Can China’s new two-child policy save the day?

November 02, 2015 10:03
It is uncertain whether the two-child policy will boost China's fertility rate. Photo: Reuters

The sensational headlines by most media on China's decision to abolish the one-child policy are way off the mark.

Beijing has only shifted the policy to two children per couple from one child. The policy of controlling China’s fertility rate (number of children per woman) still remains.

The good news is that such a policy shift will, in principle, help reverse the worsening demographic trends in China in the long term.

The bad news is that it will not have any material impact in the short  to medium term.

Even the presumed long-term benefit on boosting the country's population growth depends on whether this two-child policy will work to increase its fertility rate. In this regard, the answer is still uncertain.

What is important for economic growth is the working population (15-64 age bracket) growth and the dependency ratio, or the ratio of the young (0-14) and the old (over 65) dependent population to the working age population.

China’s working age population has ballooned since the 1970s. Coupled with the one-child policy that has suppressed young dependents, this has boosted China’s savings rate, capital formation and economic growth.

However, this trend is now reversing, with the working population declining, the old population rising and not enough young population being born to replenish the working population in the coming years.

Indeed, official data shows that after falling rapidly for decades, China’s dependency ratio is starting to rise sharply, as the working population is starting to shrink.

In principle, the two-child policy should boost the fertility rate and increase the working population in the long term.

But in the short to medium term, it will only aggravate the increase in the dependency ratio by adding more babies to the old population.

As the baby-boomers age and their children are not enough to replace them, this will put upward pressure on wage growth and fiscal spending and downward pressure on savings and GDP growth.

With China’s “population dividend” turning to a “population tax”, Beijing is now trying to reverse the negative economic impact by relaxing the one-child policy.

But as Japan’s experience shows, it is difficult to become young again once a population has aged.

This two-child policy shift has come too late to change China’s deteriorating population dynamics.

What’s more, it is uncertain whether the two-child policy will boost the fertility rate.

While the one-child policy has been blamed for China’s rapidly aging population, the demographic transition would have happened anyway due to rising levels of education and income.

Cross-country evidence from both developed and developing countries shows clearly that as a country’s income level rises, its fertility ratio falls.

Data shows that China’s fertility rate started falling even before the introduction of the one-child policy in 1979.

Even today, its fertility rate does not differ much from other countries, such as Singapore and South Korea, which do not have population control policies.

Surveys in China show that about 50 percent of Chinese couples that already have a child would want another one. This implies that if there were no policy restrictions, China’s fertility ratio would be about 1.5 (according to the government and local research estimates, China’s average fertility ratio is about 1.2 to 1.3).

However, the reality is quite different from the survey results, as policy is not the only, or main, factor depressing fertility.

Schooling, working, social freedom and rising cost of raising children are all important factors prompting women/couples to delay having children or have none at all.

Indeed, earlier relaxation of the one-child policy did not yield the desired result of boosting fertility.

Rural families whose first child is female have been allowed to have a second child since the 1980s.

Couples who are both single children are also allowed to have two children. The policy has been relaxed further in 2013 for couples to have a second child when only one parent is a single child.

This move has allowed an additional 11 million families to have a second child. But as of May 2015, only 1.45 million families had taken advantage of it.

While relaxing the one-child policy does not hurt, it is far from certain that it would reverse China’s deteriorating population dynamics. China will still need more diapers in the future, but likely for adults.

From an investment perspective, while sectors catering for the baby and young population, such as baby/child products and education, should benefit from the two-child policy, the investment theme for sectors catering for the ageing population, such as medicare, nursing homes and even funeral services, seems more robust.

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Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”