Demographics in emerging countries: necessary but not sufficient for success

George Magnus, 06 Jan 2012

It is often said that demographics are destiny, that is, that population characteristics shape societies and economies in pre-determined ways. In most of the world, rapid societal ageing is underway as a result of the unique combination of weak or falling fertility on the one hand and rapidly rising longevity on the other.

The resulting rise in age structure, in which the productive working age population (WAP) will stagnate or decline, is expected to slow economic growth, and exacerbate the financial squeeze on both governments and individuals as the dependency ratio of older citizens on the WAP rises sharply.

On current projections, several emerging and developing countries (EDCs), including China, Brazil and Mexico will be as old or older than the US before mid-century, and some developed Asian economies, including South Korea and Singapore will be as old or older than many West European countries. South Asia, Sub-Sahara Africa and the Middle East are the slowest ageing regions, and are not expected to confront rapid ageing until the second half of the century.

In most EDCs, this process is running a couple of decades or more behind that in developed nations. With a few exceptions, notably China, Russia and Eastern Europe, EDCs still have plentiful opportunities in the next 20-30 years to bank their so-called ‘demographic dividend’, which refers to the period in which they can derive economic benefits from falling child dependency and a rising WAP. The more rapid expansion in the population of older citizens will not kick in until at least the 2030s. Commercial and financial companies, therefore, view EDCs as expanding and lucrative markets in to which to sell goods and services.

Demographics are not necessarily destiny

Whether EDC are destined to become economically more powerful and prosperous, validating this view in the next 20-30 years, however, is a moot point for two reasons. First, the speed with which they are ageing is unprecedented. It took France a century for the share of the over 60s to double to about 15% of the population, and in most developed countries it took between 40-80 years. In most EDCs, the process will take about 20 years. In other words, they have far less time to build the financial infrastructure and social security systems needed to deal with the consequences of ageing and rising old age dependency.

With a median age of about 29 years and an average 2010 per capita income of USD 3,810, they are actually in worse shape than the US or Europe, which had a comparable median age at the conclusion of the Second World War, but a per capita income of roughly USD 10,000, and USD 5,000, respectively. By the 1970’s, when the median age in the US and Europe was a little less than it is China today, per capita income had risen to USD 14,000, and USD 12,000 respectively. The low starting point of per capita income and the speed of ageing in EDCs underscore the now common mantra that they will grow old before they get rich.

Well designed social safety nets are more urgent for EDCs nowadays than they were for advanced economies that have aged more gradually. They are strongly correlated with protection against economic and social shocks, and with higher economic growth and employment levels. In G20 emerging economies, especially in India and Indonesia for example, many social indicators and all social insurance and pension programmes are inferior in terms of coverage and generosity to those in their high income partner countries. Even though China scores rather better than its emerging peers in many areas of social progress and in educational attainment levels, its public pension assets may amount to no more than about 3% of GDP, vastly overshadowed by the systems in place in, say, Malaysia and Singapore, where the proportion is between 50-60% of GDP.

Second, while the demographic dividend confers enormous economic opportunities, banking it depends on more intangible and complex phenomena, such as high quality institutions. Consider, for example, the different experiences over the last 40 years of East Asia and Latin America, which had similar age structures in the 1970s. The countries in the former region were able to exploit their demographic dividend far better as a result of four key factors:

  1. better governance
  2. stronger macroeconomic, social, industrial and education policies
  3. more coherent tax and fiscal regimes that were conducive to employment and business
  4. robust legal institutions, including the rule of law, which nurture trust and certainty in increasingly complicated and globalised societies.

The original Asian Tigers, South Korea, Singapore, Taiwan and Hong Kong, have made it into the high income league, and may have been special cases in view of their geopolitical significance and their relationships with the US in particular. However, China, Malaysia, Thailand, and Indonesia have also prospered, as have Chile and Poland, in ways that have eluded many other EDCs. Most EDCs are still relatively poor, as measured by per capita income, and to make strong gains in the future, they will need to emulate the Tigers’ experience in order to overcome varying degrees of economic backwardness. If not, we only have to look at the Arab Spring to see, in extremis, how explosive the cocktail of weak governance and institutions on the one hand, and young demographic dividend populations on the other, can be.

As we look through the fog of the economic and political crises in the West to the economic and business opportunities in EDCs, then, we need to bear in mind that favourable demographics comprise an important structural advantage, but one which is not guaranteed to lead to success. As societies grow and become more modern, and before rapid ageing sets in, they face an increasing array of complex challenges to their institutions, societies and value systems. Some of the more important ones include the social costs of rapid urbanisation, rising income inequality, inadequate employment creation and educational development, and environmental degradation and water scarcity. In a more social context, modernisation and ageing will change family structures and the system of familial care, posing a significant challenge to governments to build social safety nets. In some areas, for example China and the northern states of India, chronic gender imbalance is likely to exacerbate social instability. What are the largest challenges then facing these two giants of the emerging world, which face sharply contrasting demographic transitions?

Ageing challenges in China

Following 2-3 decades, in which China’s WAP grew by about 2% per year, and in which hundreds of millions of people swapped their rural lives for more productive work in manufacturing, China now faces a triple-whammy of ageing. By 2050, the number of children aged 0-14 will have fallen by 53 million, and young adults aged 15-24 by 80 million. The WAP will decline by about 100 million, or from 72% of the population to 61%. Meanwhile the over 60s will rise by 234 million, or from 12% to 31% of the population. The old age dependency ratio is about 11% today, but it is expected to rise to 24% by 2030 (by which point there will be more over 60s than under 15s), and to 40% by 2050. In other words, the 10 workers that support each older citizen today will have dwindled to 2.5.

The economic implications of ageing in China will soon start to become more transparent. At the very least, the decline in the labour force, and the significant rise in old age dependency could knock 2 percentage points off the country’s current long-term growth rate of about 8%. Over time, ageing will also weaken productivity growth, while there will be increasing demand for China’s high savings to be allocated toward official welfare spending. In about a decade or so, the basic social contract in China, which comprises continuously rising living standards and social stability, based on vigorous investment-led growth, will be under threat.

For the time being, China’s 130 million or so pool of young rural migrants should continue to offset the effects of ageing on the productive labour force, and China’s economic goals also provide for companies to migrate to the hinterland and rural areas. However, sooner, rather than later, China will confront the so-called Lewis turning point, named after the economist Arthur Lewis, who articulated the consequences of exhausting the supply of cheap, rural labour. In fact, even though China may not yet be running out of workers, but it is already faced with a shortage of cheap workers, especially female migrant workers who tend to gravitate to factory and office jobs. Chinese companies have to compete increasingly on wages, so as to be able to attract and retain workers. Annual wage increases in manufacturing are already rising at around 12-13%, and minimum wages have been rising at over 20% per annum for the last 4 years.

However, rising wages are not yet nearly enough to provide citizens with the social and financial security, which they lost when the iron rice bowl system, introduced under Mao Zedong and which provided cradle-to –grave benefits, collapsed in the 1980s.

Although the authorities have taken steps since 2000 to broaden social security coverage and increase payments, China still lacks national programmes for healthcare, housing subsidy schemes, retirement, and social welfare. State pensions replace about half of average wages, but only 20% of urban workers are covered, and less than 10% of rural workers have any coverage at all. Health insurance cannot be transferred between jobs and work locations and, is in any case, expensive. More than half of China’s over 60s have to pay their own medical bills, and most of the rest tends to be family-financed.

In addition, China’s demographic transition is being complicated by the effects of the ‘hukou’ system of household residence permits, first introduced in 1958 to try and control internal migration. The system effectively divides urban dwellers into officially registered residents, and second class rural migrants, numbering some 200 million, who do not qualify for access to income support, subsidised housing, healthcare or public education. The rising tide of social unrest in China is increasingly being fuelled by disadvantaged rural migrants.

China’s high speed growth economy, then, is liable to slow down in years to come, and Beijing will have to manage both existing and future sources of economic insecurity, many of which are associated with rapid ageing. As more of China’s wealth has to be allocated to age-related economic and social programmes, the authorities will have to ensure that the high savings still being generated - equivalent to about 50% of GDP - are channelled into increasingly productive areas that improve the country’s social and financial infrastructure. Chinese households save about a quarter of their income, and apart from property, the bulk of their savings take the form of cash deposits, which pay miserly interest rates, determined by the government, and which comprise, in effect, a massive company and investment subsidy. At the current time, it is increasingly feared that much of China’s investment spending is misallocated and unproductive, because of the influence of and benefits received by state owned enterprises and state banks.

The risk of economic instability in coming years may also be heightened by social phenomena linked directly to China’s demographic characteristics, including for example, that of gender imbalance, to which incidents of social unrest, child trafficking and prostitution can be traced. On average, there are about 120 males per 100 females. Note that in some rural and hinterland areas, it may be as much as 130, and for second and subsequent births, it can be as high as 140-150. By 2020, about 20% of young men will never be able to marry because of the dearth of young women, and by some estimates, this proportion could rise to 40% by 2040. As single young men grow older and eventually retire, they will generate additional demands on China’s welfare system. The rising weight in Chinese society of unmarried single men, and the zero- or one-child families associated with adults who grew up as single children are also likely to undermine China’s celebrated reputation for large families, and familial and filial old age care. Importantly, they are also likely to weaken the foundations of China’s family-owned enterprises, which are in the vanguard of economic growth and employment creation.

It is too soon to assert that China will not meet its demographic challenges, but stresses from rapid economic development and ageing are already building and need to be managed if economic and social instability is to be averted. To the extent that it is, it is also questionable whether the more likely route is via the destabilising but ultimately constructive path of institutional and governance reform, or an authoritarian clampdown.

Ageing challenges in India

Sometime between 2020-2025, India’s population will overtake China. As China’s ageing process speeds up, India will still be in a prime position to reap its demographic dividend. While its fertility rate drops from 2.73 to 1.8 children by 2050, India’s WAP will replicate the 45% growth of the last 20 years. In the next 9 years alone, India’s WAP will grow by more than the entire WAP of Western Europe. Its population of over 60s will double to 15% of the population by 2040, but this is still only where China is today and where the rich world was in 1970.

India’s demographics could underpin an already promising economic performance track record built up over the last 10-15 years. Growth in the labour supply, and of course in India’s output of doctors, engineers, scientists and other skilled workers has been widely noted. Similarly, the development of successful industries, such as software and information technology services, medical research and technology, and steel, textiles, electrical machinery, and automobiles into global competitors. Indian authorities have opened the country up to more trade and investment, and embarked on important economic reforms at home. India’s demographics are well positioned to fit into the country’s recent achievements, sustaining the hope that it is far more likely to realise continuous 9-10% growth rates than, say, China.

The optimism deriving from India’s demographics, however, comes with an important qualification. India’s demographic dividend could turn into a demographic disaster if existing widespread poverty and underemployment are allowed to fester, and as a further 380 or so million people enter the labour force over the next 4 decades. The main reason is that India lacks employment-intensive manufacturing companies as it tries to jump from a low-income agrarian to a prosperous service-based economy.

Service industries account for just 25% of employment, or half as much as their share of GDP, while manufacturing industries employ just 19% of the labour force, compared with a 17% share of GDP that has not changed much for 40 years. Meanwhile, the rural sector remains home to 70% of India’s population, and still accounts for 56% of total employment. Unlike China, there is a much weaker tendency to leave the rural sector for urban work and life.

Moreover, notwithstanding its high reputation for modern economy professionals, India lags behind other Asian economies in educational achievement. Secondary school enrolments, for example, are lower than in China, and the growth in enrolments in higher education is half the rate in China. The illiteracy level for rural inhabitants is about 50% at primary school level, and 70% at the secondary level. China’s aggregate illiteracy level is thought to be less than 10%. Illiteracy is intimately related to poverty, and to ill health among children, in particular. Roughly half of Indian children under 5 years are moderately or severely underweight for their age, compared to 7% in China, and this phenomenon is associated with learning difficulties. More broadly, in India 75% of the population live on less than USD 2 a day, 42% live on less than USD 1.25 a day, and 29% are undernourished and below the official national poverty line. By contrast, Chinese proportions are far lower, at 36%, 16%, and 3%, respectively. The impact of low educational attainment means that far too many people are ill equipped for productivity-enhancing work.

Although the recorded unemployment rate is a relatively low 7%, underemployment is widespread, especially for females, and in rural areas. The high incidence of poverty among people who are employed in some capacity, roughly 27%, suggests that the true measure of unemployment may be at least 30-35%, or roughly 250 million people.

To succeed in alleviating current unemployment and in employing hundreds of millions of new entrants to the labour force, India will have to confront head-on criticisms that the state has failed to provide basic public goods, including high level primary and secondary educational facilities and attainment, and rural and urban infrastructure. It will have to remove unnecessary regulations and protection that suppress employment and business start-ups, and develop a coherent industrial policy. India has time to prepare for more rapid ageing, but it also has a pressing need to demonstrate that it won’t squander its demographic dividend in the interim, leaving its rising proportion of older citizens eventually without adequate support and care.

This essay draws on parts of Uprising: will emerging markets shape or shake the world economy? (John Wiley & Sons, 2010) by George Magnus.

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George Magnus

Senior Economic Adviser, UBS Investment Bank

George Magnus is the Senior Economic Adviser at UBS Investment Bank having previously been the Chief Economist for 10 years. He is a well-known and highly regarded economist and writes regular opinion columns in the Financial Times. His latest book, Uprising: will emerging markets shape or shake the global economy? was published at the end of 2010. George Magnus was speaking at the 7th Chief Risk Officer Assembly at the Swiss Re Centre for Global Dialogue, 16-17 November 2011.

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