Second Child Syndrome

Is the relaxation of China's one-child policy too little, too late?

Will China get rich before it gets old? That's the question I've been asking myself for a few years now, ever since I saw the long-term demographic projections for the world's second-biggest economy. It used to look like the answer was no, but the relaxing of China's one-child policy could change that -- and much more.

As I wrote here about a year ago, the age profile of China's population will look roughly the same as Japan's within three decades. Japan has one of the world's oldest populations, with the highest median age anywhere. As a result, there are fewer workers to support every Japanese retiree through the pension system.

These demographics can be a significant drag on growth, since a greater share of the economy's production is devoted to supporting people whose contributions to output are decreasing. In other words, either average living standards have to decline or more output must go to consumption rather than the creation of new capital and technology.

With life expectancy rising, immigration far outweighed by emigration, and fertility controlled by the one-child policy, China has been heading rapidly towards the same demographics as Japan. To be sure, longer lives and loopholes in the one-child policy have allowed its population to keep growing, unlike Japan's. But China's aging population is poised to put a dent in the economy before it can exhaust one of its most powerful engines of growth: urbanization.

Urban areas are good places to make workers more productive by raising their living standards, teaching them better technology, and giving them access to more capital. In cities, it's easier to build and maintain factories, get access to energy, and achieve economies of scale. It's also easier to reach workers and their families with health care, education, and other services. New ideas travel faster in cities, too, helping to improve the processes of production.

In terms of urbanization, China is four decades or more behind Japan. The share of China's population living in cities is just over 50 percent -- about where Japan was in 1950 -- but it is urbanizing more quickly, according to the United Nations. But as I pointed out above, China has been on track to become as old as Japan within just three decades, suggesting that the fulfillment of China's basic economic potential could end prematurely. Continued urbanization might help China to deal with its forthcoming pension burden, but growth and living standards would still suffer.

Softening the one-child policy, as the Central Committee of the Communist Party of China has promised, could alter this economic future. If fertility rates were to increase by, say, 20 percent, then in two decades -- before China was supposed to look like Japan -- the annual cohorts of workers entering the labor force would start to be 20 percent larger as well. Within another decade, the overall increase in the labor force might reach 5 percent. And as time went on, the ratio of workers to retirees would continue to rise.

By pushing back the aging of the population, China would give itself a longer time horizon for strong growth. Of course, it would still face other roadblocks, including weak legal institutions and a corrupt business climate, but its main sources of growth would be less constrained. The story does not end there, however.

The one-child policy has been a fundamental part of Chinese culture for decades, and any change will profoundly affect major decisions among families. Parents who have only one child tend to invest a lot in that child. But when they have one more, some combination of three things might happen: 1) the parents can work harder in order to provide the same resources to two children as they would have to one, though this cuts into the time available for child care and family leisure; 2) they can spread their resources evenly between the two children; or 3) they can devote more resources to the child who seems more promising or, conversely, to the one who seems to need more support.

Many Chinese families have not had to make this choice. Instead, they have invested everything they could in their little emperors, leading to better nutrition, health, and education. The country's enormous improvement in human development indicators since the 1980s, as measured by the United Nations, surely owes some credit to the restrictions -- some would say human rights violations -- of the one-child policy. But in removing these restrictions before China is wealthy enough to take care of an increased populations could slow the pace of these advances, hampering growth.

The transition to a two-child (or more) policy could also generate more immediate risks for China. The sudden increase in the supply of labor when the first big cohort hits the market could lead to a spike in unemployment, which is fuel for unrest and political dissatisfaction. A surge in the native-born population of Chinese cities could slow urbanization, too, if the competition for jobs were to stoke hostility against internal migrants.

Early reports suggest that the transition will be gradual, so some of these risks might be finessed. It's also possible that changes in the one-child policy will only have a marginal effect on fertility, affecting only about 20 million parents. And of course, plenty of families might simply decide not to have more children. But even if the eventual abandonment of China's limits on childbearing led to an additional 10 million births a year, as the government's own estimates have suggested it might, the long-term effects on the economy would be decidedly mixed. Immigration, anyone?


Daniel Altman

The Dim Sum Dollar Carry Trade

What's driving the boom market in Chinese currency bonds?

The pitch goes something like this: "Hey, buddy, want to make a quick buck? Well, have I got a deal for you! My pal, Ben, will lend you a bunch of money, see, and then you go buy some stuff from Mr. Zhou over there. You give that stuff to the Irishman. Then tomorrow, when the Irishman returns the stuff, you sell it back to Mr. Zhou at a profit and pay off Ben. So, you in?"

If you spend too much time thinking about the financial markets, like me, you've probably figured out that Ben is Ben Bernanke, the chairman of the Federal Reserve, and Mr. Zhou is Zhou Xiaochuan, the governor of the People's Bank of China. You may even have twigged that the Irishman is Alan Mulally, Ford's chief executive. Either way, you've undoubtedly guessed that this little vignette describes a series of transactions that can only be called the "dim sum dollar carry trade."

If you don't spend all day and night thinking about the financial markets, your response to all of this is probably, "Excuse me, what?" But stick with me -- even if you're not a swashbuckling securities trader, the dim sum dollar carry trade affects you a great deal.

Let's start with how the trade works. The Fed is still keeping interest rates low by injecting billions of dollars into the credit markets through purchases of publicly available securities. As of this writing, the 1-year Treasury note was yielding about 0.1 percent. It costs more than that for traders to borrow money, but not too much more. Once they borrow -- and at these rates, they definitely will -- the question is what they should do with the cash.

Buying "dim sum" bonds has become a frequent answer. Since 2010, businesses from around the world (including Ford) have been issuing bonds in renminbi as a way to raise money and hedge their currency risks. Many of the bonds are sold in Hong Kong, but some have gone on the market as far afield as Moscow and Sao Paulo. And these bonds have two things going for them: a relatively safe return from an investment-grade company and Mr. Zhou.

Under the stewardship of Zhou and his bosses in the Chinese Politburo, the renminbi has been allowed to appreciate moderately against the dollar every year since 2010. Except for a slight depreciation last year, the currency's climb in value has been virtually linear. This is good news for investors who borrow dollars, trade them in for renminbi, and then use the cash to buy dim sum bonds. As the renminbi rises, so do the value of the bonds' coupon payments and principal.

For many investors, this trade has been an almost guaranteed winner. The yields paid by the bonds themselves are not as high as they might be for dollar-denominated bonds, since the issuers are well aware of the potential gains by the renminbi. But the dim sum bonds have still been lucrative for investors -- to say nothing of the banks and law firms helping to organize their sales.

At least, they were lucrative until this summer. As the days began to shorten, the dim sum story took a dark turn; issuance of the bonds slowed almost to a standstill. Between the second and third quarters of the year, new sales dropped by 88 percent. Several factors explain the sudden decline: Chinese economic growth has moderated, suggesting the renminbi will not appreciate as quickly; Chinese companies had used up their government-imposed quotas for issuance; and access to local sources of credit had improved. Yet there was one other big factor driving the slowdown that was largely unrelated to China: the taper.

Markets shuddered in June when Bernanke suggested that the Fed might slow or stop those billions of dollars in monthly purchases of securities. They weren't reacting only to the possible effects of tighter credit on the American economy. No, if anything, an end to the purchases would have signaled that the economy was in better shape and poised for steady growth; in that situation, companies should have been seen as more profitable, not less. Rather, the markets were lamenting the end of cheap cash.

When the Fed threatened to turn off the taps, the issuers of dim sum bonds knew that demand would no longer be as strong. But investors hadn't just used the easy money for dim sum bonds; they'd also put large chunks of it into fast-growing emerging economies. With a taper on horizon, traders knew they'd have a much tougher time generating big returns.

As a result, some of them had to sell a portion of their other holdings, especially stocks, to cover their risks. The markets took a dive, bruising the portfolios of millions of Americans, and it had nothing to do with the prospects of American companies or the domestic economy. Instead, it was because the Fed was hinting that the party was over.

All of that seems like ancient history now. Looking forward, the prospects for dim sum bonds are rosy again. The Fed has repudiated its earlier position, thanks in part to the latest fiscal crisis, and its top officials now say that any taper is a long way off. Beijing is meanwhile launching a new round of quotas for Chinese issuers. And the impending convertibility of the renminbi will push its value still higher by bolstering demand from investors, companies, central banks, and sovereign wealth funds.

Once again, traders are happy, and the markets are rising. Time for another round of dim sum? Plenty of them will say, "Yes, please!"