Demographic Change is One Reason Why China’s GDP Growth is Slowing

With the IMF recently changing its forecast of China’s GDP growth for 2015 to 6.8% there has been much surprise expressed.  Yet one of the most significant determinants of the trend of a country’s GDP, demographics, has been indicating this downward trend for some time now and it should not really be a surprise.  Furthermore, the same factors indicate that for the decade 2015 to2025 the average compound growth rate will fall to 4.5% per annum (although short term stimulus can move year on year growth rates around that trend).

Demographics influence GDP growth rates through the following variables; The number of workers and the change in the productivity of those workers and that in turn is a function of resources available to the worker (Accumulated Fixed Capital Investment) and skill (education) level of the worker. This Insight will look at the expected trend of these factors.

Labour Force Size

The size of a country’s labour force is itself a function of two variables. One of which can be forecast with high reliability, the other is subject to some potential change. The first variable is the size of the working age population. That is the number of persons being of an age when they can, (if they want/are able to) work. This has typically been defined as 15 to 64 years but as discussed below, that is no longer an appropriate definition. The second variable is the propensity of a working age person to be employed. Not all persons of working age work. This is for a variety of reasons, but the reality is that propensity to work is changing over time and in the case of more affluent and educated societies with longer life spans the change is quite considerable.

In the case of China, the number of persons aged 15 to 64 years (which is traditionally defined as working age) is now 1.004 Billion, but with the ageing of the population it inevitably declines to 975 million by 2025.  If the more appropriate working age definition of 15 to 74 is used, then the working age population actually increases to 1.1 Billion.

The Rural scenario

However, there is a significant differential between urban and rural populations.  The rural working age population (15 to 74) is currently estimated at 437 million and the combination of an ageing population and rural urban migration means that it is expected to reduce to 313 million by 2025.  That is a 29% decline in the ‘key resource’ of working age persons.

The second factor affecting the size of the rural workforce is propensity to be employed.  On this measure China has one of the highest rates in the world.  For rural populations 87% of 15 to 64 years olds are employed and 2% of 65 to 74 years old.  This is projected to decline for the younger set to 85% by 2025, bit increase significantly for the older (65 to 74 years) to 8% by 2025 given the trend of the last decade and also simple demand for farm workers. The net effect is that even though propensity to be employed is relatively stable the overall number of rural employed persons is projected to decline from 345 million in 2015 to 231 million by 2025.  That is a drop in 33% and in order to maintain total rural output the productivity per worker would need to increase by that amount.  That is around 4% per annum.

The Urban scenario

The Urban picture is quite different.  As a result of rural to urban migration the working age population (15 to 74 years) is projected to continue to grow – from 658 million now to 803 million in 2025.  This is a 22% lift which is a lot but is less than the previous decade lift of 47%.   It is slower because the number of rural to urban migrants is reducing per annum, and also the base on which the growth is calculated is increasing in size.

The second change in the urban areas is the propensity to be employed.  With increasing affluence and the relaxation of the one child policy to allow two children to parents with an urban hukou, it is expected to result in the propensity to decline slightly – from 68% to 66%.  Again like rural, the propensity of the older working age person (65 to 74 years) is expected to continue to increase – from 3% to 10%.

The net effect of these changes in the urban population indicates that the urban labour force will continue to increase in size – but, at a much slower rate than the previous decade.  Total employed is expected to lift from 416 million to 474 million.  A growth rate of 1.3% per annum compared with 3.9% per annum for 2005 to 2015.  So good news in that the most productive workforce (urban is about 3-4 times more productive than rural based on relative wage rates) is still growing but bad news in that its growth rate is slowing.  Furthermore, that trend will continue into the next decade – where there is virtually no further growth in the urban labour force between 2025 and 2035.

Total Labour Force

Figure 1 shows the historic and projected size of the urban, rural and total labour force of China for the period 2015 to 2035.  It demonstrates how the overall workforce declines, but all of this decline is rural in nature.  It also shows how the growth of the unban labour force will decline significantly from 2015 onward.  These changes are almost inevitable as most of the people included in this forecast are already alive and hence the future age profile (working age population) is inevitable.  The propensity to work is more variable – but with increasing affluence the trend is likely to be more downward than upward.

Figure 1: Projected Trends in Total Population, Employed, Dependents and Working Age: 2015 to 2035

China's GDP

Productivity of The Worker

This is really the second determinant of GDP growth – in that productivity per worker multiplied by the number of workers equals total real GDP.  There is no systematic relationship between education (skill) level of workers combined with resources (Accumulated Fixed Capital Investment) per worker and the absolute level of GDP per worker across the 78 countries we cover.  But, as shown in Figure 2 below, there is a good relationship between the trend in the two inputs of education and resources and the trend in productivity in terms of GDP per worker over 5 to 10 year periods.

It is necessary to use a range of years as the productivity per worker can be influenced a lot by government policy on investments. Such is the case in China where a stimulus via massive fixed capital investment projects increased total GDP (and hence productivity).  However, while FCI will continue that rate of increase is slowing as indicted in the latest economic statistics released by the government.

This is necessary for two reasons.  First the debt levels are inhibiting the ability to continue such investment and second the level of return per dollar FCI is now low by international standards thereby indicating that the capital available per worker is now at a level suitable for the skill level of the worker and increased returns will not happen until the skill level of the worker increases.

Accumulated Fixed Capital Investment

The capital resources available to a worker is measured by the Fixed capital investment per annum, depreciated at 10% per annum and accumulated over a 10-year period.  That gives a relative measure of the total resources available, whereas the annual FCI figure can fluctuate significantly but have only a small impact on total resources available in that one year.

In the case of China, the Accumulated Fixed Capital Investment per worker in 2005 is estimated to be Rmb 212,000 and if annual Total FCI grows at 3.1% per annum then Accumulated FCI will reach Rmb 417,613 per worker in 2025.  This is a growth rate of 7% per annum.  If a higher rate of total FCI per annum is assumed, specifically 5.4% per annum, then the Accumulated FCI would be Rmb 501,667 – a growth rate of 8.8% per annum.  One thing for certain the historic rate of growth in total annual FCI will not continue.  For 2003 to 2013 it was 16.2% per annum.  That is not sustainable for the reasons explained above – debt and return on investment.

Education (Skill) Profile

Looking at the Education level of the workforce (the other key determinant of the trend in productivity per worker) China scores well.  In 2015 it is estimated that 74% of its adult population have completed lower secondary or above.  By 2025 this is projected to be 84%.  This is compared to 60% in 2005. This impressive performance is however, also China’s vulnerability in terms of GDP growth.  It is getting to the point where the marginal impact of new, better educated, entrants to the labour force is limited.  The impressive decline of the proportion with ‘none’ or ‘primary only’ education is substantially done so the easy gains in overall profile have been made.  Second the number of new entrants in the labour force has declined significantly.  Using the number of 15 year olds as an indicator, there are 14 million in 2015, and stays at that level through to 2025.  This compares with 24 million in 2005.

As a result, the improvement of the education profile of the labour force slows considerably.  The index for this grew at 1.6% per annum to 2015, but is projected to grow at just under 1% per annum to 2025.

The overall impact on growth of GDP per worker

The combined effect of the trend of these two variables on the trend in productivity per worker is summarised in Figure 2.  As shown the growth rate of the two drivers slows and with that so does the projected growth rate of the productivity of the worker (GDP per worker).  From 9.3% per annum average for 2005 to 2015, to a projected 5.1% per annum for 2015 to 2025.

Figure 2: Projected Trends in Education and Accumulated FCI and Productivity per worker: 2015 to 2035  

What This Means For Total Real GDP Growth

Of the three drivers of GDP:

Labour force growth is in decline overall, and much slower growth for the more productive urban sector.  This is inevitable.

 Education profile continues to increase, but the big changes have been achieved and the number of new better educated entrants to the labour force is declining in marginal impact.  This is inevitable.

 Fixed Capital Investment could not continue at the historic rate of the stimulus period and this is now evident in the latest (2014 and early 2015) economic data.  A significantly slower growth rate of FCI is expected (but not a decline).

 

So the three drivers are all expected to continue to grow (in the case of workers, urban workforce is the real issue) and therefore so is the overall economy of China.  But they all grow at slower rates compared to the previous decade and this means total real GDP of China also grows at a slower rate than before.

Based on the numbers detailed above, it is expected that total real GDP growth for 2014 to 2015 will be 6.7% and by 2025 the annual growth rate will have slowed to 3.5% per annum.  The projected average for the decade is estimated at 4.5% per annum.

Variation from these forecasts requires that there be significant changes in the annual Fixed Capital Investment.  Of the other variables, education profile cannot be changed rapidly – and certainly no more rapidly than China is currently achieving which is a very high rate of improvement.  Similarly, the number of workers is largely defined by demographics.

Figure 3:  Historic and Projected trend in GDP Drivers, GDP per worker, Workers and Total Real GDP.

It is not impossible for China to maintain its very high historic rates of FCI, but it is unlikely, and even if It was at a higher rate (specifically 5.4% pa rather than 3.1%) its impact on Accumulated FCI is not sufficient to offset the slower growth rates in the urban labour force and education profile.  Under this higher FCI investment scenario the average GDP growth rate for the decade to 2025 would be 5.4% per annum.  However, for 2015 it would be 8.1%. Latest economic data indicates that this is not the scenario taking place.

SO WHAT IS THE IMPLICATION FOR COMPANIES AND INVESTORS?

The conclusion has to be that to assume that China’s total real GDP will continue to grow at 7.0% per annum or faster is quite unrealistic – a conclusion that has been evident for some years now.  The trends in terms of labour force size and education improvement have been evident for the last decade and it was really a question of when they would offset the rapid FCI investment growth, or when FCI investment would start to slow given that the marginal returns have been declining for some time.
One of the reasons for historic optimism (or wishful thinking/ investment justification) has been urbanisation.  It is correct that the shift of workers from rural jobs to urban jobs had a significant positive effect on overall productivity of the worker.  However, it should be noted that the physical relocation of individuals (and type of work) is no longer dominant.  Until 2010 the migrant was aged 15 to 39 and few outside that range moved from the rural areas to urban areas.  Since 2010 the age band of rural to urban migrants has changed significantly – to now almost representative of the overall population profile.  This is a reflection of the reality that many rural areas are being (quite correctly) reclassified as urban as their profile has changed.  This applies to small townships that have literally been subsumed into larger towns.  So the urban population is still growing, but there has been no change in jobs, nor is there additional demand for urban housing – they are already housed.

Finally, what about consumption? Next month we will provide information on the forecast for that.  It is expected to grow, but while wages will increase, household incomes will grow at a slower rate as there will be fewer workers per household, and expenditure will grow at an even slower rate as the propensity to save increases with affluence in China and there is no evidence of that relationship changing in the near term as a result of increasing concerns about (aged) health care and adequate pensions in people’s minds.

Find Out More

A more detailed analysis of the changing demographic profile of China, and its implications for the future consumer profile, labour Force, household number and structure, GDP, household incomes and expenditure, and consumer age/income segments through to 2035 is available in our latest publication:
China’s Demographic Future

This provides a no nonsense analysis of the underlying demographic trends in China.  By reading it you will be prepared for the China of the Future, rather than surprised by itClick here for a detailed Chapter description and purchase options.