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Will China's demographic time bomb end the low-inflation age?

Rising wages at 'world's factory' threaten widespread disruptions

Employees manufacture camera lenses for cellphones at a factory in Lianyungang, Jiangsu Province. As a key contributor to global supply chains, what happens in China could impact wide swaths of the global economy.   © Reuters

TOKYO -- As China faces a growing labor shortage and a rapidly aging population, concern is growing that rising wages in "the world's factory" could push up price levels globally and put an end to years of low inflation.

China's Communist Party unexpectedly announced late last month that it would allow married couples to have up to three children. As the population ages, the labor force will decrease and burden of nursing care will increase, Ning Jizhe, head of the National Bureau of Statistics, had explained at the time.

The sudden policy shift was triggered largely by the 2020 census results published on May 11. The once-a-decade census found that while China's total population grew by an average of 0.53% a year for 10 years to 1.41 billion, the working population -- those aged 15 to 64 -- had actually shrunk by 38 million from its 2013 peak to 968 million. Instead, the number of those aged 65 and older increased 60%.

In one survey, China's manufacturers named staffing shortages as the biggest challenge to their business.

Chinese wages have doubled since the global financial crisis in 2008, and labor shortages will only accelerate the trend. Given that China lies at the heart of global production and accounts for roughly 20% of the world's working-age population, the impact of rising wages there is seen rippling far and wide.

China is bringing an end to the age of low inflation, argues Charles Goodhart, emeritus professor at the London School of Economics.

China has been considered a source of deflation since the 1980s, when the country began leveraging its massive labor force to ramp up cheap industrial exports. The world's access to high-quality labor doubled after the Cold War as former Soviet bloc nations rejoined the fray, which, combined with increasingly globalized production, drove global prices down.

By the mid-1990s, inflation rates in advanced economies fell into 2% territory from figures that had once raged in the double digits.

But the gears of this process are now turning in the opposite direction, according to Goodhart.

A worker arranges suits at a Shandong Daiyin Textile and Garment Group factory in Tai'an, in Shandong Province. Many Chinese manufacturers say they are suffering from a labor shortage.   © AP

In the 2020 book "The Great Demographic Reversal," Goodhart and co-author Manoj Pradhan argue that aging populations will increase inflationary pressures as people continue to consume goods and services, including nursing care, even as they retire from the workforce and contribute to a labor shortage.

An aging population would also squeeze government coffers by increasing social spending, and raising taxes will be politically difficult. Therefore, governments will aim to reduce their real debt burdens with inflation. Central banks will be pressured to keep a lid on interest rates, which will spur inflation on.

Goodhart paints a bleak picture, but as a longtime adviser to the Bank of England and one of the world's most respected financial scholars, his warning cannot be ignored.

Still, inflationary risks posed by China have not drawn much attention until recently. Why is this?

A lack of global perspective in analyzing labor and prices is one reason given. For example, the Phillips curve, a widely used economic model that represents the inverse relationship between unemployment and inflation, focuses on domestic employment and prices.

Many economists declared the Phillips curve dead when price levels and unemployment both fell in the 1990s and beyond. But Goodhart attributes the trend mostly to external factors, such as the supply of labor from China and other countries.

The looming question now is how quickly increasing wages in China will impact the global economy. Downward pressure on prices in the 1990s spread far and wide across the world, even though China at the time accounted for a few percentage points of global exports and many places had no direct contact with it.

Andy Xie, an independent economist based in China, believes the reason China had such control over prices is that it was always available for locating manufacturing capacity if needed, workers and companies had no choice but to keep it in mind when deciding wages and prices.

Now Chinese exports account for more than 10% of global exports in terms of value. The power of the global inflationary wave could exceed that of the former wave of price destruction.

Of course, there are ways to increase productivity to offset the lack of workers. Tech and automation would be the key to that pathway. But the Chinese economy, which was once labor-intensive, is moving at the forefront of automation. Wringing out even more labor-saving solutions will not be easy.

Many observers expect the easing of restrictions on births to have little real effect on its own. When the government began allowing all couples to have two children in 2016, births briefly picked up that year but continued to slide thereafter.

The working-age population appears to be topping out in the U.S., and already peaked in Japan in 1995 and in the European Union in 2009. The overall figure for the Group of 20 -- which includes countries like India with relatively youthful populations -- is expected to start trending downward in about a decade.

While financial markets fear the U.S. stoking inflation through coronavirus relief and stimulus measures, China's population decline could prove more problematic on that front in the future.

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