Has China’s Demographic Dividend Payout Ended?

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Op-Ed Commentary: Chris Devonshire-Ellis

Nov. 23 – This is Part II of my essay concerning the discussions and findings of the annual Economist China Summit which took place in Beijing last week, bringing together the cream of China-based businessmen, academics and analysts. Part I may be viewed here and Part III here.

In this discussion, dealing with China’s population and labor demographics, the panel consisted of KK Fung, managing director of Jones Lang LaSalle; Cai Fang, director of the Institute of Population at the Chinese Academy of Social Sciences; and Gordon Orr, chairman of McKinsey Asia.

“Chen Deming (China’s Minister of Commerce) has stated that China has 10 years left before population demographics weaken in terms of employment. Others feel that point is already here. Has China reached a tipping point?”

Reacting to the statement above, Cai Fang suggested that China has reached the end of its demographic dividend, and that the employment age ratio in China of those 16-60 as a working age is defined as the support ratio – those members of Chinese society who support the young, elderly and infirm. Fang predicted that the disappearance of the demographic dividend will be reached between 2013 and 2015, and that using cheap labor to sustain China’s growth model is no longer sustainable. He also stated that China needs more increases in productivity rather than financial injections.

China’s second and third-tier cities to provide growth
KK Fung reacted to this by stating that the number of second-tier cities in China has grown in number from 30 to 50 over the past five years, and that within the next five years, second and third-tier cities will represent 30 percent of China’s total GDP and 6 percent of the global total.

He further stated that more regional hubs are developing from within these cities – mentioning Wuhan, Chengdu and Chongqing especially – and that all second and third-tier cities will move up the value chain. China will, he said, see investment move increasingly inland, while the services industry is also developing, with China recognizing this by diverting 2 percent to 3 percent of its GDP into research and development (a figure comparable to that of developed countries such as Japan and the United States). Therefore, the emphasis should change from investment in infrastructure towards investment in human capital.

Investment in vocational training an issue
Gordon Orr suggested that internal migration of labor within China is continuing, but has changed insofar as migrants are now traveling intra-province rather than on a national basis. He stated that migration has slowed, down to 5 percent of the total working population from 15 percent in 2000, and that some 85 percent to 90 percent of migrant workers aged 20-25 are willing to work “off-farm” as he called it, and seek employment in cities. Orr also noted that demand for machine tools has increased 70 percent annually in China, but that the real problem lies with retraining migrant workers. He said China has a significant shortage of semi-skilled and skilled workers, echoing the points made by Fung concerning investment in human capital.

The question concerning the potential raising of China’s retirement age was aired again (see part one for more) as it was estimated some 80 million workers will otherwise retire within the next decade. Here, it was felt that China’s hukou system (which limits the ability of migrant workers to obtain loans and even social security from anywhere other than their hometown) is still problematic, but is unlikely to be lifted due to social security concerns.

Land reform required to free up agricultural workers?
On the subject of vocational training, it was recognized that this is a huge problem and that it is required on a massive scale. Also problematic is China’s land use laws, and how to get economies of scale into China’s agricultural land. If this can be done, an increased mechanization of China’s farming can potentially release a further 20 percent of agricultural workers into the urban labor pool. Land reform is needed to restructure rural land ownership and to stimulate more of China’s workers to migrate towards its cities.

Fung mentioned that this is already occurring, with domestic companies being given incentives to move into China’s cities. Stating the case of Beijing, he noted that in 2009, total office vacancies were running at about 20 percent, but this has dropped to 8 percent as of November 2011 mainly due to previously rural-based companies moving into the city.

Changing China’s one-child policy
The concept of scrapping China’s one-child policy was raised, with Orr mentioning that China’s fertility rate is considered very low at 1.4 per woman. The replacement level is 2.1. However, he mentioned that the low fertility rate is not a result of policy, so the one-child issue is partly irrelevant. However, Fang interjected and suggested that if the birth rate remains below 1.8, the policy could be amended. He suggested that it may not altogether be done away with, but could be altered to allow, for example, two single children of single parents to have two children instead of one. There would be problems if it is scrapped altogether, he said, as it will load more burden onto the supporting workforce. He recognized that “China will get old before it gets rich,” so it needs to acquire more national wealth and reserves.

He went on to mention that China needs to focus not just on the quantity of China’s population, but also on the quality. China wants 50 percent of its population in tertiary education by 2030, meaning that children will need to be dependent by age 22-23.

Serious issues with China’s labor pool
Questions were raised among the panel concerning the longer term viability of China’s labor pool, given the general consensus that labor is in short supply, the current retirement age is low, there is a shortage of skilled labor, and no national vocational training scheme is in place. Additionally, existing unskilled labor will increasingly be replaced by machinery, leaving China with a potentially massive unskilled labor force and no training in place. This is likely to result in a slowdown of productivity unless methods to correct this can be found. It is this labor dynamic that is proving potentially damaging for China’s longer term growth.

Inland regions set to develop
Fung noted that to date, China has relied upon rural labor progressing to urban areas, and as a result coastal regions of China have become more expensive. Accordingly, the inland areas of China represent a better environment. Orr noted that in 2004, intensive labor among Central China’s workforce amounted to just 4 percent of the total, and that this had risen to 8 percent by 2008, and was expected to keep increasing as a result of manufacturing industries expanding inland. Labor is also remaining inland with less migration than before, with Cai Fang being of the opinion that China still has plenty of “flying geese” and that the country’s advantage in demographics concerning cheap labor will remain.

The matter was put to a floor vote, “Has China lost its cheap labor advantage?” A strong 72 percent of respondents said “Yes” while 28 percent said “No.”

Audience with Gary Locke, U.S. Ambassador to China
U.S. Ambassador to China Gary Locke has only recently taken up his position in China, and is unusual in that he is the first ethnic Chinese American citizen to hold such a role. Locke attended Yale University, graduating in political science, and obtaining his Juris Doctor from the Boston University School of Law in 1975. He became the first Chinese-American Governor in U.S. history in 1996, and after leaving office in 2005, joined the Seattle office of international law firm Davis Wright Tremaine LLP, in their China and governmental-relations practice groups. In 2009, he was sworn in by U.S. President Barack Obama as U.S. secretary of commerce, and earlier this year was made ambassador to China.

Ambassador Locke began his speech by saying that the U.S.-China economic relationship is of “immense” importance, and that the United States wants to share a healthy, stable, reliable relationship. He stressed that China, as the world’s second largest economy after America, must now step up and take on a global role in world affairs, and that this included regional and global security issues, climate change, and averting famine in addition to economic balancing.

Stating that in security, the United States and China had “mutual” interests, he suggested that few global conflicts can be solved without China’s involvement – stating that the two countries need to work together over Iran. He stressed that a strong, successful and prosperous China is in the interests of the United States, and that a strong U.S. economy is also in the interests of China. Looking at the trade figures, Locke said that he has been charged by President Obama to double U.S. exports by 2015, and that this would help create American jobs. Noting that already, U.S. exports to China had risen by 32 percent this year, he will increase the number of senior level trade missions to China from the United States, look for Chinese companies to invest in the United States, and look at assisting China to open up its markets.

“Abolish the FDI catalog, and do away with joint ventures”
Locke noted, however, that China’s growth model of the past 30 years now needs to change. In quoting Wen Jiabao at a speech made at the recent Guangzhou Trade Fair, he noted that China’s current growth has been described as “unsustainable, uncoordinated, unstable and unbalanced.” Locke suggested that there is now a gap between China’s planning and actions upon them, and that the current business climate demonstrates a conflict between the Chinese government and its business community, bluntly stating that there is a “lack of openness” in China.

China’s FDI policies, he went on to say, contain substantial restrictions in many areas including mining, telecommunications, energy and finance. He added that China regularly chooses domestic companies ahead of foreign investors, and that China’s FDI catalog of restricted industries should be abolished and the need for foreign companies to form joint ventures should be completely done away with.

Financial services, he said, were highly restricted, and this alone is damaging China. Locke said that a more open and dynamic financial system will assist with providing a better quality to China’s savings and in utilizing them. He stated that in financial services, including pensions, insurance and even payment systems, China is backward and this is damaging. It would be to the detriment of China if these markets were not opened to foreign investment and expertise, and that if these markets are opened, this would assist with an improvement in both the global economy and the Chinese economy.

“Vietnam sells more legitimate software licenses than all of China”
Concerning intellectual property, Locke mentioned that while progress has been made, it was minimal and that rampant theft continued. He stated that U.S. trade data shows there were more legitimate sales of software licenses last year in Vietnam than in all of China, and that he also heard many stories of Chinese companies themselves being ripped off.

He also stated that China’s RMB exchange rate with the U.S. dollar needs to move to a market determined system and not be manipulated. He said that although the United States has started exporting more to China, the trade deficit is still not coming down, and U.S. companies in China are not treated in the same manner as Chinese companies in the United States. They cannot operate the same freedoms as exist in the United States and there is a need to further liberalize markets in China to foreign companies.

Military ties throughout Asia
Concerning the U.S. military presence within Asia, Locke noted that we all live in a more volatile world, with a growth in extremism, and that the United States would like to work more with China especially over issues concerning terrorism, which he said affect both nations. The United States, he said, wants a better understanding with China as regards solving issues, and better communication. This includes disputes arising over the South China Sea, where, he said, the United States does not take any side in the various claims, but only wants a peaceful and mutually agreed upon solution.

The repositioning of 2,500 marines to Darwin in northern Australia is for training purposes, he said, and the United States is redeploying troops as they wind down military activities in Iraq and Afghanistan. This repositioning is needed as a fast reaction in case any regional flare ups occur. He stressed the Australian marine training deployment is not aimed at China but has been the end result of several years of discussions with the Australian government and is nothing new in terms of a strategic development.

“Asking China for five-year visas”
Ambassador Locke commented on the provision of U.S. visas to Chinese nationals, stating that this is a major priority for the United States to improve upon. Stating that the U.S. Embassy in Beijing had, for the first time, processed over 1 million visas this year to Chinese nationals, he said that he expects demand to rise tenfold within the next five years, and that the creation of facilities 10 times larger would be impractical and necessitate instead a change in visa issuance policy. He also vowed to improve the waiting time and procedures for the issuing of visas to Chinese nationals.

He noted that Chinese investment into the United States has increased 400 percent over the past three years, and that some 5 million Americans worldwide are currently employed by foreign companies overseas. In order to alleviate the visa issuance problem, he said that the American government is prepared to issue five-year multiple entry visas to Chinese nationals, which would cut down on the stress load of having to apply each time a visit was required. Noting that the United States has a policy of reciprocity with other nations concerning visa issuance, he said the idea has been put to the Chinese government and that they are waiting for a reply.

Ambassador Locke came across as a firm, analytical and well-reasoned individual quite prepared to do business with China, but also willing to take on more difficult subjects. He was eloquent, and maintained a “man of the people” image, for example drinking directly out of a plastic water bottle instead of using the glass provided. The Chinese people certainly seem to have taken to him – he is often compared to China’s own leaders in positive terms. Ambassador Locke, I feel, is going to remain a key and important player in the evolution of China over the next few, potentially awkward years.

This is Part II of a three part report.

Chris Devonshire-Ellis in the founding partner and principal of Dezan Shira & Associates. To read his report on last year’s Economist China Summit, please click here.

The Economist Newspaper has been published since 1843 and is one of the world’s leading newspapers detailing the global economy and its political influences. The Economist runs, through its conferences division, a global series of high profile events. To view the Economist conference schedule, please click here.