This article was first published at Exante Data’s Money Inside and Out.
China was ready for its historic opportunity.
Although a widely used aphorism, “demographics is destiny” is not strictly true in the modern era. Long gone are the days when troop size could on its own determine the outcome of a war, or when deploying manpower on a massive scale could result in a decisive economic advantage. Brute force just isn’t what it used to be. Today, thanks to advanced technology, small groups can inflict enormous damage in war, and a handful of software programmers can create billions in new wealth.
That said, demographics remains an important part of destiny in combination with other non-demographic factors.
Some of these factors can mitigate, or even completely counteract, a deteriorating demographic picture. Others can multiply the positive effects of demographics. This distinction—between demographics as a leading determinant of national stature vs. demographics as merely one of several components —can be illustrated by the following two opinions.
The first is a view promoted among others by Fareed Zakaria in his book The Post-American World (2008). Here is Zakaria in a 2008 Newsweek column The Rise of the Restrepeating the theme of his book:
It is an accident of history that for the last several centuries, the richest countries in the world have all been very small in terms of population. Denmark has 5.5 million people, the Netherlands has 16.6 million. The United States is the biggest of the bunch and has dominated the advanced industrial world. But the real giants—China, India, Brazil—have been sleeping, unable or unwilling to join the world of functioning economies. Now they are on the move and naturally, given their size, they will have a large footprint on the map of the future.
The second is from Winston Churchill’s speech Fifty Years Hence. It is from 1931 but remains as pertinent as ever:
When we look back beyond a hundred years over the long trails of history, we see immediately why the age we live in differs from all other ages in human annals. Mankind has sometimes traveled forwards and sometimes backwards, or has stood still even for hundreds of years. It remained stationary in India and in China for thousands of years. What is it that has produced this new prodigious speed of man? Science is the cause. Her once feeble vanguards, often trampled down, often perishing in isolation, have now become a vast organized united class-conscious army marching forward upon all the fronts towards objectives none may measure or define. It is a proud, ambitious army which cares nothing for all the laws that men have made; nothing for their most time-honoured customs, or most dearly cherished beliefs, or deepest instincts. It is this power called Science which has laid hold of us, conscripted us into its regiments and batteries, set us to work upon its highways and in its arsenals; rewarded us for our services, healed us when we were wounded, trained us when we were young, pensioned us when we were worn out. None of the generations of men before the last two or three were ever gripped for good or ill and handled like this.
Zakaria was not wrong about the growth of China, India, Brazil and others (he was after all writing in 2008 when that growth was already evident) but he gave demographics more weight than it deserves. Zakaria saw the overwhelming success of the less populous West as an “accident of history” while “the real giants – China, India, Brazil – have been sleeping, unable or unwilling to join the world of functioning economies.”
By contrast, Churchill saw the West’s advance as no accident and as the logical result of scientific progress. Note in the excerpt Churchill’s mention of India and China, to emphasize that demographics had been overtaken by science.
For the TLDR reader, we could end the article here because this is in summary most of what one needs to know about the roles of demographics and innovation in the economy. One can then infer, almost country by country, how we got to the present and what is likely in store for the future.
But there is reason to further systematize our understanding in order to identify the policies and responses that are more conducive to future prosperity.
The misunderstanding about the role of demographics in the economy is still widespread today. Remember, for example, the recent celebration of India and its economic promise merely because its population is now believed to have surpassed China’s. Of course, population size is important for the economy. But a larger population does not guarantee that an economy will prosper. If that were true, Nigeria would be richer per capita than Switzerland, and Russia richer than Norway. If they are not, it is because other non-demographic factors are critically important.
A Window of Opportunity
The strongest way that demographics changes an economy from one generation to the next is through a demographic dividend. A demographic dividend is a window of opportunity that opens when a country’s dependency ratio declines. The dependency ratio is the ratio of dependents (children and the elderly) to workers. When the birth rate falls from period A to period B, there are fewer dependents for workers of period B than there were for workers of period A. This leads to a decline in the dependency ratio. The funds that are saved from having fewer children can now be diverted toward higher-value consumption, savings and investments, all of which provide a boost to the economy.
Aside from a falling birth rate, there is one other way that the dependency ratio can decline and that is with a greater number of women joining the workforce. This increases the denominator (more workers). And it decreases the numerator (children dependents) because working women tend to have fewer children. This dynamic was described in my 2017 article The Economics of Dependency.
Three Pillars of Prosperity
A lower dependency ratio is Step 1 or Condition 1 in the attainment of a demographic dividend. In mathematician’s lingo, it is a necessary but not sufficient condition. In other words, the window of opportunity has opened but other conditions need to be present for this opportunity to be seized.
The other major sets of conditions needed to capture a demographic dividend fall into two categories: Innovation & Productivity and Society & Governance. In brief, countries that embrace science and are able to innovate end up being more prosperous. Others that invest in productivity through education and infrastructure manage to raise their per capita GDP. These items require a backdrop of positive and inclusive society and governance, a context where corruption is low, contract law is respected, property rights are upheld, and where the government is accountable and the judiciary independent.
The combination of all these factors in pursuit of a demographic dividend is summarized in the chart below. The state of the economy is the result of inputs from people and capital and the demographic dividend is no different. When the window of opportunity for such a dividend opens, a national economy can capture that dividend if there are two virtuous cycles of people and capital, with their respective inputs from the three pillars of prosperity: Innovation & Productivity, Demographics & Health and Society & Governance.
For example, female literacy lags male literacy in developing countries. An improvement in female literacy leads to lower child mortality and to fewer children (lower fertility) and so on. On the capital side, better governance and transparency lead to more inward investments and greater job creation.
A Demographic Event
With all this in mind, the development and enrichment of China since 1990 can be seen as the most successful demographic dividend in history. Examining the items that contributed to it, we see that the window of opportunity opened for China when its dependency ratio started to decline. China’s birth rate was falling even before the one-child policy was enacted and it fell some more after it was enacted. This decline led to an unprecedented halving of the dependency ratio between the late 1970s and the early 2010s.
The chart below shows China’s dependency ratios using different age cut-offs for the young and elderly. For example, the blue line is the ratio of those aged less than 15 added to those aged more than 64, divided by the 15-64 age cohorts. The 15-64 dependency ratio fell by half between 1975 and 2008. The 25-64 dependency ratio fell from 1.80 in 1972 to 0.7 in 2015. And so on. (Note that the y-axis shows the ratio x 100)
These are very large declines, not seen in any other major country in recent decades. Japan had experienced a sharp fall in its dependency ratio in 1950-80 but Japan’s was less precipitous than China’s.
Non-Demographic Factors
When the dependency ratio fell and the window of opportunity opened, China was ready. Its literacy rate had reached a level in the late 1990s that rivaled those of much wealthier nations. According to UNESCO, China’s adult literacy rose from 65% in 1980 to 91% in 2000 and 96% in 2015. And female youth literacy (for those aged 15 to 24) surpassed 90% as early as 1986.
In addition, there was a new wind in Chinese society and governance, and a will to relax central control over the economy and to let laissez-faire run its course. In 1978, China’s GDP was the same size as Italy’s. Today, it is the second largest in the world. The first and main political actor in this historic shift was Deng Xiaoping starting in the late 1970s. This excerpt from The Conversation identifies three key dates that marked Deng’s transformation of the economy:
1978: Deng’s authority manifested itself at the Third Plenum of the 11th Central Committee of the Chinese Communist Party. In modern Chinese history, this event is seen as the starting point for the massive shifts that would loosen up China’s economy and dismantle what was known as the “bamboo curtain” that had shielded it from the outside world.
1980: In a speech whose importance is sometimes lost in historical accounts, Deng laid down the “Great Tasks” facing China in the last two decades of the 20th century and beyond. Among those tasks was the quadrupling of gross national product by 2000, an aspiration that was initially scoffed at. Under the Deng-initiated reforms, which included the de-collectivisation of agriculture and the unleashing of an entrepreneurial business class, China achieved that goal in a canter.
1992: Deng, then 90 and in bad health, embarked on what was described as a nanxun, or southern inspection tour, in which he re-energised the reform process after it had fallen into the doldrums following Tiananmen… Historians may well come to regard Deng’s nanxun as not simply his last hurrah, but his most enduring contribution to China’s surging power and influence.”
Finally, there were China’s trade deals with the United States and other countries and its 2001 membership in the World Trade Organization, all of which accelerated China’s development. President Clinton signed an executive order in 1993 to give China most-favored nation status, an important marker in China’s development as a manufacturing and export powerhouse. MFN status was made permanent by a vote in Congress in 2000.
All of these factors combined to deliver a massive demographic dividend for China starting in the 1990s and until around 2010.
If we look at where we are today and examine the chart above, we see that the dependency ratio has reversed around 2010 and that it is set to climb for the next six decades. In essence, the demographic dividend has been successfully realized and is now behind us. Today, the demographic component of growth has turned from a positive to a negative, and the question is whether China is able to act upon other levers of prosperity in order to overcome its demographic slowdown.
In an upcoming post, we will examine the present and likely future course of the economy as it tries to adapt to a rising dependency ratio, over-investment in infrastructure, and shifting priorities in governance.
In Demographic Dividend: Which Countries Are Next?, I looked at Sub-Saharan Africa’s own historic opportunity for a demographic dividend.