Falling Birth Rates: A Vote on Economic Policy?

 Olga and Hugo consider China’s rapidly dropping birth rate and its implications for growth. Demography isn’t necessarily destiny. Other countries have seen dramatic declines in fertility—only to turn things around with economic recovery.

Hugo: In these conversations, Olga, we’re often thinking long term, but the long term is triggered by something that’s happened in the short term. We recently learned that China’s birth rate has fallen precipitously, for the second year in a row. And that’s against the backdrop of a working-age population that already had begun to shrink.

It’s often stated that demography is destiny. Standard economic theory is that an increase in the working-age population generally increases gross domestic product (GDP). Therefore, a shrinkage in the working-age population could have a negative impact on GDP.

As a growth economist, how concerned are you about what’s happening to the population in China? And how does that trend translate into economic outcomes such as GDP and consumption?

Olga: Hugo, looking at the latest numbers, China’s total fertility rate in 2021 was 1.16 births per woman, and the replacement rate, just to keep population constant, is something closer to 2.1.

Given current projections, China’s population at large—not just its working-age population—is slated to shrink dramatically. This trend, combined with longer life expectancies, means that the number of people in the labor force 20 years from now, relative to the number of people that they need to support in retirement, is going to be very low. These are massive drags on consumption and on growth in general.

China’s population at large is slated to shrink dramatically. However, demography is not destiny.

However, demography is not destiny. Contrary to what some pundits have said—that China is going to revert to the standard of living that it saw in the ’80s—we need to be careful about extrapolating a doom-and-gloom scenario.

Fertility rates are not constant. We have seen big drops in fertility rates across the world, and these usually happen in response to not just wars but adverse economic outcomes. Of course, China has endured two-plus years of COVID and extremely strenuous lockdowns. That crisis has probably had an outsized impact on fertility rates.

We have several examples, most notably in Europe, where fertility rates dropped perilously in the past 30 years, only to recover quite quickly once the economic situation had normalized. China’s drop, although very large, is by no means unprecedented. And there already are signs that the current leadership is taking this quite seriously and moving to mitigate some of the factors that may be barring people from having more children.

Hugo: If you look at people’s productivity throughout their lifetimes, they cost more when they are young, they cost a lot when they’re old, and then they’re productive in the middle.

If you have the forced change in fertility rates that China created through its one-child policy, maybe that gives you an economic boost for a while, because you forgo some costs and you get productivity. But does it catch up with you? Is that a risk for China—that you distort the dependency ratio for a generation, and then it comes back to bite you?

Olga: Implicit in your question is this idea that there’s some demographic dividend that enables a period of rapid economic growth. I would contend the relationship is rather more nuanced and frequently the other way around, meaning that a period of rapid economic growth actually then results in a demographic dividend.

When you are toiling away on a subsistence farm, and your mortality is sky-high, you need a lot of hands, and so your fertility rates are high. When there’s an opportunity to move even to low-value-added manufacturing, your fertility rate drops dramatically.

Fertility rates may be your ultimate indictment of economics.

This was true in China, and not just as a result of its one-child policy. This was true across any country at any period of time that it went through industrialization. This was true for South Korea, for Malaysia, for every Asian tiger economy. This was also true in the United States. This was true in the United Kingdom when it industrialized—although, obviously, these statistics are several hundred years old, so they’re a bit patchy.

The demographic dividend is just as much an outcome of rapid growth as it is an enabler of that growth. The causality runs both ways. So it’s too simplistic to say that China enjoyed a strong demographic dividend because it restricted births and therefore the costs of caring for youth were lower.

Hugo: Why do you think fertility rates go down? Does the fertility rate have something to do with people’s views of the future?

Olga: I love this question. This is where I think fertility rates are your ultimate indictment of economics. There are a lot of objections that China is not democratic, that people don’t have a chance to vote. But in effect, they’re voting. They’re saying, “We’re refusing to have a family, because our economic circumstances don’t allow it.”

If there is a lack of healthcare, rendering it very expensive; and of education, making it extraordinarily expensive; and of affordable housing, rendering it very difficult to have a larger family; and having to work the famous “996,” 9 a.m. to 9 p.m. six days a week, when are you going to have time for your children?

All of these are economic concepts, which means that your fertility rate is responsive to changes in economic policies. China has been experimenting with the concept of the 15-minute walking city, where amenities from grocery stores to health clinics to schools will be within a 15-minute walk of every urban resident. That kind of policy can be effected faster than almost any other kind of employment policy, and it could have a sizable impact on fertility rates.

To your question, Hugo, the fertility rate is not just a demographic concept. It is not purely a function of mortality rates. It’s very much an economic concept. And I would even argue that it’s a means of voting. You can understand what people think about their future, and how excited they are to bring more children into this future, by their fertility rate.

Hugo: Can you give some examples of countries that previously had performed badly but recovered economically and improved their fertility rates?

Olga: The poster child for a rapid turnaround would be Russia. Fertility rates dropped off a cliff in the early ’90s, all the way through 1995. Then they recovered quite sharply, such that we saw a very pronounced, V-shaped recovery.

We saw the same sharp V in the Czech Republic, almost coincident with Russia—not a surprise, given the massive upheaval in the post-communist transition.

This is a different order of magnitude, but we observed the same sharp drop in Denmark in the early ’90s, given the famous Scandinavian experiments and the difficulties that were brought on by the collapse of the Soviet Union. This was true in Sweden as well. As these challenges were overcome, ultimately these economies emerged stronger. As a result, we saw a sharp snapback in fertility rates, closer to the 2.0 rate. And these are not the uber-fast growers of the world. The common factor here is a massive, structural economic change that enabled a response in fertility rates.

Hugo: Is it inevitable that a country’s economy will shrink if its population is shrinking? Particularly if it’s the working-age population that is shrinking? I suppose the context is important. If you’re the only country that’s experiencing it, maybe it doesn’t matter so much. Japan’s demographics declined first, but everyone else was in OK shape, so there was plenty of growth in the world. But what happens when countries representing a large percentage of global GDP have shrinkage or near shrinkage in their working-age populations?

Olga: That’s a more challenging question. If you think about GDP as a simple function of labor input and productivity, everything we’re talking about with demographics is focused exclusively on labor input. And you’re right: This is nothing more than working-age population times some kind of employment rate times hours worked.

But different things can offset each other. Your working-age population may be shrinking, but the hours worked are higher, or the employment rate is stronger. Indeed, employment rates in Northern Europe are close to 80%, whereas in the United States it’s in the low 60s.

We saw something similar as a result of Abenomics in Japan. Before 2012, there were comparatively few women in employment, relative to Organisation for Economic Co-operation and Development (OECD) averages. Within just four or five years, the number of highly qualified female workers in Japan eclipsed that of the United States. These were well-educated potential employees who, for a variety of reasons, were sitting on the sidelines. There were policies that incentivized their return to the labor force. And so we observed a significant change in labor inputs.

Lower population growth or outright declining population will change consumption patterns.

So just because your working-age population is shrinking doesn’t mean your labor input automatically will. Having said that, obviously, if your population is shrinking massively, there’s only so much you can do on that side.

That brings us back to the big driver of GDP growth: productivity. This is a really nebulous concept. It’s not observed; it’s hard to measure. But most of our growth is about productivity. In the heyday of China’s growth, when it was north of 10%, less than 2 percentage points of that was about labor. The vast majority was productivity gains as they were rapidly catching up.

Obviously, in the OECD you can’t have massive productivity gains, because we’re at the forefront of innovation, and innovation is painfully slow. But the point is that rising living standards have much less to do with the number of people working and much more to do with productivity, which need not be impacted by challenging demographics.

Indeed, in the case of Japan—and this may become more obvious everywhere—we see the rise of robotics and how many lower-value-added activities can be automated. That, in itself, is a tremendous boost to aggregate productivity that is grossly underappreciated and, frankly, very difficult to capture in statistics.

Lower population growth or outright declining population will change consumption patterns. People who are over 60 years old consume different things at different rates than people in their 20s. But in terms of aggregate productivity gains, the story’s not over.

Olga Bitel, partner, is a global strategist on William Blair’s global equity team.

Hugo Scott‐Gall, partner, is a portfolio manager and co-director of research on William Blair’s global equity team.

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