The trade tiff with China lingers on—let’s just cut a deal for zero tariffs and move on. Then we can tackle the next question: Is there any real chance that China—with gross domestic product per capita lower than Mexico’s—could soon pass the U.S. in size and strength? The prospect is daunting, but we’ve been here before. Does anyone remember books like “Trading Places: How We Are Giving Our Future To Japan”? Me neither. The reality is that for every country, demographics is destination.
I recently attended the Sohn Conference in San Francisco, which raises money for charity by having hedge-fund managers pitch their best investment idea. Most talks were about broken stocks or esoteric cloud software companies hoping to double in value in three years. But Adam Fisher from Commonwealth Asset Management talked about decadeslong trends in China. (I didn’t talk to Mr. Fisher directly: Silly securities laws prohibit funds from marketing broadly while they’re raising money. So my notes will have to do.)
It turns out that China’s work-age population has peaked or is close to peaking—that pesky one-child policy worked. Even worse for Beijing, according to projections by the United Nations Development Program, China’s 65-and-over population is expected to grow by more than 150%, from 135 million in 2015 to 340 million by 2040, which will be 21% of the population. That’s a lot of retirees. By the way, the current retirement age in China is 60 for men, 55 for women, though both are set to increase gradually.
By comparison, Japan’s 65-and-older population reached 26% by 2015. But as the saying goes, Japan got rich before it got old. What about China?
According to the political economist Nicholas Eberstadt, less than 65% of Chinese workers are covered by any retirement benefits. That share drops to 35% for urban migrants. That’s many mouths to feed in old age.
And here’s where it gets dicey. China’s big coastal cities, Beijing, Shanghai, Shenzhen and Guangzhou, have already caught up with the wealthy countries of East Asia in terms of productivity and purchasing power parity. Mr. Fisher notes that sustained growth will therefore depend on improvements in China’s inland. He calculates that western China would have to increase its total-factor productivity by 8% to 10% a year to pay for those 205 million additional retirees. Unless China develops an antigravity device or a perpetual motion machine, that’s a virtual impossibility.
Recall what happened in Japan. Since its stock market peaked in 1990, Mr. Fisher says, total hours worked in Japan have dropped 20%. In the U.S., hours worked rose 40% in the same period. Even though Japan’s productivity was higher than the U.S. (with a stress on “was”), its nominal GDP flatlined. Its government had to step in with increasingly worthless stimulus programs.
Japan’s debt-to-GDP ratio has risen to an eye-popping 238%, while interest rates have dropped. The interest-rate decline has been partially offset by the strong yen. This was the great “carry trade,” of which many hedge funds took advantage: Borrow cheap in Japan and invest elsewhere, though you’d lose some of the leverage when repaying the loans with a more expensive currency.
Mr. Fisher thinks something similar will happen in China. As its public sector—yes, the Communist Party—levers up to compensate for the GDP shortfall, interest rates will drop, then drop some more. Mr. Fisher thinks they’re headed toward zero.
Why? Here’s how the Federal Reserve puts it generally: “The overall boost to savings at the expense of current consumption caused by an increase in life expectancy puts downward pressure on r-star,” the “natural” rate of interest. Also, more retirees mean lower output, so governments must intervene with stimulus as production drops.
China’s currency is also a factor. Maybe the yuan will rise like the yen, creating another great opportunity for a carry trade. But no one can say (this is why macro investors have spotty records). Remember that unlike Japan, China will get old before it gets rich. Ever lower interest rates might mean an ever-weaker currency. Or they could mean China will prop up interest rates to protect its currency, which would further hurt its economy. A rock and a hard place.
Beyond an interesting investment thesis, this has global implications. China is a manufacturing powerhouse, but for how long? Rising wages mean its comparative advantage is leaking away. Productivity growth is its only hope. Think robots!
Unlike a one-child policy, productivity can’t be legislated. It takes smart people with incentives and property rights to innovate and solve real problems. White House National Economic Council director Larry Kudlow told last year’s Wall Street Journal CEO Council that China’s “state run economics is doomed to failure. Doomed.” As its population ages, we’ll see if Messrs. Kudlow and Fisher are right.
Write to kessler@wsj.com.
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