East Asian Demographic Crisis Threatens Global Economy

Catastrophic population decline puts one quarter of global GDP at risk.

China, Japan, and South Korea are all facing dramatic demographic declines. Japan has the world’s oldest population (after Monaco), South Korea has the world’s lowest fertility rate, and the Chinese population declined last year for the first time since the great famine in 1961.

These worrying demographic trends will not only challenge the ability of these countries to finance their pension systems, the economic effects will be felt globally. The East Asian giants are crucial to international trade, collectively accounting for approximately one quarter of the world’s GDP.   

While Europe and the United States are also experiencing declining fertility rates, immigration is offsetting the effects on their working age populations. East Asians, in contrast, are reluctant to embrace large numbers of immigrants, preferring to maintain ethnic homogeneity.  

Japanese Prime Minister Fumio Kishida’s recent pronouncement that it is “now or never” for Japan to deal with its low fertility rate or else “cease to function as a society” reflects the severity of the situation. Almost a third of Japan’s population is over the age of 65, and as many as 10,000 schools have closed down since 2000.

In South Korea, the government pay families with new-borns 700,000 won ($550) per month for a year, with the figure set to increase to 1 million won ($800) next year as current attempts to boost fertility have failed.

Meanwhile, new estimates suggest China’s population could halve to roughly 700 million people by the end of this century.

The Importance of China

Not only have many countries become dependent on affordable exports from China to keep inflation and interest rates low, but emerging markets have come to rely on China as an export destination for their commodities as well as a major source of development finance. As such, the ramifications of a shrinking and ageing Chinese population will be felt well beyond the borders of the mainland.

Although there is no direct correlation between population growth and economic growth, the size and average age of a population has discernible effects on a region’s consumptive potential, labour market dynamics, and prevalence for innovation.

As such, India, and Africa (the 3rd and 4th largest economies in the world by GDP PPP), will become increasingly important to the global economy as future drivers of economic growth. With the two largest populations in the world, these regions are massive consumer markets as well as important sources of labour and innovation.

That said, one need consider the base effect, which illustrates why a shrinking Chinese population poses a major threat to the global economy. India is already growing at a faster rate than China, but in absolute terms China’s economy is still increasing in size by a larger amount each year.

If China’s $18 trillion economy were to grow by 1% a year, India’s approximately $3 trillion economy would have to grow by roughly 6% per annum to keep up, and if the Chinese economy were to stop growing altogether, the world would need the equivalent of five India’s to compensate for the loss of China’s average annual growth to the global economy.  

Solutions for China’s Demographic Decline

China will continue to be the world’s largest economy (by GDP PPP) and will remain indispensable to global supply chains for the foreseeable future. As such, it is important for both China and the rest of the world that the Chinese government implements policies to offset the economic effects of China’s demographic decline.

The government already scrapped its one-child policy in 2016 and are now encouraging families to have more children. But due to the high cost of living in urban areas, the change is yet to take effect.

A new policy in Japan designed to encourage families to move to rural areas might prove a more effective solution as it combines direct payments with a policy orientated towards de-urbanization.

Urbanization is good for GDP because it brings economic role players closer together. This produces spending efficiencies on infrastructure while increasing property prices and the velocity of money. However, urbanization is generally a bad thing for demographics.

As cities grow and property prices increase, this adds to the cost of living. To be competitive in an urban labour market also requires higher levels of education, adding to the cost of raising children.

While China could increase its human resource potential despite a shrinking workforce by increasing public investments into education, additional measures will be required to safeguard its economic prosperity from population decline.  

Additional Measures

Chinese firms can move their operations overseas. Instead of importing foreign labour or reversing the declining fertility rate, Chinese businesses could simply open more factories in other countries.

China could use of Artificial Intelligence and automation in order to remain competitive, increasing productivity to offset the shrinking workforce. China already leads the world in robotics, accounting for the majority of new installations each year, and a smaller population may even be beneficial in a world where AI threatens to upend labour markets.  

De-dollarisation could prove useful in lessening the negative effects of population decline too. A stronger yuan could increase per capita consumption despite a shrinking consumer base and the internationalisation of the yuan will enable China to use monetary policy to offset the deflationary effects of population decline.

As such, one can expect a greater emphasis on the use of the renminbi in trade settlements as part of a strategy to secure its reputation as a global reserve currency. This is the best way to support the currency (as seen with US dollars) without relying on selling foreign exchange reserves (like Japan).

If the Chinese economy is able to withstand the negative effects of population decline via effective policy interventions there is every chance that China’s per capita GDP may increase. Contrary to the forecasts of most analysts, this could see the Middle Kingdom become old and rich simultaneously.