China: Population Decline = Growth Headwind

22 January 2023

In addition, China’s shrinking population will continue to shape both the nation’s long-term economic strategy, and the government’s short-term policy focus. In particular, with inflation low, monetary and fiscal policy will need to remain stimulative. However, government spending priorities will need to be altered dramatically. This shift will not only support China’s cyclical recovery, but also would advance the key goal of rebalancing the economy towards the consumer and services.

Long-term, boosting productivity growth will be critical to limiting the slowdown in the nation’s growth potential. Consequently, China’s government will continue to prioritise the expansion of the technology sector. As geo-political pundits increasingly believing that conflict between the USA and China is inevitable, China’s need to lift productivity may provide an opportunity for greater cooperation. We’ll see about that. Of course, the structural deceleration in China’s long-term growth potential will create challenges for both the Asian and global economy.

Population Slump Defines Economic Priorities

The slump in China’s birth rate following the introduction of the One-Child policy is largely responsible for the declining population (Chart above). However, the ending of this program in 2016 has not prevented a further decline in fertility rates. Indeed, China’s government may discover it was easier to restrict family size with sanctions than it is to incentivise greater procreation. In addition, the sharp decline in China’s birth rate during the pandemic may also shed light on how devastating the lockdown has been to confidence in the future.

The Chart at the top of the blog illustrates that China’s population demographics compared unfavourably to many other key nations. In particular, the US population continues to rise, supported by immigration, from which China does not benefit. Indeed, China’s experience most closely mirrors that of Japan, which contributed to the secular growth slowdown in that country (Chart above).

With its population and labour force declining, will capital spending prevent slowing long-term growth prospects? Not likely. First of all, the government’s long-term aim is to reduce the economy’s reliance on unprofitable over-investment. Indeed, the previous borrowing binge has produced unsustainable corporate debt levels (Chart above). Despite the surge in public sector lending to State-Owned enterprises during the pandemic (in 2020 especially), the government recognises the clear need for business deleveraging. Some progress was made in 2022, but the process may be a growth headwind for several more years.

As a result, improving productivity must be the key driver of China’s future economic prosperity. Unfortunately, however, China has not been spared the world-wide slump in efficiency following the Global Financial Crisis (Chart above). President Xi’s “China 2025” program recognises the urgent need to expand the domestic technology sector and boost efficiency. Of course, this has the potential to produce conflict with US (and other) competitors. However, perhaps it also creates opportunities for collaberation, e.g. easing the rules for joint ventures in the local technology market, etc. Perhaps.

Will the Post-Lockdown Economy Surge?

With the rapid reduction in Covid restrictions, economists now expect GDP growth to accelerate to an above-trend pace of 4.5% during the Year of the Rabbit. I have my doubts. In addition to the long-term headwinds discussed, the economy has little momentum as 2023 begins. Indeed, GDP slowed to only 2.9% YOY in Q4 2022 (compared to 3.9% in Q3), and recorded no growth at all on a QOQ basis. The lack of impetus was widespread, but the consumer was especially weak — retail sales declined 2.8% during the last three months of the year (next Chart). Meanwhile, reflecting the weakening global economy, exports ended 2022 on a weak note: foreign sales slumped 6.3% during Q4 2022 versus a 7% rise for the year overall. As a result, industrial production advanced a meagre 1.3% in December versus 2022’s 3.6% overall gain.

The consumer holds the key both to China’s near-term cyclical rebound, and to the long-term rebalancing goal. To be sure, Chinese households do have large amounts of precautionary savings accumulated during the pandemic (and even before). Unleashing pent-up consumer demand will require, first of all, that Covid cases do not pick up on a sustained basis. Given the low level of consumer confidence, the population may not be quickly convinced.

In addition, monetary and fiscal policy will need to remain stimulative. With inflation remaining low, PBOC interest rates are likely to remain unchanged in 2023, even as other central banks continue to tighten monetary conditions. Unlike the past, however, rising public sector debt limits the space for fiscal expansion (Chart above). Therefore, the public sector must establish budgetary goals. As usual, the government channelled funds into SOE investments during the pandemic, while support for households remained limited. This contributed to the pandemic-era surge in corporate borrowing, while consumers retrenched. In support of both the near-term recovery and its medium term deleveraging objective, therefore, the government’s priority should be to reallocate spending away from SOEs and towards households.

China’s declining population underscores the urgency of this transition. China’s pension, social security, health care and unemployment safety net is less generous than many key G20 and emerging nations. Providing greater security for China’s aging population would lead to lower precautionary savings — exactly the formula for near-term economic recovery, and rebalancing over the medium term.