For three decades, the inexorable rise of China has been a fundamental force in the global economy. Questions about what China would do next have long shaped economic analysis and corporate strategy. What sub-segment of manufacturing would it tackle next? Where would it invest? How would its rising wealth and soaring new cities affect world commodity markets?
Today, China has risen. It has passed Japan in GDP and is closing in on the United States. This raises new questions about China’s role in the global economy. It should also encourage new ways of thinking about China and the world.
Even now, the focus of China watching has shifted from concerns about how it might dominate a new world order to whether its slowing growth will drag down the rest of the global economy. Whether Chinese GDP grows by 7.5 percent or 7 percent per year—or even by 6 percent or less it still adds a Canada to global GDP every 2 years.
More importantly, we should be concerned about how China deals with the forces behind its slowing growth. Some of these forces, such as aging and skill gaps, are seen around the developed world. Some, such as rising labor rates, are standard for developing economies that are moving up toward middle-income status. Others, like the soaring debt that has attended China’s rapid urbanization are unique to China.
The Challenge of an Aging China
Aging, for example, will have outsized impact on China. As the world’s most populous economy, China will be hit hard by the costs of aging. The number of Chinese 55 or older is expected to rise from 26 percent of the population today to 43 percent in 2030. Public pension expenditures are expected to rise from 3.4 percent of GDP today to 10 percent in 2050, and public health costs are expected to rise even faster. By 2040, China could have more dementia patients than in all advanced economies combined. All this happens at a relatively low level of per capita income.
Indeed, China is getting old before it will get rich. Usually dependency ratios (the number of minor children and senior citizens in proportion to the number of working age citizens) drop in developing economies as they industrialize and only rise when they have become middle-income or wealthy.
China’s dependency ratio has already begun to climb and could approach current EU levels (above 30 percent) by 2020, even though China’s GDP per capita (based on 2010 US prices) then is projected to be just $8,000, compared with $49,000 in the United States and $32,000 in South Korea.
Aging also challenges China’s labor-intensive growth model. In the past few decades, tens of millions of Chinese workers entered the global labor force, helping to drive GDP growth and lifting hundreds of millions of Chinese out of poverty. This demographic dividend is disappearing because of aging and a low birth rate. In January 2013, China’s National Bureau of Statistics announced that the country’s working- age population actually fell in 2012 and it has continued to decline.
At the same time, China faces a looming skills gap as its economy moves to a more consumption-based and services-oriented economy, a pattern that all developed economies have followed. Despite a dramatic expansion of post-secondary education, China could have 23 million too few high-skill workers (loosely defined as those with college degrees) by 2020.
Debt, Infrastructure, and Financial Strain
China also has a difficult path to navigate between maintaining healthy growth and controlling the enormous debt that has been incurred to support that growth, particularly in the years since the global financial crisis. China’s total debt rose to 282 percent of GDP in 2013, from 158 percent in 2007, and is higher as a share of GDP than US debt.
About a third of this debt is associated with booming real estate markets, including debt of supplier industries such as construction, steel, and cement. These industries now have excess capacity and real estate demand has softened. Also, it is not clear how the shadow banking system that has funded these industries can cope with defaults—even though it seems to be widely assumed that the government would intervene to avoid a debt crisis.
The most troubling debt challenge, however, may be in local government finances. With the encouragement of the central government, local governments have run up $2.9 trillion in debt since 2009, much of it issued by off balance-sheet entities known as local government financing vehicles. The central government has initiated reforms and efforts to restructure local government debt—including by allowing provinces to roll loans into bonds, but demand for these bonds has been weak.
At the same time, urbanization continues apace with 100 million more citizens coming into cities by 2020. Continuing urbanization is important for continuing growth, but will require additional investment in housing and infrastructure—and additional financing.
Advanced Challenges for an Advancing Economy
If we think about all these challenges, we begin to see China in a very different light. The qualities and strategies that have brought it so quickly to the forefront of global economies will continue to serve China, but are not sufficient to tackle these challenges.
Modern China finds itself confronting a full range of economic and social challenges that are characteristic of advanced economies, even as it remains a developing economy (at least by the metric of GDP per capita).
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I’m a senior partner in McKinsey’s Shanghai office and Director of the McKinsey Global Institute (MGI) in Asia. I also co-lead the Urban China Initiative (UCI), a thinktank devoted to transforming China’s urban future. Visit the UCI website here. Read my latest work as co-author of No Ordinary Disruption (PublicAffairs, May 2015), which examines how long-term shifts in the global economy challenge long-held assumptions.