Ambrose Evans-Pritchard of the Telegraph had an interesting post out yesterday on demographic trends in China. He writes that the working-age population in China is now shrinking as China ages quickly, in part due to the one-child policy. The upshot of that demographic change is that China may be hitting what economists call the Lewis Turning Point when worker supply dwindles and wages rise at a rapid pace. Here are my thoughts.
Evans Pritchard writes:
There is little Beijing can do to head off the shock. The effects of low fertility rates – and the one child policy – are already baked into the pie. It would take half a century to turn around the demographic supertanker.
The Lewis Point, named after St Lucia’s Nobel economist Sir Arthur Lewis, is when the supply of workers dries up and city wages soar. It is when labour turns the tables on capital, and profits crash.
You could argue that such a process already well under way, and is why Chinese equities are trading at a third of their 2007 peak in real terms. Manufacturing pay has risen 16pc a year over the last decade in the East Coast hubs of Shenzhen, Beijing, Shanghai and Tianjin, though this slowed sharply in 2012.
Boston Consulting Group says that “productivity-adjusted wages” were just 22pc of US levels as recently as 2005. They will reach 43pc by 2015, or 61pc for the American South.
It is a key reason why General Electric, Ford, Caterpillar and others are “re-shoring” from China back to the US, though cheap shale gas, a weaker dollar, and shipping costs all play their part.
This is no bad thing. The world economy is rebalancing. China’s current account surplus has fallen from 10pc of GDP to just 2.5pc.
China’s corrosive gap between rich and poor should narrow. The GINI coefficient measuring inequality should come down from stratospheric levels, 0.61 according to researchers at Chengdu University.
I think this notion of the Lewis Turning Point is controversial. I first broached the topic three years ago, writing that a “Labour shortage could spell inflation and trade deficits for China:
What Lewis found is that industrial wages rise very quickly when the supply of excess rural labour is exhausted. This is called the Lewis Turning Point and is where China is right now.
This will have major implications for the Chinese domestic economy and the world economy. The first implication is inflation. Without the endless stream of excess rural labour, wages are going to go way up in China and this means inflation will be a problem. Over the last twenty years, the introduction into the global economy of the former Eastern Bloc and China has meant a huge surge in available labour. Despite a flood of money from the Japanese and U.S. central banks, this influx of labour has effectively capped consumer price inflation in developed economies. The result has been the so-called Great Moderation.
If China has reached its Lewis Turning Point, all of that is out the window and Central banks will face a Scylla and Charybdis flation challenge for years. China’s labour shortage will work in concert with resource constraints and likely excess money supply as an inflationary force. These forces are countered by major deflationary forces from the debt overhang resulting from the implosion of the global asset bubble. We are seeing those deflationary forces in Greece right now.
From a Chinese domestic perspective, the Lewis Turning Point will crater productivity levels as wage rates rise. The corollaries of this increase in wages and lower productivity are slower GDP growth, higher consumption, lower savings and a deteriorating external balance of payments aka current account deficits.
Remember, this is just a thesis, not a fact. But the numbers do seem to confirm that a labour shortage and wage pressure are having an impact on China’s macro economy. Two years ago, Andy Lees argued persuasively that China is losing competitiveness. SInce then a lot of manufacturing has left China and ‘onshored’ again or been moved to other manufacturing centers like Mexico.
The real problem with this secular thesis are the other secular forces in terms of debt and the resulting capital misallocation. When the debt cycle turns nasty, the Lewis Turning Point will be moot because the market will be flooded with labour. Michael Pettis made this point to me by e-mail in 2011 as China’s credit cycle started to turn down. Moreover, as Michael also wrote, the demographic trends in China are more akin to what we see in Russia, Japan, Germany and Italy than in traditional emerging economies where the Lewis Turning Point has been applied. That should make one cautious about applying this model to China.
Irrespective, China is in the midst of a serious reflation effort. As the European crisis started to hit China and threaten it with a hard landing, the factor mobilisation story in China started to turn negative. The outcome was a huge rise in non-performing loans. But China hit the panic button as growth in 2012 was slowing at an abrupt pace. Policy makers directed banks to lend and this credit creation has effectively papered over these NPLs. So the unbalanced investment-led growth in China is continuing despite increasing stories of local governments being propped up only via debt rollover schemes (see here and here).
Yes, you can argue that this kind of macro policy is folly. Stephen Roach did so quite forcefully in a recent Project Syndicate piece. And I believe this policy will cause the eventual hard landing to be that much harder. Nonetheless ,from a macro view it means that the same demographic issues forcing up wages, eroding productivity in China, and lowering trade surpluses are now at play. As I wrote Michael in 2011, “if China overcomes its bubble by successfully socialising losses, it can resume growth and then you might face the same problems again.” That’s where we are right now.
Source: The Telegraph
*Editor’s note: articles like these are usually reserved for Credit Writedowns Pro members but we have decided to put this one outside the paywall because I think the policy issues are just as important as the investing ones.