A Shrinking Society Can No Longer Support Expansionary Government
Li Honggang
DATE:  Jul 24 2017
/ SOURCE:  Yicai
A Shrinking Society Can No Longer Support Expansionary Government A Shrinking Society Can No Longer Support Expansionary Government

(Yicai Global) July 24 -- We often call it "new normal." Some people call it "L" growth, and pays special attention to the question of whether L (growth) can come bottom up. But given the background I'm talking about, I think it's hard to see the economic growth rate coming up from the bottom of this L in the long term. A new phase that we are going through currently makes the backdrop of this era: as a result of demographic changes, we are entering the age of "shrinking society." I would like to emphasize that the concept of "shrinking society" doesn't refer to simple economic recession, but it is a general trend of economic and social development, emphasizing the contraction of the entire socio-economic situation resulting from changes in population structure and volume, in which demographic change is the dominant factor.

We divide this kind of contraction state into two levels: one is the level of overall amount, with the other being the structural level. On the two levels of change, we can distinguish between the relative changes (soft contraction) and absolute changes (hard contraction). Relative change emphasizes decline in growth rate, which is the decline of growth speed, while the absolute change emphasizes the decline of absolute level.

From the level of overall amount, China's population has declined relatively in the middle of 1980s, but the absolute decline will take several years. There are several estimates. Yi Fuxian's high birth rate program estimates it to be 2020. Professor Su Jian expects it to be 2022. They are only three to five years away from now. Professor Zhai Zhenwu is optimistic. He estimates that it will be in more than 10 years' time. In most experts' opinions, the absolute decline in China's total population should happen before 2030.

From the structural perspective, our social contraction is in fact already in progress in the absolute sense. Here I mainly focus on the structural contraction of population age (time) distribution and structural contraction of regional (spatial) distribution.

On the age distribution structure, the more comprehensive quantitative measurement method is the "population pyramid." It can be seen from Figure 1 that the age structure of our population has entered into contraction. In particular, if we focus on the labor force (which refers to the population aged between 15-59), China's labor population has absolutely dropped since 2012: down by 3.45 million in 2012, 2.44 million in 2013, 3.71 million in 2014, 4.87 million in 2015, 3.49 million in 2016, and 17.96 million in total in five years. Professor Su Jian expects to see acceleration in demographic decline after 2022, more than 10 million each year. In respect to active population, such as the 15-45-year-old group, the decline is also expected, and its impact on the economy could be more severe.

We are also experiencing a structural contraction in regional distribution. First, the concept of village is disappearing. As early as in 2012, Feng Jicai said: "[In my county] 80 to 100 villages disappear every now and then." Now the vast majority of villages are experiencing population decline even if not completely disappearing. Second, some large regional social contraction is also very obvious, such as the northeast phenomenon which caught wide attention. Researcher Yi Fuxian made early warning of the northeast dilemma from a population perspective.

The social contraction caused by depopulation is not only a problem for China, but a worldwide issue today. The most obvious example is Japan which witnessed a total population decline in 2006, but the decline in its labor force began in 1990. Japan's vacant houses are 8.2 million units in 2017. It is expected to reach 14 million units in 2023, and 20 million units in 2033. We often say that the Japanese economy "lost 25 years," but what is the most fundamental reason?

I think it is important that the population decline leads to a shrinking society. This is Japan's "new normal", and it entered the "new normal" 25 years ago. In fact, Europe has long been in a social contraction and the major reason why it is not so obvious like Japan's is due to the migration of foreign population.

For countries with net population decline, such as Hungary, the population definitely dropped in 1980s, and its social contraction was much more than Japan's. During a visit to Budapest, capital of Hungary, in 2011, it was noticeable that buildings were old, and some places were like the ruins of a thriving civilization. Even in France where the population is still growing, the villages are shrinking and disappearing, and rural populations are moving to cities.

Economic growth in a shrinking society

What are the characteristics of socio-economic growth in this contraction type society? I would like to raise a theoretical question here: What is the long-term economic growth rate of a closed shrinking society?

According to the mainstream economic theory, the sources of economic growth include population, natural resources, capital (physical capital and human capital), and technical knowledge. For some countries, it may also include institutional transformation or structural change. These factors together determine the potential growth rate of an economy. The population seems to be just one of many factors, but in fact it is not an ordinary variable. It plays an engine role. Here, the population is not an isolated element, but it has a decisive role for the development and use of natural resources, regardless of material capital and human capital accumulation, and the renewal of knowledge and technology. Population and other factors are not simply substitutable relations, but should be a complementary relationship.

From a systematic point of view, there is a system integration effect, that is, the whole is greater than the sum of the parts (the so-called "1+1>2"). This seems to be economies of scale, but in fact, it is beyond economies of scale. Among them, the population is the decisive factor. Like the number 10,000, the other source factors are "0s" at the back, but the demographic factor is "1". Moreover, the demographic factor includes both "manpower" and "population." The former is supply-side factor, and the latter is demand-side factor. Other growth factors do not have this dual attribute. If the population supply attribute drives the potential growth rate, the demand attribute of the population will push the potential growth rate to the actual growth rate.

Therefore, based on the above theory, I suppose that the economic growth rate of a closed shrinking society is more related to the population growth rate. 'The Limits of Growth' published by the 'Club of Rome' in 1972 suggested that resources and environmental constraints will lead to the limits of economic growth. In my opinion, a population shrinking society will also face a growth limit. Of course, the limit here does not mean that the economy is not growing at all, but it means that the rate of economic growth is low (it does not exclude negative economic growth).

Moreover, this growth may be caused by the stochastic progress of technology and the synergistic influence of the world economy. In the past, academia often explained that the developed economies were slowing down from the marginal decrease of factor productivity, but in fact, the factor of population should play a more important role.

As a practical illustration, let's look back at Japan's postwar economic growth rate. After Japan's absolute decline in the labor force in 1990, its smooth GDP growth rate has never exceeded 2 percent, which cannot be compared to its two-digit growth rate when it had population explosion in the 1960s. Similarly, the growth rate of Europe, which has entered a shrinking society, has been hovering in the low growth rate zone.

One often cited view is that when population growth falls, higher economic growth can be sustained by raising per capita GDP. According to my earlier analysis, this view probably won't hold water. Let's look at the data in Japan again. After the decrease of its population growth rate, its per capita GDP has not increased much. And, in fact, the growth rate of GDP per capita is high when the population growth rate is high, while in the age of absolute population decline, the per capita GDP growth rate is also low, and some years they even had negative growth. 

How to cope with a shrinking society

Lastly, I would like to talk about how to deal with a shrinking society. Since this shrinking society is mainly caused by population contraction, the first thing we should consider is to minimize the impact of this reduction. It is important to adjust direct and indirect population policies as soon as possible. The direct population policy should release birth restrictions as soon as possible, and in some areas where the birth rate is very low, a policy should be introduced to increase it. Indirect population policies are economic and social policies that are beneficial to those who want to give birth, such as housing supply and low-density urban planning, kindergartens and educational provision. We cannot 'dislike' having a large population. In fact, without a certain birth rate, one or two decades later, the societal impact of a strongly contracting population be severe.

However, regardless of the policies adopted, with social and economic development the birth rate will be lower than the replacement level in the future, and the absolute population decline will be almost inevitable. Even if the country tries to delay and weaken contraction, a shrinking society is still the general trend. To cope with this, we need to adapt from the habits of an expanding society to those of a shrinking society. Whether we are individuals, families, enterprises, institutions, or the government, we should have this sense of transformation. This will be a real, new situation that has not been encountered since ancient times.

For individuals and families, we may first of all need major adjustments for the anticipation of survival and development in the future. For example, the past 30 years can be regarded as the strongest expansion period in Chinese history. Both the state and personal income growth were so rapid that people could become too optimistic about future revenue growth. Now many people would buy houses with leverage. I estimate that the current housing prices imply a very high growth rate for future earnings. But in the face of an increasingly shrinking society, this optimistic expectation of income is unlikely to come true.

Millenials will probably not experience the same income growth of Generation X, because the former is facing a shrinking society, and the latter was in an expanding society. This is the development side. In contrast, there is the survival side. For families, the problem of supporting old people after their retirement in some typical '421' or '422' families (those living as four grandparents, two parents, one or two children) is a serious issue. Allowing the elderly to have a dignified later life is important. Both millenials and those from Generation X should consider their life post-retirement, as the problem becomes more acute in a shrinking society.

For enterprises and institutions, the implementation of strategies for expansion must be cautious in the face of a shrinking society. Most businesses and institutions may not be able to expand as fast as they used to. They may still be expanding regionally and structurally, but overall expansion has been challenging as, in general, the supply side and the demand side are both contracting.

In an expanding society, expansion is often based on the scramble for increments while in a shrinking society, expansion is a struggle based on the existing size of market. The latter is more difficult. As a result, China has been in an age of intensive development rather than expansion, which is often imbalanced. Some enterprises, especially basic consumer goods makers, like beer and instant noodles companies, are already feeling the chill of a shrinking society with a continuous decline in demand.

Another example is colleges and universities. Many universities are now vying for talent and students as they look to develop fast. However, if the population base is decreasing and total demand is shrinking, universities will find it difficult to expand. People often say that a lack of money is not currently the problem, the problem is the lack of talent and labor. In time, both talent and money can become problems.

All levels of government should consider public policies in a shrinking society more deeply. We used to say that to solve problems in development in increments is actually to solve problems in expansion. The expanding society over the years has gradually developed our habitual way of thinking. However, we may have to face a shrinking society in the future and have to solve problems in decrements.

Moreover, the contraction does not only affect China, but also the whole world. When looking at countries all over the world, apart from probably Africa and some Asian countries where the population is still expanding, the population in most of the world's more affluent economies is structurally or grossly contracting. How the government copes with this situation, from the manner of solving problems during expansion to learning to solve problems during contraction, will represent a major change in policy thinking. The following are possible directions for policy adjustment.

Regarding fiscal policy, the rapid expansion in the past 30 years has seen China support an increasing fiscal expenditure with taxes, fees and land transfer revenues, including large administrative expenses and government investment spending. As the country becomes a shrinking society, the government's growth in revenue will slow significantly, while social pension spending will increase rapidly. This requires the country to enact a new fiscal and tax policy. In particular, the country has to cut government spending, including government administrative costs and investment. This essentially requires China to reduce to reduce both the size and actions of the government in a shrinking society. We need to be very clear that a shrinking society can no longer afford an expansionary government!

Regarding monetary policy, the rapid growth of the economy in the past has seen the implementation of a long-term, highly expansionary monetary policy. This kind of policy can still be implemented in an era of acceptable moderate inflation because of rapid economic growth. However, we are now facing a shrinking society, so highly expansionary monetary policy should be reversed. Otherwise, we will face high inflation or a serious asset bubble (essentially inflation). This leads to the devaluation of the currency. The reduction in money credit eventually leads to the collapse of government credit and social credit.

Since last year, nationwide housing prices have soared due to factors regarding people's confidence in the CNY. As with fiscal policy, a shrinking society is no longer able to support a highly expansionary monetary policy. Interest rates at home and abroad are currently at historic lows. Renowned investor Bill Gross, the so-called bond king said: "Global interest rates are at their lowest level in their 500 years of history." I believe this is probably not a short-term phenomenon. If we consider real interest rates, they will probably be at that level in the future. This should have something to do with the worldwide population contraction. It also shows that currency in the world is overextended.

With regard to land policy, the country's policy in the past was based on the panic regarding land resource availability caused by population growth. For example, "The protection of 120 million hectares of arable land from urbanization and industrialization" is one of the pillars of China's land policy. In fact, in the face of the current structurally contracting society, any panic regarding shortages of land would be alleviated and the more effective use of land resources should be considered instead.

Moreover, this effective use should also be considered in the integration of urban and rural areas. At present, the rural society is in a state of absolute contraction and abandoned land is increasingly common, while cities are still in a stage of expansion. The current land management policy has created obvious distortions in the allocation of resources, which is also one of the main reasons for the price bubbles in some cities. The protectionist policy regarding rural land also limits the intensive use of rural land and rural development.

China should allow more urban and rural interaction in the future, so as to promote balanced development between urban and rural areas. They should let some rural farmers live in cities (housing prices should not to be out of reach for them) while letting some urban people go to the countryside (leasing land), develop the countryside, slow the pace of rural area contraction. This is just as important as fiscal and monetary policy.

Overall, we have encountered an unprecedented situation, and need to face the issue of a contracting society. The contracting society has different characteristics from the expansive society, which requires us to adjust our habits and governance style to those of contracting society. The transition is not easy but we have to move on.


The author is a professor of Systems Science at Beijing Normal University

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Keywords:   POPULATION,Decline,Aging,LABOR,Force,Young,GOVERNMENT,Economy,Theory,Shrinking,Society,Contraction,Governance,MILLENNIALS,Generation X