Peter Redward explains how China's one child policy will slow economic growth in decades to come and why a 2008-style spending splurge is unlikely to be repeated

By Bernard Hickey

New Zealand-based economist and strategist Peter Redward of Redward Associates is pointing economic and corporate planners in Australasia to the effects of China's one child policy.

The trend for Chinese economic growth is likely to slow in the years to come as its population ages, its savings rate falls and the dynamism of its currently young workforce ebbs away. The effects could be quite dramatic from the 2030s as China's population is expected to start falling from then. Slower economic growth is expected to reduce demand for imports and weaken commodity prices.

China's birth rate is around 1.2/1.3 children per woman and has been for 30 years, well below its replacement ratio of around 2.2 children per woman, Redward said, pointing out that the second wave of children from the policy were now being born, leaving in many cases an inverted familial pyramid of four grandchildren, two parents and one child.

This policy had initially helped boost China's growth rate over the last two decades as the 'sweet spot' of a higher proportion of younger workers dominated.

"Once you start on the downward path your dependency ratio initially improves tremendously. There's very few old people and less children and your savings rate jumps and you see a massive increase in savings, and that's what China had just been through," Redward said his Monthly Emerging Asia report on Interest.co.nz.

"Once this starts turning, the dependency ratio has the potential to rise very quickly and that will weigh on growth," Redward said.

"Capital accumulation slows, which reduces the capacity to invest. On top of that it means the population of working age people starts contracting, which means there are less workers. And then as the demographic structure changes and the people age, older people are generally less innovative then younger people," he said.

"All of that means that China's growth rate is coming down and will continue to come down on a trend fashion over the next 20-25 years."

Most demographers estimate China's population will start to fall from the 2030s.

"When it starts it could be quite aggressive, as it has been in Japan."

What's happening now

Meanwhile, China's economy continued to slow down through April, May and into June as factory output and construction cooled, Redward said.

"There are some positive signs, but we think the general slowdown in industrial production and activity is continining. The main factor is the delayed impact of tight monetary conditions last year combined with significant overbuilding in the construction sector and infrastructure over many years," he said.

Redward estimated growth in Chinese private sector domestic consumption and investment had slowed from around 7% per annum to around 2%.

"The slowdown is largely a domestic story. People talk about the external environment creating problems for China, but that's not what is driving the slowdown. It's very much centred on industrial production and fixed asset investment," he said.

A modest increase in government consumption through some stimulus measures was offsetting the domestic spending lowdown, along with an improvement in the external sector's contribution as import growth slowed faster than export growth.

"The pace of import growth has been running well below export growth this year up until May, and that's before the significant fall in commodity prices in May and June. Once you factor that in, then import value growth will be even weaker," Redward said, adding China's trade surplus could therefore be US$100 bln larger this year than last year.

What it means for Australia and NZ

"That means for Australia and New Zealand that we're getting this crunching down of commodity prices, principally thermal coal prices have been hit the hardest and iron ore prices have come back, and we've seen weakness in alumimium and copper prices," he said.

Iron ore exports represented about 25% of Australia's merchandise exports, while coal made up 13% of exports, he said.

"That will crunch down Australian export numbers, and that's a factor driving the Ausssie (dollar) down," he said.

Redward repeated that Chinese policy makers were unlikely to stage a repeat of the 2008/09 infrastructure spending spree that helped cushion the impact of the Global Financial Crisis for Australia and New Zealand. See last month's Emerging Asia Report here.

"Policy makers there have been very clear they have no intentions of doing a 2008 (Version) 2.0 and that's justified. The nature of the shock this time around is different. It's much more linear. It's not like a financial dislocation shock," he said, adding however that a Lehman-style dislocation was still possible from Europe.

"Policymakers are much more concerned about the balance sheets of the central and provincial governments so they're tending to lean more on the monetary easing, which is taking time to come through," he said.

No splurge repeat

China eased monetary policy last month.

Local governments, who did much of the investing in roads, rail and new apartments in 2008 and 2009, would be much more circumspect this time around because of heavy debts in Local Government Financing Vehicles, many of which were behind on payments or being forced to roll over loans. The local governments have also been banned from issuing their own bonds to refinance these financing vehicles.

"A lot of local governments have debt/GDP ratios of close to 100%. They've been funding their expenditure plans through the selling of assets and collaterising the value of their land against their local government financing of debt," Redward said.

"Even if Beijing pushes the funds to these local governments, because of the risk of the pressure from the Local Government Financing Vehicles, I don't think they'll necessary spend the money even if they receive it," he said.

'Not so simple'

Many economists have called on China to rebalance its economy away from high savings and high fixed asset investment towards higher domestic consumption, which would ease some of the imbalances in global trade and capital flows.

Redward said this would not be easy for China to do, given the demographic issues bearing down on the population, the lack of a social safety net and the history of social instability in recent decades.

"Restructuring the economy away from fixed asset investment and construction-led growth to consumption is not simple. You've got to change consumers' savings and investment habits and their incentive structures, and given the one child policy in China and the demographic overhang and the social turmoil we've seen in recent decades, there's a very high preference for saving," he said.

"The best way of engineering a pickup in consumption is for the government to step in and start implementing some social welfare and safety nets. Once they do that, the need for large scale precautionary savings will drop away and people will be in a better position to consume more goods and services."

See more here about Redward Associates here, which produces Emerging Asia Today, a daily subscription newsletter.