Could Demographics Be a Dagger to China?

The country's aging population is a looming problem

By Alyssa Oursler, InvestorPlace Contributor

Everyone loves to talk about China — the fourth and final of the so-called BRIC nations. But somewhere between chatter of a slowdown and soft landing, of stocks and sectors, of growth and GDP, something seems to be forgotten — its population.

I don’t mean the fact that China’s population is the largest in the world, either. I’m talking about the actual billion-odd people that make up the behemoth emerging market.

And the bottom line is not just that there are a lot of them, but that they’re getting old.

The Downside to Demographics

Earlier this week, I took a look at demographics as a potential indicator for growth. More specifically, I charted the change — past and expected — in the dependency ratios (dependent vs. working population) for various countries. In theory, as the dependency ratio declines, it opens the door for the attainment of a “demographic dividend” that can result in accelerated economic growth.

China was used as an example of a country where you’re too late to cash in on promising demographics because, while the dependent population was on its way down for decades, it has already bottomed out and is set to reverse.

Unfortunately, what I didn’t cover is the fact that there’s more to this story than just missed opportunity in terms of growth;  there’s a whole lot of downside.

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See, on the one hand, a falling dependency rate means there are fewer people to support — good news for economic growth. A smaller number of births (thanks, in China’s case, to the one-child policy) means fewer dependent children, which means a larger chunk of the population working.

Right now, such a reality is reflected in the age structure in China, which is shown below from the CIA World Factbook. The diamond shape is at-a-glance proof of the high proportion of working-age citizens.

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As we saw in the first graph, such a structure is far from sustainable. Instead, the aforementioned dependency ratio reverses because the working population — the longest bars in the diagram — inevitably ages and thus is again part of the dependent population.

With that, low birthrates become a bit of a Catch-22. While they limit the number of dependent youngsters, that also limits the pool of people that can soon replace aging workers. (Despite this, China has no plan to scrap its one-child policy, it announced this week.)

Some call this the circle of life. For China — and China’s trade partners — it should just be called trouble. Having to support a large proportion of its population will weigh on the economy’s shoulders — especially since there are such high growth expectations for the emerging market.

On top of that, China’s pension arrangement is a double-whammy on the economy. As Mark Frazier explains in What Happens When China Goes ‘Gray’?pensions have become the most expensive function of the Chinese government. By 2013, China’s pension system will have a $2.9 trillion gap between assets and liabilities. By 2033, that gap is expected to be $10.9 trillion — just under 40% of its GDP.

Plus, that’s only half the story. China’s pension plan is a hybrid arrangement, meaning it also relies on mandatory individual accounts. The result? Said increased coverage from the government doesn’t even put extra money in consumers’ pockets. Aging itself tends to hold back consumption; couple it with forced saving and it seems like a near-guarantee.

That’s hardly a good sign for companies pushing hard into the market, from Yum Brands (NYSE:YUM) and McDonald’s (NYSE:MCD), to Volkswagen (PINK:VLKAY) and even Apple (NASDAQ:AAPL), much less for Chinese companies like China Mobile (NYSE:CHL) and CNOOC (NYSE:CEO) — top holdings in the Xinhua China 25 Index Fund (NYSE:FXI).

Of course, in terms of both downside and growth, demographics are just one piece of the puzzle. For China, though, it’s a very troubling piece to say the least.

As of this writing, Alyssa Oursler did not own a position in any of the aforementioned securities.

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