China Enters Demographic Danger Zone

From an IMF
Working Paper released this January: (emphasis by the
Wrongologist)

China
is on the eve of a demographic shift that will have profound consequences on
its economic and social landscape. Within a few years the working age
population will reach a historical peak, and then begin a precipitous decline.
This fact, along with anecdotes of rapidly rising migrant wages and episodic
labor shortages, has raised questions about whether China is poised to cross
the Lewis Turning Point, a point at which it would move from a vast supply of low-cost workers to a labor shortage economy.

What
is the Lewis Turning Point? Sir
Arthur Lewis, a Nobel economist, found in 1954 that industrial wages rise very quickly once the supply of
excess rural labor is exhausted. The Lewis Turning Point is when the supply
of workers dries up and city wages soar. It is when labor turns the tables on
capital, and profits crash.

Crossing the Lewis Point would have far-reaching
implications for China, most
notably, inflation. Without the
flow of excess rural labor, wages are going to go up in China, causing chronic
inflation. When wages go up, productivity levels fall.

The corollaries to increased
wages and lower productivity are slower GDP growth, higher consumption, lower
savings and a deteriorating current account surplus. In fact, the world
economy is rebalancing before our eyes: China’s
current account surplus has fallen from 10% of GDP to just 2.5%, although still
a large number.

The IMF paper concludes that the transition to a labor
shortage economy will occur between 2020 and 2025. At that point, China’s demographic
dividend will be exhausted. The IMF report says the reserve army of peasants
looking for work peaked in 2010 at around 150 million. The numbers are now declining.
The surplus will disappear soon after 2020. A decade after that, China will face
a labor shortage of almost 140m workers, surely the biggest jobs crunch the
world has ever seen.

Combine
this problem with the statistics for China’s elderly: They will number 200
million in just three years and top 300 million by 2025. By 2042, more than 30%
of China’s total population will be over 60. The implications for China’s social
policy and the growing need for safety net spending are obvious.

Ambrose
Evans-Pritchard of the Telegraph writes: (emphasis by the
Wrongologist)

There is little
Beijing can do to head off the shock. The effects of low fertility rates – and
the one child policy – are already baked into the pie. It would take half a century to turn around the demographic
supertanker.

The process
is under way. It may explain why Chinese equities are trading at a third of
their 2007 peak in real terms. Manufacturing pay has risen 16% a year over the
last decade in the East Coast hubs of Shenzhen, Beijing, Shanghai and Tianjin, although
it slowed in 2012.

Boston Consulting
Group says that “productivity-adjusted wages” were just 22% of US levels as
recently as 2005. They are forecasted to be 43% by 2015.

As the
Wrongologist reported
in December, labor cost is a key reason why General Electric, Ford, Caterpillar
and others are “re-shoring” to the US some manufacturing from China,
though cheap shale gas, a weaker dollar, and lower shipping costs also play a
part.

Remember, this is still just a thesis, not
a fact.
But, the numbers do seem to confirm that labor shortage and wage pressures are
having an impact on China’s macro economy. Japan hit this inflection point
fourteen years ago, but by then it was already rich, with $3 trillion of net
savings overseas. China has hit the wall a quarter century earlier in its
development path.

Of course, this is the Chinese dilemma: If they hadn’t practiced
population control, it would have been standing room only in the country by
now.

This is a
dangerous moment for Beijing. The Lewis Point tests catch-up economies like
China: What happens when they can no longer rely on cheap labor, copied
technology, and export-led growth to keep the game going?

Success on
the global level depends more on technology, the rule of law and the free flow
of ideas. Failing to add these attributes to China’s portfolio will cause a slide
into a middle income trap, where others have gone. The Soviet Union failed. The
Philippines, which was richer than Korea in the 1950s, failed. Most of Latin
America failed in the 1960s and 1970s, although it seems that Argentina and
Brazil are succeeding this time.

However, there is no global labor shortage. The Wrongologist wrote in October, 2011,
citing the book, The Coming Jobs War:

Of the 7 Billion people on earth,
5 Billion are aged 15 and older
Of that 5 billion, 3 billion say
they work, or want to work
Today, there are only 1.2 billion
full-time, formal jobs in the world
This is an 1.8 billion job
shortfall compared with the 1.2 billion who are working

Of
the 3 billion who work or want to work, 50% are currently seeking a formal job,
while another 10% are looking for part-time work.

So,
China could quite
easily import cheap labor from anywhere, if they wish to remain on the cheap
labor, export-led growth path. However, their culture is a barrier to
succeeding with immigrant labor.

Alternatively,
they could outsource. Again, outsourcing is not in their current management bag
of tricks.

One thing
is for sure: China, with a shrinking work force, the threat of both inflation
and lower GDP growth, is not likely to displace the United States as the globally indispensable leader.

We are
certain to see at least one last cycle of high Chinese growth before their aging
crunch, inflation and the coming credit hangover combine with toxic and
possibly, permanent effect.

Food for
thought. Make mine moo-shu.

Next, we will
examine China’s need for coal, their coming water shortage, and how those forces will
act as yet another brake on China’s GDP growth.