China’s Ageing Challenge
Like many countries, China made the transition from third world to emerging market by focusing on low cost manufacturing. The ability to cheaply manufacture products for developed markets is a time-honored tradition for countries that are looking to join the ranks of global traders and it was no different in China.
One of the reasons why developed markets look to emerging markets to manufacture goods is the lower cost of labor. To make a product in China where labor costs are very low compared to the U.S. makes financial sense even when factoring in the cost of transportation and logistics involved in getting the completed product to market.
As time goes on, countries like China need to maintain their competitive edge as other countries enter the market as new low-cost manufacturers. They can stay competitive by improving product quality and lowering defects, ensuring intellectual property protection, maintaining a labor cost advantage over new entrants, and by highlighting the advantages of having more highly skilled workers.
China has shown varying degrees of success on these fronts, but a demographic issue could have a long-term impact on the country’s competitiveness as a low-cost manufacturer of global goods.
Dependency Ratio Explained
This demographic issue is the dependency ratio, which measures the difference between the working age population (aged 15-64) and the non-working age population in a given country. Non-working age dependent populations are broken into youth (younger than 15), and old age (over 65) dependency. The ratio tells us how many dependent age people there are in a country for every 100 people of working age.
Let’s take Japan as an example as China’s neighbor to the east will enter a crisis stage in their dependency ratio over the coming decades. The Dependency Ratio chart shows that by 2050, for every 100 people of working age in Japan, there will be over 95 people of dependent age. And the majority of these will be old age dependents. In fact, Japan's youth dependency will have shrunk by over 30% between 2000 and mid-century while old age dependency will have grown by over 350%.
This poses a crisis because once workers leave the labor force, they become eligible for government sponsored social support programs. Government sponsored programs like these are typically funded by working age tax payers. As the ranks of old age dependents increases, there are more people for the government to support. As the working age population shrinks in Japan, a perfect storm is created. Fewer people are paying into social programs and more people are pulling money out of them. This creates a situation where the workers still funding the programs have to put a higher percentage of their pay into the programs in the form of taxes, while governments could have to incur debt to supplement the costs of social programs.
The China curve on the chart shows that the country’s dependency ratio has bottomed out this decade, and is starting to rise. While the ratio is not projected to approach the levels Japan will experience, the rising rate does pose some issues.
Why has the dependency ratio risen in China?
The cause is a result of the after effects of The One-Child Policy. By limiting the number of births in the country, the government ensured there would be an era where the dependency ratio would take a turn for the worse. The One-Child Policy began to be phased out in 2015 partially in response to the realization that this demographic issue was taking place. There are a few reasons why the new Two-Child Policy might not have the desired effect of increasing the working age population.
First, during the time the policy has been in effect, there has been an uneven distribution of gender among the population. With more men than women, some of the male population will be unable to find partners, leaving a portion of the population subject to an unintended “no child policy.” Second, while the implementation of a Two-Child policy should result in an increase in the fertility rate from 1.6, it would take a far larger increase to structurally impact the working age population. Finally, even if a baby boom takes place as a result of the new policy, it will take at least 15 years for newborns to join the workforce.
The lasting effects of the One-Child Policy has put China in a precarious position, and other countries, such as Mexico, are well positioned to capitalize. Mexico has a much different demographic profile than China. Without caps on their fertility rates, the Mexican population continues to grow, so that the working age population grows with it, and dependency remains low. This trend could accelerate. If the U.S. continues plans to limit the number of immigrants allowed into the country from Mexico, the working age population could get a further boost as fewer works head north of the border for work. If the Mexican government can address security concerns and continue to promote the manufacturing sector, the geographic proximity of Mexico to the U.S. could drive US manufacturers to opt for Mexican manufacturing over China or other Asian countries.
What should Chinese companies do to maintain business from developed market manufacturers?
- Think about locking in long term contracts with companies. Offer reduced rates through the life of contracts to lock in future revenue.
- Keep costs low by switching out low skilled workers with automation like 3-D printing and robotics.
- Focus on process improvements, including on time and accurately fulfilled orders.
- Work to ensure Intellectual Property Rights of western businesses are protected
If Chinese companies can maintain low costs and process efficiency, Developed Market companies could fear that the cost of change would outweigh any labor cost savings realized by finding new countries in which to manufacture their goods.
Two other factors are joining forces with the changing demographic profile to impact the competitiveness of Chinese manufacturing. First, China’s transition from a manufacturing based economy to an economy that is more balanced between exports and domestic consumption creates a shift in the types of jobs workers are taking up. At the same time population factors are shrinking the total number of people in the workforce, this economic shift is cutting down the number of Chinese who will look toward jobs in the manufacturing sector. A shrinking supply of workers increases competition for those workers, and that increased competition will result in increased wages, which means higher employment and manufacturing costs.
Second, additive manufacturing, or 3-D printing, is making it possible for companies in developed markets to re-shore manufacturing. With relatively inexpensive 3-D printers, goods that were previously produced in China can be made anywhere. While the use of 3-D printers is not conducive to large batch manufacturing, there are benefits to the customization possibilities inherent in additive manufacturing.
These three factors: a rising dependency ratio, the shift away from a manufacturing based economy, and the advent of 3-D printing are combining to disrupt China's position as a leader in low cost manufacturing.