The End of Abundance

November 17, 2016

4 minute read

China’s astounding economic boom has led to an age of abundance, but this could end before the eyes of today’s young generation. After three decades of hyper growth, it may be no coincidence that recent economic turmoil comes at the point when the country is reaching the end of its demographic dividend. The concept of economic life-cycle describes patterns of consumption and income that occur across age groups and lead to a mismatch between material needs and the ability to satisfy those needs through one’s labor. In all societies, the young and the old consume more than they produce, while working adults consume less than their labor income.

Data from national accounts and household surveys show that most developed countries run a life-cycle deficit. China, however, has generated a sizeable surplus, with labor income far exceeding consumption throughout its decades of rapid hyper growth. Between 2002 and 2007, this surplus almost doubled to 3.47 trillion RMB. The economic boom, as well as the frugal consumption and high saving rate of older generations, contributed to this.

POPULATION CHANGES AFFECT SURPLUS

But as has been observed in other countries, changes in the population can affect the life-cycle surplus. In China, decades of rising longevity, and below-replacement fertility exacerbated by the one-child policy, mean population aging is now unfolding at a rapid, underappreciated pace.

As a significant part of China’s life-cycle surplus is due to its favorable population age structure, aging will change the dynamics of the economy. In 2012, for example, for the first time, China reported a decline in its labor force (those aged 15–59) by 3.45 million, as more workers exited than entered the workforce, a trend expected to continue at least until 2030.

Declining numbers of workers does not necessarily mean a contracting economy. However, as growth over the last three decades relied heavily on cheap young labor, the decline of the workforce could see China lose out to competitors in the international labor division. This would mean stagnation or even negative growth that depresses income.

The alternative will be for China to upgrade its economic structure. This could result in rising incomes and longer working years. But in either case, population aging will lead to changes in consumption, having an impact on the lifecycle surplus.

WHEN WILL THE SURPLUS END?

The question is, if consumption changes, how long will the surplus last? The answer depends on economic growth, but the experiences of societies such as Taiwan can shed light on China’s future trajectory. Although often at loggerheads with China, Taiwan shares social and cultural background characteristics with its giant neighbor. Taiwan’s well-documented life-cycle experience between 1980 and 2000 also mirrors China’s.

Beginning in the 1960s, Taiwan transformed from an undeveloped, agricultural island to a dynamic, capitalist and export-driven economy with a strong middle class emerging in the 1980s. These developments placed Taiwan firmly in the club of Asian Tigers. When comparing the labor income and consumption profiles of Taiwan to China, interesting parallels arise. Figure 1 shows that while the labor income age profile of Taiwan changed little between 1980 and 2000, the level of consumption rose, with larger increases recorded in the young and old age years, reflecting rising expenditure and healthcare costs. These changes are similar to China between 2002 and 2007 (Figure 2).

Figure 1

Figure 2

While China’s labor income profile is similar to Taiwan’s in 2000, China’s consumption profile in the corresponding period was much lower. In a 2014 paper, China’s age of abundance: When might it run out?, my colleagues Yong Cai, Ding Li, Xiwei Wu, Ke Shen and I examined the effect that population aging and life-cycle economic profiles could have on future needs for intergenerational transfers. Using the Taiwan experience as a basis, we concluded that China’s life-cycle surplus could be erased before 2035. Our projections used different consumption ratios relative to average prime working age (30–49) labor income.

A major source of China’s current abundance has been extremely low consumption. In 2007, at prime working age, an average person consumed less than 45% of the income generated from their labor. Should this continue, it will counteract the effects of rapid aging, which will reduce the size of life-cycle surplus, but not erase it. The surplus would continue to the end of this century.

However, even a modest increase in consumption will eat into the life-cycle surplus. Should China increase consumption to 60%, a level still below Taiwan’s in 2000, there would be no surplus, even under the current favorable population age structure.

As the population ages, China’s consumption level is expected to rise significantly: social welfare programs will expand, there will be increases in public spending and a rise in the individualistic culture. In fact, politicians and economists count on China’s increasing domestic consumption as a new engine of future economic growth. Reductions in China’s life-cycle surplus between 2007–2009 hint that this is already happening. The young Chinese, especially in cities, are earning more and spending more than previous generations, but to an extent they are living off the wealth generated by their parents and grandparents. Their higher consumption rates mean they will not be able to pass on wealth to their own children.

Our projections show that China will face a challenge in finding a balance between rising levels of consumption and expanding life-cycle deficit. If consumption rises similar to the historical experience of Taiwan, the life-cycle surplus is expected to be erased before 2035 – bringing to an end China’s age of abundance.

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