustment from a rapidly growing working population to a rapidly shrinking working population.