China's Economic Development - People ... I see no People

Guest Post by Claus Vistesen

Most eyes these days are centered, and rightfully so, on the steady deterioration of economic conditions in the US and thus by derivative the USD. The last event to keep our gaze fixed was the trouncing of the Bear Sterns stock, a US securities firm, on the back of the news that the Fed had supplied emergency funding for the company. Furthermore, we learned today that the Fed has exited the weekend by lowering the discount rate (from 3.25 to 3.00) as well as provided JPMorgan with funds to aim them in their buy of Bear Sterns.The situation in the US is of course turning into a real cliffhanger at the moment with the Fed working at all cylinders trying to allow the economy to emerge from one of the worst economic and financial crises in the US since, dare I say it, the 1930s. One thing is for sure, the US economy is down ... it most definitely is. But by peering across the commentary landscape you could easily get the idea that as the USD continues its decline the US economy is going to sink into the ground, move to Mars or whatever and the world can point to it as an example of what not to do and move happily forward. This is obviously not going to happen and my guess is that we are not going to get very far with this the US v. Europe et al. football match discourse but at this point in time, this is what we have.

Meanwhile, in terms of the global economy and the future sustainability of whatever economic/social system we want to preserve China would perhaps be a better place to look. And why would I be saying that you might ask?

Quite simply, an awful lot seems to depend on China in terms of solving some of the most pressing structural challenges for the global economy and the yoke is not for the faint of heart. On the main global macro level we have the pressures for China to revalue its currency to lead the way in an adjustment process of the global macroeconomic current account balances. As a part of this adjustment process China is also supposed to switch almost two decades' of development strategy into one where consumption and not investment/exports becomes the main driver of growth. In this respect, China also still has more than a trillion dollars worth of FX reserves it needs to allocate. Even more pressing, China now seems to be a net contributor to rising global inflation pressures through rising domestic consumer prices and wage costs (transmitted through) as well as China's hunger for energy and commodities which is providing a high floor for world base commodity and energy prices even if growth slows. Coupled with the newfound focus on global climate changes this is further putting the heat on China.


I don't deny that China is changing and that China has the power to surprise but when I look at the evidence presented to us from the data and reports from China I am increasingly worried that she simply won't be able to muster the load we are piling onto her shoulders and if a faltering US economy is bad for the global economy hick-ups in China could prove just as menacing if not more. At the heart of my argument lies demographics which should not surprise my readers. As such and if we want to fully understand the Chinese economy we need to realize the effects of a prolonged period of tough enforcement of one-child policy which are now set to enter the stage alongside the rest of the economic factors noted above.


In order have an anchor on which to tie my argument and the points I want to emphasise I am going to move in behind my colleague Edward Hugh who recently took the China issue under his clout in two most worthwhile notes. As Edward points to this may very well be a question of 'it's the fertility stupid' and in this light the tendencies we are currently observing in China should be watched very closely. The reports and incoming data all seem to point in one and the same direction. The double digit growth rate seems to be continuing as ever before even if exports recently waned to reflect the growing effect from a struggling US economy. However, and where China hitherto only had to worry about bubbly asset prices core prices and most strikingly wages are also now beginning to increase at levels which should have our eyebrows raised more than a bit. Curiously, this tendency coincides with the growing number of reports indicating how the idea that China is sitting on an endless pool of cheap labour to fill the factories is a myth in serious need for debunking. As Edward points to ...

For decades most labor economists saying that China’s vast population would supply a nearly bottomless pool of workers. So many people would be seeking jobs at any given time, this reasoning went, that wages would be stuck just above subsistence levels, probably for decades. As recently as four years ago, some experts estimated that most of the perhaps 150 million underemployed workers in the countryside would be heading to cities. The reality however has been quite different. Instead, from 2003 onwards sporadic labor shortages started to appear with growing intensity at factories in the Pearl River delta of southeastern China. Now those shortages seem to have spread to factories up and down the Chinese coast.

Only this week the Economist reports - in an article entitled Where is Everybody - that the vast annual migration of around 20m people that has been fuelling the manufacturing boom in southern China over the past two decades is rapidly diminishing.

Back in August 2007 Keith Bradsher had a good article in the NYT in which he makes the much cited connection between rising wage costs and rising import prices from China thus pointing to end of global labour arbitrage and what has been known as the Great Moderation. Of course, the picture is a bit more complex than this or as Scott Peterson notes in a recent piece, it may simply be a question of China trying to move up the value chain;

It seems that now that China has raised the standard of living for a sizable chunk of its workers, the rest of the work force isn't willing to accept the difficult working conditions that gave China its manufacturing cost advantage. This puts China in the same stage of workforce condition as Western countries. By that I mean that holders of capital can't find workers willing to take jobs at the wage on offer, so the country must either import workers willing to work at that wage as the US has done with agricultural workers, or outsource the work to foreign labor. Since bringing foreigners in is politically and practically nonsensical for China, the work goes overseas.

In fact, China may not in fact be lacking labour as such but there does indeed seem to be a lack of young labour with respect to ensuring the continuation of the Chinese growth model where investment and cheap factory capex have been the main driver. It still is of course but now the ill-wanted companion of inflation now seems to be slotted in on the passenger seat threatening to pull the gear lever and the steering wheel to make the car stray off the road. Paraphrasing Edward in his quote of Keith Bradsher the following is a fine summation of the problem at hand ...

"Plant owners’ refusal to hire blue-collar workers over 35 or 40 is colliding with the demographic reality of China’s one-child policy".

The evidence presented so far seems to be confirmed if we hit the world of academic journals. Consequently, a recent paper published in 'China and the World Economy' A Counterfactual Analysis on Unlimited Surplus Labor in Rural China starts out by debunking the myth of the unlimited supply of surplus labor from Rural China. The paper is about more than that however and thus enters the very pertinent discussion about how China is to integrate the rural regions with its coastal urban counterparts and how to manage the flow from one end of the value chain to other. At the heart of this rapid depletion of Chinese labour resources is then first and foremost the very rapid economic development which in itself has feasted upon the cheap labour supply. However, in the background of all this the one-child policy has surely and steadily exerted its effect and now the curves might just be intersecting. And the result? Well, there now seems to be mounting evidence that growth is now accompanied by ensuing effects of wages costs and inflation grapping hold not least because the composition of China's population is changing at a time where China is thundering ahead at double digit speeds. China's demographic profile and by derivative its fertility patterns are notoriously difficult to get a hold on. In a paper from March 2007 (Population and Development Review) four Chinese scholars embark on the formidable task of extracting an overall pattern from the very heterogeneous nature of Chinese fertility regimes as they vary between provinces ...

At both the prefecture and province levels, policy fertility ranges from the one-child rule to a policy that allows two children and more. At the same time, birth control regulations drafted and implemented by China’s provinces allow numerous kinds of exemptions to the one-child rule, based on considerations ranging from the demographic to the political. These results highlight the complex nature of Chinese birth control policymaking and implementation. Both regional and demographic distributions of policy fertility show that the mode of the policy falls into the category of 1.3 to 1.5 children per couple (38 percent of the prefectures and 53 percent of the population, respectively). The majority of the Chinese population (more than 70 percent) live in areas with a policy fertility level at 1.3 to 2.0 children per couple.

(...)

Based on local fertility policies and corresponding population distributions, we estimate that the overall average fertility targeted by the fertility policies for China as a whole is 1.47 at the end of the 1990s. This level is far below replacement.

The difference between policy and actual action has been frequently cited in a Chinese context as couples have attempted to circumvent the official policies to have more than one child. However, on the other hand it also seems that especially fertility rates in urban are persistently underestimated. The picture we are left with is that the TFR is (and has been for around a decade) in the region of 1.5 (with the pessimists tending towards 1.3 and the optimists 1.7). In the grand scheme of things these numbers are not so important when it comes to pointing out a path for China's population in the immediate future. What we know is that China is not set to age very rapidly and that the composition of the population will undergo a change of historical proportions as China irrespective of what happens to economic development now is set to join the league of economies with a steadily rising median age. In fact, China's size here aids us tremendously in our analysis as immigration to mitigate the effects is completely out of the question due to the size of the Chinese population. All this does not of course spell doom for China but it does mean that China is now entering a new stage of its economic development process. As Edward points out and as is echoed by this piece by one of the blogosphere's main China savants Michael Pettis this means that the number of young workers (aged 15 to 19) is now set to steadily decline as a proportion of China's population. We also know that the demographic changes will come very swiftly now and there does not seem to be many remedies on the table at this point. And those that we have are simply not adequate I am afraid and to pick (perhaps unfairly) on one I could refer to Yi Zeng's paper from June 2007 in which he sketches the 'options' for a fertility transition bringing China out of the vice of below-replacement fertility.

(...) the author concludes that China needs to begin a gradual modification of its fertility policy as soon as possible. He proposes a three-stage "soft-landing" strategy for fertility policy transition: (1) a 7-year initial smooth transition period; (2) from approximately 2014-15 to 2032-35 a universal two-child policy combined with late childbearing in both rural and urban areas; (3) after 2032-35 all Chinese citizens would be free to choose family size and fertility timing. This strategy will enable China to have much more favorable demographic conditions and socioeconomic outcomes, as compared to keeping the current policy unchanged.'

If we leave aside the rather dubious point that Chinese women are programmable robots who can actually be submitted to such a transition we also need to consider the speed with with the current process is moving along. The suggestion above simply denotes an understanding of the demographic transition which is wholly out of sync with the way it actually works in the real world. I won't be picking extensively on this paper and if anything we should be acknowledging the fact that this is actually narrated as a problem which needs to be addressed. Yet, we also need to understand that given the trajectory of China's demographics and its rampant growth rates any actions, on this front, taken in a post 2015-2020 perspective will literally be subject to such long term projections before they may have a concrete effect that it does not, in a scientific or policy related context, makes sense to discuss their merits.

So what the hell am I getting at here?

In the main, I have tried to take sketch, or take proprietorship of, the part of the discourse on China's economic development and its role in the global economy which should be specifically related to demographics. But how does it link in with the general narration of China in the global economy? Well, demographics are not destiny and you should not leave this note thinking that this is what I am advocating. However, there is mounting evidence that once fertility (TFR) drops into the 1.5 region and stays there for a prolonged period the forces of demographics steadily and rapidly begin to take center stage as one of the main macroeconomic explanatory variables.


In China's case this becomes rather preoccupying. In this way and if we return to my introductory remarks I would argue that the rapidly changing demographic profile of China quite simply is at odds with all those changes we believe China is to make in order to, as least partially, lead the process of global macroeconomic adjustment. In fact, there may be a rather worrying precedent for the process China is now set to enter. If we consequently peer a bit to the West from the Chinese mainland we run into Russia and then further on the Eastern European economic edifice. What we have seen in this region since the end of 1980s is a process by which these countries have been in a veritable race against time to move up the value chain fast enough to escape the burden of completely lopsided demographics as fertility collapsed in the beginning of the 1990s and outward migration steadily began to drain their labour markets (Russia is an exception here). This process is now set to come to a very abrupt standstill prompted by the simple fact that these countries are now out of road in terms of having qualified labor to continue to process.

Moreover, the process itself has been one which rampant inflation and wage costs have followed in the heels of the build-up of large negative external positions. And what is at the heart of this then? Well, surely it is not all about demographics but in the main I think it is. In essence these countries have quite simply not had the demographic profiles to support the massive expectations of growth opportunities which were vested on them in an external context and whatever importance we ascribe to institutional reform (and nobody can argue that this is unimportant) the speed by which this has happened has left traditional reforms completely helpless in keeping up.

Allow me then to end this piece on a rather ominous note. I don't deny for a minute that China needs to correct, not for a minute and 'yes Virginia, exchange rates do indeed matter'. However, the global economy also has a distinct stake in not allowing China to enter on a road like the one we have seen in Eastern Europe. It takes a strong back bone to act as the global importer of last resort and at the heart of that backbone is a strong demographic profile. Yet, if China now is on the path of engaging in a breathtaking race against time to fulfill the obligations to become the new consumer driven nation of the world we at least need to look at what the potential consequences could be. One common fallacy in this respect would be how an appreciation of the Yuan would have a mitigating effect on inflation and overheating pressures. Of course, this is what theory tells us and I think that everybody can see that a revaluation is badly needed at this point. But such an adjustment process would also require that China invested more of its reserves in the domestic economy as well as foreign money and goods would come pouring in at a pace which itself could stoke a lot of bubbly tendencies. At the end of the day, I may be too pessimistic here.

Recent data out of China show that income is growing and that domestic demand is booming as a consequence. That is good. But if the process is too fast and too abrupt lingering inflation is likely to take hold and that would not be welcome by any standards. In a more immediate context I have this year's Olympic games as a sort of litmus test. There is no doubt that China will race through this at her traditional pace but what happens afterwards?


Post script ...

If we leave aside the rather dubious point that Chinese women are programmable robots who can actually be submitted to such a transition we also need to consider the speed with with the current process is moving along. The suggestion above simply denotes an understanding of the demographic transition which is wholly out of sync with the way it actually works in the real world. I won't be picking extensively on this paper and if anything we should be acknowledging the fact that this is actually narrated as a problem which needs to be addressed. Yet, we also need to understand that given the trajectory of China's demographics and its rampant growth rates any actions, on this front, taken in a post 2015-2020 perspective will literally be subject to such long term projections before they may have a concrete effect that it does not, in a scientific or policy related context, makes sense to discuss their merits.
So what the hell am I getting at here?
In the main, I have tried to take sketch, or take proprietorship of, the part of the discourse on China's economic development and its role in the global economy which should be specifically related to demographics. But how does it link in with the general narration of China in the global economy? Well, demographics are not destiny and you should not leave this note thinking that this is what I am advocating. However, there is mounting evidence that once fertility (TFR) drops into the 1.5 region and stays there for a prolonged period the forces of demographics steadily and rapidly begin to take center stage as one of the main macroeconomic explanatory variables.

In China's case this becomes rather preoccupying. In this way and if we return to my introductory remarks I would argue that the rapidly changing demographic profile of China quite simply is at odds with all those changes we believe China is to make in order to, as least partially, lead the process of global macroeconomic adjustment. In fact, there may be a rather worrying precedent for the process China is now set to enter. If we consequently peer a bit to the West from the Chinese mainland we run into Russia and then further on the Eastern European economic edifice. What we have seen in this region since the end of 1980s is a process by which these countries have been in a veritable race against time to move up the value chain fast enough to escape the burden of completely lopsided demographics as fertility collapsed in the beginning of the 1990s and outward migration steadily began to drain their labour markets (Russia is an exception here).

This process is now set to come to a very abrupt standstill prompted by the simple fact that these countries are now out of road in terms of having qualified labor to continue to process. Moreover, the process itself has been one which rampant inflation and wage costs have followed in the heels of the build-up of large negative external positions. And what is at the heart of this then? Well, surely it is not all about demographics but in the main I think it is. In essence these countries have quite simply not had the demographic profiles to support the massive expectations of growth opportunities which were vested on them in an external context and whatever importance we ascribe to institutional reform (and nobody can argue that this is unimportant) the speed by which this has happened has left traditional reforms completely helpless in keeping up.

Allow me then to end this piece on a rather ominous note. I don't deny for a minute that China needs to correct, not for a minute and 'yes Virginia, exchange rates do indeed matter'. However, the global economy also has a distinct stake in not allowing China to enter on a road like the one we have seen in Eastern Europe. It takes a strong back bone to act as the global importer of last resort and at the heart of that backbone is a strong demographic profile. Yet, if China now is on the path of engaging in a breathtaking race against time to fulfill the obligations to become the new consumer driven nation of the world we at least need to look at what the potential consequences could be. One common fallacy in this respect would be how an appreciation of the Yuan would have a mitigating effect on inflation and overheating pressures. Of course, this is what theory tells us and I think that everybody can see that a revaluation is badly needed at this point.

But such an adjustment process would also require that China invested more of its reserves in the domestic economy as well as foreign money and goods would come pouring in at a pace which itself could stoke a lot of bubbly tendencies. At the end of the day, I may be too pessimistic here. Recent data out of China show that income is growing and that domestic demand is booming as a consequence. That is good. But if the process is too fast and too abrupt lingering inflation is likely to take hold and that would not be welcome by any standards. In a more immediate context I have this year's Olympic games as a sort of litmus test. There is no doubt that China will race through this at her traditional pace but what happens afterwards?


Post script ...

China and her economy obviously commands much attention in the general debate and as always it is difficult to find time to read everything. I suggest you go for quality then. Brad Setser and his global imbalances watch is a must and even though Brad and I have our little exchange rates v demographics argument I still think that he is indispensable. Another author you need to read here is Michael Pettis (who recently had a guest posting spell on Setser's blog). Michael writes exclusively on China and you would be hard pressed to find a better one-stop source. Finally, this small space tracks the quarterly journal China in the World Economy as well as Edward and I have our small China Economy Watch which will be updated on an ad-hoc basis.

Too Little Pork, Too Much Money, Or Both of These Plus Too Few People To Work The Land, To Grow The Pork, To Move The Money.......?

The yuan today climbed yet one more time to its highest level (against the dollar, but not of course against the yen or the euro) since China its peg in the summer of 2005 as the central bank stepped up efforts to curb inflation which is currently running at an 11-year high. China has so far permitted a 3.4 percent gain in the currency so far this year, almost half the advance for the whole of 2007, as it seeks to cut the cost of imported goods and slow export growth. The precipitating factor in today's rise was yesterdays decision by the People's Bank of China that banks should set aside more reserves. According to the new ruling banks must now place a record 15.5 percent of deposits with the central bank, up from the previous 15 percent. This is the second time this year it has done this foolwing ten similar hikes last year (all but one of which were by 50 bp) , and, although the increase is not especially large, it does give us some indication of the difficulty the central bank is encountering in its ongoing effort to slow down expansion in China's money supply.

One indication that such measures may well fall far short of what is needed is provided by today's movement in government bonds, which gained after the finance ministry sold 10- year notes at a yield which was sloghtly lower than the market generally anticipated. The finance ministry auctioned 27.9 billion yuan ($3.95 billion) of the securities at 4.07 percent, compared with the 4.1 percent general estimate among analysts. The yield on the 4.16 percent note due in February 2023 also fell 3 basis points to 4.17 percent, according to the China Interbank Bond Market. The price of the bonds was up 0.34 per 100 yuan face value to 99.9. All of this suggests there is still very ample liquidity left in the system, and considerable "draining" yet to do.

The yuan was up by 0.26 percent on the back of the news - to 7.0630 to the dollar - as of 5:30 p.m. in Shanghai, the biggest gain so far this month, according to the China Foreign Exchange Trade System. The currency has so far climbed around 0.6 percent in March alone. However gains in the yuan have trailed behind some other Asian currencies over the past month, suggesting the central bank may have been intervening to slow its appreciation. The yuan has risen 1.2 percent against the dollar in the period, while the yen has gained 8.3 percent and the Taiwan dollar 3.3 percent. Obviously the yen is a somewhat special case, since the unwinding of the carry trade is an important part of the picture here, but still a rather greater increase in the yuan could really have been expected.

China's stocks rose, giving the CSI 300 benchmark index its biggest increase in six weeks. Yuan-denominated A shares listed on China's two exchanges, gained 124.91, or 3.3 percent, to 3,888.86 at the close today. This is the biggest rise since Feb. 4, and follows hard on the heels of a five-day, 15 percent loss. Only yesterday the index tumbled 5.1 percent yesterday - to its lowest since July 16 - after Premier Wen Jiabao said the government will take "forceful" measures to battle inflation. In more general terms the index is now down by about 40% from its November peak.


Obviously, as I keep signally, inflation is definitely the biggest worry, with consumer prices rising at an 8.7 percent annual rate in February, the fastest pace in 11 years, as wahes continued to increase at a 20% plus annual rate, and food and energy prices held steady to their long upward march.





Michael Pettis over at China financial markets blog had a relevant posting on the inflation front yesterday. Alongside a detailed analysis of the breakdown of the inflation data, he reports on the February wholesale price index reading which was released yesterday. February wholesale prices were up 9.2% year on year and 1.1% month on month (which amounts to an annualized 14%). Thus inflation is at this point well engrained inside the system.

As Michael notes we do have some quite stunning differences in the components of price inflation. Foodstuffs - which constitute some 33% of the basket - increased by 23.3 percent year-on-year. Of the foodstuffs total, the price of meat, poultry and associated products surged 45.3 percent (of which, that pork component which has attracted so much of ken Rogoffs attention increased 63.4 percent).At the same time price deflation persisted in other areas. The price of clothing declined 1.4 percent year-on-year, while the price of garments alone dropped by 1.6 percent. The price of durable consumer goods was up a mere 0.8%, while household services, maintenance and renovation (which is of course very labour intensive) were up 8.5. Not surprisingly communication services were down by 19.9%.

Housing costs were up by 6.6 percent year-on-year, and included in this category are the price of water, electricity and fuels, building and decoration materials, and renting, which were up 6.5, 5.9, and 4.5 percent respectively. What this indicates - when we consider these price rises along with the rise in wages - is that second round effects are now well into the system, following a pattern which is all too familiar already from Russia and Eastern Europe.

But given the great variance in prices we seem to have structural constraints in some areas and not in others. Agriculture seems to be the bigggest issue, given the percentage of additional income that Chinese families are liable to spend on food. So what is happening?

Well perhaps one clue is provided in another piece of information which Michael has dug out for us from the pages of the People's Daily;

Tian Chengping, Minister of Labor and Social Security, said on March 9 that there are 24 million job-seekers in cities and towns every year, including the new additional urban workforce and the people carried over from the previous year who did not find work. But there are only a little more than 12 million jobs available in cities and towns every year. Approximately 8 million additional rural laborers move into cities and towns every year; and this phenomenon will continue for quite some time. The current employment situation remains grim.

Tian Chengping said that in the future, we should promote employment in six ways that include regulating and controlling unemployment; establishing an early warning system for unemployment; and making efforts to maintain stable employment conditions.

So what we may well have here are some rather important structural mismatches between jobs on offer and the people who are applying to do them. I do find it hard to see how there can be year on year wage increases in the 20 percent plus range if there are serious surplus labour pressures.




What we have are 8 million people flooding into the cities and towns from the countryside every year, and 12 million jobs being created there. What this means is that you can have a backlog of people already in the cities who are finding it difficult to obtain work, some of them being unemployed of over one years duration. But just how many of the over one year unemployed people are actually employable? This is a question which we have been having to ask in country after country across Eastern Europe, and I doubt the situation is that different in China.

What there may be are a lot of people over 40 (for example) underemployed, or something like that, there may also be too many people arriving in some urban areas looking for work for those areas to absorb, while in other areas - and especially some rural ones - severe shortages develop. Some of this then gets knocked on to the food prices issue.

But this "buffer overflow" in the urban labour market is not at all inconsistent with labour shortages in other areas of the economy, particularly in the rural ones, where in fact food prices may be rising due to the unavailability of sufficient labour to work the land intensively enough, and the very low productivity of labour which can't simply be changed overnight. If this is the case then the "pork barrel inflation" (my apologies to Ken Rogoff) may well be about more than money and only money. As he admits why we didn't get inflation before in China, given that the monetary conditions were already present, is rather surprising:

Inflation of more than 6 per cent is the immediate problem. Those who think inflation is caused by too little pork rather than too much money are wrong. China’s relatively pegged exchange rate system has led the authorities to flood the economy with renminbi. ... The real surprise is that inflation did not sprout earlier. The authorities must stuff the inflation genie back in the bottle. It is not going to be easy...

Could it be that before living standards hadn't risen far enough or fast enough, and that there was still sufficient surplus labour out there in the heartlands, surplus labour which - like that legendary liquidity over at Paribas on the 9th August last - has suddenly and astonishingly evaporated as the Olympic driven boom finally takes the system near to breaking point. Remember that the Economist reported that 7 million people failed to return to work in the "growth hothouse" Guandong region after this year's New Year holiday. So could it be that despite all that excess liquidity there are now be deep seated structural questions lying behind China's recent inflation surge. Some additional evidence for this is provided by a paper that Claus Vistesen dug out and reported on in this post.

Basically in the February 2008 issue of the journal "China and the World Economy" Fang Cai (Director of the Institute of Population and Labor Economics, Beijing) and Meiyan Wang publish a paper entitled "A Counterfactual Analysis on Unlimited Surplus Labor in Rural China". Here is the abstract.

Using a counterfactual analysis approach, the present paper examines a host of conventional wisdoms relating to issues of farmer, the countryside and agriculture, which are believed to be all originated from the existence of mass surplus laborers in China. When analyzing various sources of statistics, evidence shows that there is no longer a large pool of surplus laborers in rural China as most people believe. Based on this counterfactual result, all related events, such as the direction of agricultural technological changes, the level of comparative productivity of agricultural labor, and the degree of rural-urban income gap must be reconsidered.

So what this suggests is that China may indeed be finding it difficult to increase food production due to rural labour shortages which are a direct consequence of the one child per family policy. What I feel is that if this view is right we shouldn't be treating increasing food prices as a temporary blip in inflation, since the shortage of rural population (and the low productivity of Chinese agriculture given the labour quality of what is left) and the increasing living standards of the urban population is going to put an upward pressure on prices for some time to come. Add to this labour shortage generated pressures on wages and you are into all sorts of problems.

Evidently, given they will continue to need to increase the volume of food imports, letting the yuan rise can ease the internal inflationary pressure, but this will only result in exporting Chinese inflation out into global food prices for the rest of us. So really, you could say you are going to see the direct impact of thirty years of one child per family policy sitting right on your dinner plate.


Postscript

Those interested in a more growth-theoretically oriented explanation of the argument in this post may find my "Has China's Economic Growth Passed It's Peak? post well worth reading.

And for a fuller explanation of the inflation dynamics problem in another context see my "Inflation in Russia: Too Much Money Chasing Too Few People?".

Also of general interest are my "China's Inflation and Labour Shortage Problem, It's The Fertility Stupid!" and Claus Vistesen's "China's Economic Development - People ... I see no People"

China Fixed Asset Investment February 2008

China's sending on factories and property rose at an annual rate of 24.3 percent in February, maintaining pressure the Chinese administration to try to prevent the world's fastest- growing major economy from overheating.

Fixed-asset investment in urban areas rose to 812.1 billion yuan ($115 billion) year on year, according to the latest data from the Chinese statistics bureau. The rate was also up slightly from the 23.4 percent pace achieved in January and February 2007.





The worst snowstorms in half a century failed to prevent a 33 percent jump in spending on real-estate development. China may now move more strongly to allow appreciation of the yuan, to raise interest rates and to increase bank reserve requirements after inflation in February accelerated to an 11-year high.


The yuan rose today to its highest level since the fixed exchange rate peg was ended in 2005. It traded at 7.0864 versus the dollar as of 3:42 p.m. in Shanghai up from 7.0900 yesterday. At the same time the CSI 300 Index of stocks fell 1 percent for the sharpest weekly decline since the index was introduced in April 2005, amidst growing concern that the government is about to raise interest rates. The People's Bank of China lifted borrowing costs six times in 2007 and has pushed banks' reserve requirements to 15 percent, the highest ever. The key one-year lending rate is currently at 7.47 percent.

The rate of investment compares with the 25.8 percent increase for the whole of 2007, but this years economic statistics for January and February this year have been distorted by the recent blizzards, making it harder to evaluate the effects of what the government terms its "tight" monetary policy.

Inflation shot up to 8.7 percent in February. Producer prices, the cost of goods as they leave the factory, also rose at the fastest pace in three years. Retail sales climbed the most in nine years, partly on rising prices.

Weaker export growth illustrated the threat that slowing global economic growth may represent for China. Overseas shipments rose last month at the slowest arte in five years, cutting the trade surplus, as demand in the United States waned. Money-supply growth also slowed, while industrial production expanded in the first two months by the least in a year.

The acceleration in property investment - up by 32.9%, an increase from the 30.2% pace for the whole of 2007 - even after the government tightened land-use rules, raised mortgage costs and increased down payments is bound to represent a cause for concern.

Non-metal minerals investment surged 61 percent in the first two months from a year earlier, coal jumped 31 percent, and oil and natural gas rose 9.8 percent. Spending on electricity production fell 3.7 percent.

China Industrial Output February 2008

China's industrial output grew at the slowest pace in over a year in January and Fenruary as exports cooled and the worst snowstorms in half a century closed factories and disrupted power supplies. Output rose 15.4 percent in January and February from a year earlier, the statistics bureau said today, after gaining 17.4 percent in December.




Industrial production may be slowing in China, but it still grew at almost triple the pace of the increase in India, the world's second fastest-growing major economy, in January, and we need to see what happens in March and April when hopefully there will be no snow blizzards or similar so we can get a true picture of what is happening.

Chinese Premier Wen Jiabao told lawmakers last week that inflation and overheating are the nation's biggest economic risks this year. Consumer prices surged 8.7 percent in February on food costs.

Slowing global growth, a U.S. housing recession and an international credit crunch may all combine to put a break on China's expansion by curbing the demand for Chinese exports. Money-supply growth cooled in China in February as the trade surplus narrowed 64 percent and exports rose 6.5 percent compared to Fenruary 2007. This was the slowest pace in almost six years.


The People's Bank of China lifted borrowing costs six times in 2007 and raised bank reserve requirements to 15 percent, the highest ever. China has also let the yuan appreciate more quickly (although many would argue not quickly enough) to reduce import costs. The currency has climbed 2.9 percent this year versus the dollar following a 7 percent gain in 2007.

China Retail Sales February 2008

China's retail sales climbed 20.2 percent in money terms in February accrording to the statistics bureau this morning, matching the fastest rate of nominal increase at least nine years. The increase for January and February was the same as that for December. It is important to remember, however, that this figure was boosted by the fastest inflation in 11 years.



If we strip out the monthly year on year increase in the consumer price index, however, things look a little different, and we no longer have the impression of steady acceleration, but rather it seems the rate of increased peaked - at least for the time being - in December.





Consumer-price inflation accelerated to 8.7 percent in February, underscoring the risk the world's fourth-largest economy will overheat after expanding 11.2 percent in the fourth quarter. Producer prices, the cost of goods as they leave the factory, rose 6.6 percent in February, the fastest pace in three years.

Jewelry sales rose 47 percent from a year earlier, grain and cooking oil climbed 41 percent, and petroleum jumped 40 percent. Furniture gained 26 percent, while automobiles surged 34 percent.

To foster domestic consumption, China is raising welfare payments and subsidizing farmers' purchases of televisions and refrigerators. Urban disposable incomes climbed to 13,786 yuan ($1,900) last year, while rural earnings rose 15.4 percent to 4,140 yuan.

Monetary policy is still incredibly loose in China with thre real interest rate being in negative territory (the real rate is the rate of interest after allowing for inflation. The key one-year deposit rate is 4.14 percent, less than half the current rate of inflation.

China Consumer Inflation February 2008

China's inflation accelerated to its fastest pace in 11 years in February as the worst snowstorms in half a century disrupted food supplies, adding to pressure on the government to step up administrative measures to try and slow the economy and on the central bank to raise interest rates. Consumer prices climbed 8.7 percent in February from February 2007 following a gain of 7.1 percent in January, according to the statistics bureau in Beijing earlier today.

This is obviously very bad news indeed, and makes the Chinese problem look ominously like what we have been seeing in some East European economies and Russia. Obviously rising living standards which produce pressure on restricted global food prices don't help, nor does the strong flow of speculative funds entering China in the expectation of yuan revaluation. But to the discerning eye there is obviously a much more profound process at work here. The problem seems to be that China - despite its enormous size - is chewing up its labour reserves faster than new labour market entrants are arriving, and this is happening in large part due to the structural population break which has been produced by several decades of one child per family policy.




The issue is simply that China cannot continue to grow at anything like the double digit rate it has become accustomed to in recent years, in particular due to the growing constraints on labour supply. It should be remembered here that China has so far been focusing on low value work which is hugely labour intensive.

If you want some idea of what this means in practice, just look at this opening sequence from Jennifer Baichwal’s documentary "Manufactured Landscapes". And notice, apart from the scale of the enterprise, and the types of activity engaged in, the comparatively young age of most of the workers.




The New York Times's Keith Bradsher was in China last summer, and he pointed out that while there are no really reliable figures for average wages in China there is widespread evidence that factory owners and experts who monitor the labor market are noting how that businesses are having a hard time finding able-bodied workers and are having to pay the workers they can find ever more money.

For decades most labor economists saying that China’s vast population would supply a nearly bottomless pool of workers. So many people would be seeking jobs at any given time, this reasoning went, that wages would be stuck just above subsistence levels, probably for decades. As recently as four years ago, some experts estimated that most of the perhaps 150 million underemployed workers in the countryside would be heading to cities. The reality however has been quite different. Instead, from 2003 onwards sporadic labor shortages started to appear with growing intensity at factories in the Pearl River delta of southeastern China. Now those shortages seem to have spread to factories up and down the Chinese coast.

Only this week the Economist reports - in an article entitled Where is Everybody - that the vast annual migration of around 20m people that has been fuelling the manufacturing boom in southern China over the past two decades is rapidly diminishing.

The Guangdong Labour Ministry is reporting that 11% of the workers did not return after the January holiday period, and independent estimates put the number as high as 30%. Whatever the exact details, many factories are reeling. Wages were already rising (according to government figures by around 20% y-o-y) now they will surely go up further. Meanwhile, revenues are falling due to slowing demand from America and a reduction, following pressure from other countries, in China's complex system of export subsidies.

The Federation of Hong Kong Industries have also produced some gloomy looking figures. Members estimated 10-20% of the 70,000 factories in Guangdong province had closed in the past year, and they expected a similar number to close within the next two years. Two-thirds of those polled said they were unsure whether to invest more in the region; one-third planned to cut investment. Only one respondent was optimistic. As the Economist notes, not all of this is bad news by any means since to some extent the closures are the objective behin a recent government plan to force dirty, low-paying industries out of business or into poorer interior regions that have so far missed out on the country's growing industrial wealth. But then we have the inflation data, and we can see that there is more at work than a simple "facelift" operation.

When pressed Chinese officials are quick to say that there is no overall shortage of labor — rather, there is a shortage of young workers willing to accept the low wages that prevailed in the 1990s (see again the video clip above). Factories in cities like Guangzhou advertise heavily for young workers, even while employment offices consider it a success if someone over 40 can find any job in less than a year.

Keith Bradsher quotes Jonathan Unger, director of the Contemporary China Center at Australian National University in Canberra, to the effect that “Now they’re taking workers into their early 30s, but anything older than that and they think they can’t take the conditions, the 11-hour days.... as well as work on weekends, and a tedious life in factory-owned dormitories". and as Brasher says "Plant owners’ refusal to hire blue-collar workers over 35 or 40 is colliding with the demographic reality of China’s one-child policy". And on his vists to villages from tropical Gaoyao in the southeastern corner of the country to dusty Houxinqiu in the northeast, what he found most striking was how few young adults remained after so many had left for the cities. He cited a recent government survey of 2,749 villages in 17 provinces and autonomous regionswhich found that in 74 percent of villages, there were no workers fit to travel to distant cities. Of course this is what they are now noting in Guandong.


The Real Issue is Inflation and Rapid Growth


The big unknown in 2008 in China is what is going to happen happen to inflation. Most analysts are assuming that the application of a traditional set of policy measures - letting the yuan rise, raising interest rates at the central bank - will produce a very gradual slowdown in China. Having seen what I have seen in Eastern Europe, and looking at what is now happening in Russia, I have my doubts abou this.

The inflation problem they have is a very real one - as we are now seeing month after month -and at this point in time it is hard to see how they can adequately address it. Certainly unchaining the yuan could just as easily lead to an acceleration of inflows and an increase in the overheating problem as to any more benign outcome, and I would treat New Zealand (and India for that matter) as the "Canary in the Coalmine" (or if you prefer "smoking gun") here. So I would just like to put up a question mark on this count, and I would do this especially in the context of the underlying and strong structural break in the Chinese population pyramid which has been produced by many years of the one child per family policy. Looking at those other canaries - Latvia and Estonia (and then Russia) push-comes-to-shove time does seem to arrive a lot earlier than we had all been anticipating. As I say, 2008 could well be the year that inflation gets a hold on China. In which case the whole thing could simply continue overheating till it simply cannot anymore, and then we could see a quite severe slowdown, a slowdown which given China's size and growing economic importance could have an impact across the entire global economy.

The danger is that a feedback mechanism is created whereby rising wages (according to data from the statistics office Chinese wages are now rising at something like 20% year on year) feed into producer prices, which then feed into consumer price inflation, and so we go on. Certainly this weeks producer prices data was hardly reassuring, since producer prices climbed 6.6 percent in February, the fastest pace in more than three years, giving us yet one more indication that the "cheap Chinese labour" global disinflation process most likely has now come to an end.



What we really need to be noting here is the fact that China's demographic trajectory is virtually unique, especially in terms of economic growth and China's demographic transition, since it is surely the case that China was getting some sort of demographic dividend or other (in terms of having an increasing proportion of the population in the workforce) well before the recent growth wave really took off in the late 1990s.

What we do know is that from the late 1990s onwards China systematically introduced a very extensive labour and financial market reform process, and this certainly has served to unlease a huge amount of pent-up potential both interms of labour supply and sectoral shifts in economic activity, and it is this which has given us the sustained growth since the turn of the century.

What is interesting to note is how the recent uptick in inflation coincides almost exactly with the peaking of the 15 to 19 age group, as you can see in the chart below, and it is important to note that the decline in this age group will now continue as far ahead as the eye can see, and especially over the next several years is really going to be quite dramatic, as you would expect from the drastic one chile per family "torniquet" policy which was applied.




I have selected the 2022 horizon looking forward based on the fact that this is now known data. We can predict with a reasonable degree of accuracy just how many 15 year olds there will be in China in 2022, since they have now already been born. So we have a pretty good idea of China's new labour supply going forward. Obviously China can still get considerable growth by relocating the existing workforce across sectors to more productive ones. But the end of the labour intensive low economic value growth must now surely be in sight, and the big question is can China sustain inflation-free growth of the order of magnitude we have been seeing in recent years, bearing in mind that much of the recent growth in many of the higher growth developed economies - the US, the UK, Ireland, Spain - has been very labour intensive. My feeling is that it can't, this is why all those exhausted canaries swooning in Latvia have been so useful, and that we will see a slowdown in China which will not simply be cyclical, but rather structural. Possibly the moment of inflection (or tipping point) here will come around the time of the Olympic Games.

So, as I say the 15 to 19 age group has now peaked in China, and from here on in it is essentially downhill all the way, as far ahead as anyone can see. The truth is that no-one at this point in time knows what the consequences of this are going to be. But don't worry, since at least one thing is for sure: we are all just about to find out.

Postscript

Those interested in a more growth-theoretically oriented explanation of the argument in this post may find my "Has China's Economic Growth Passed It's Peak? post well worth reading.

And for a fuller explanation of the inflation dynamics problem in another context see my "Inflation in Russia: Too Much Money Chasing Too Few People?".

China Trade Surplus February 2008

China's trade surplus fell for the first time in almost a year in February as the worst blizzards in half a century disrupted the flow of shipments at the same time as demand from the Unietd States weakened.

The surplus was down by 64 percent in February from a year earlier, to a level of $8.56 billion, according to data released by the Chinese customs bureau.

Exports rose year on year by 6.5 percent, which was the slowest rate of increase in almost six years.

For the first two months of the year combined, the surplus was down 29 percent (at $28 billion) over january-February 2007. Imports, on the other hand, were up 35.1 percent in February, which was the biggest gain in more than three years. A significant part of the increase was the result of higher prices for commodities such as crude oil, iron ore and soy beans.

In January, exports rose 26.6 percent and imports climbed 27.6 percent.


It would be wrong to place too much importance on the change in the rate of surplus increase at this stage since China was swept by snowstorms in mid-January, and these will have delayed deliveries to ports and disrupted production at manufacturing companies. Also China's week-long Lunar New Year holiday also started earlier this year than last, leading exporters to bring some shipments forward to January. Another factor which will have contributed to the lower rate of export growth will have been abnormally high - 52 percent y-o-y - rate increase in February 2007, when exporters were pushed shipments through early to beat tax increases.

On the other hand import growth is likely to stay strong since China will continue to need materials for utility, railway and housing projects and for reconstruction work after the snowstorms.


Inflation is also busily creeping up. China's producer prices climbed 6.6 percent in February, and this was the fastest pace in more than three years, according to data from the statistics office today.




The consumer price inflation figure will be released tomorrow and many economists expect China to further raise interest rates, which are already at a nine-year high, possibly within days,.

The yuan traded near its highest level since the direct dollar peg ended in July 2005 on speculation the government will allow further gains in the value of the currency to help combat inflation. The yuan was at 7.1069 per dollar as of 4:15 p.m. in Shanghai, compared with 7.1110 on March 7.