China’s two paths to urbanisation | FT Alphaville

China’s two paths to urbanisation

China’s growing demographic challenges have been well documented and their economic impact much discussed. So how about urbanisation being touted as the solution?

After all, more people working in cities generally means more productive workers, hard to argue with that. But Beijing’s traditional policy of encouraging urbanisation through greater infrastructure investment is getting ever diminishing returns. If the government really wants more people to move to the cities, argues Wei Yao at Société Générale, it must start treating its new urbanites better.

But before we get to that, here are some (worrying) figures. China’s national statistics office announced recently that the share of population aged between 15 and 60 fell for the first time in 2012 — by 0.6 percentage points to to 69.2 per cent, as the chart below from the Economist shows.

And the country’s labour force is on track to actually shrink between 2015 and 2020, according to UN forecasts. The effect of all this will be a slower capital stock growth in China, which was responsible for something like 40 to 50 per cent of its GDP growth in the 1990s and 2000s.

Wei runs through the dynamics:

First, slower labour growth pushes China ever closer to the “Lewis turning point”, at which the excess labour in the agriculture sector is fully absorbed into modern sectors. It is evident that China is already much closer to this inflection point than just a couple of years ago. Wage growth of migrant workers accelerated from around 10% per annum between 2003 and 2008 to nearly 20% in 2010 and 2011. As wage pressure continues to build, the competitiveness of the tradeable goods sector (i.e. manufacturing) will be further eroded and the economic structure is likely to gravitate towards the service sector. Capital intensity of growth is destined to decline.

Second, an ageing population puts downward pressure on the savings rate and drives up the cost of capital, while a larger capital stock means more depreciation and requires more savings to keep it new. We estimate that for every 1ppt increase in the old-age dependency ratio (defined as the number of elderly people as a share of those of working age), related spending (private and public together) would rise by 0.4-0.6ppt of GDP. As the old-age dependency ratio is expected to rise from 11% currently to 17% by 2020, China’s gross savings rate could decline by 2.4-3.6ppt of GDP in the 2010s. This would be reflected in a lower investment share and/or a smaller current account surplus. If the authorities proceed with interest rate liberalisation, we would expect investment growth to bear a bigger share of the impact resulting from sliding savings rates.

One obvious cause of this declining working age population is the one child policy. But abolishing it probably isn’t the solution. Why? Well, firstly even if that happens tomorrow, it’s going to take some 16 or 17 years before those babies are conceived, born, raised and enter the work force. Something needs to be done sooner. Secondly, on average Chinese women already have more than one child. And third, it’s unlikely to result in a big surge in pregnancies, because many Chinese families today don’t want more than one child. From The Economist (our emphasis):

China’s one-child policy is not quite as strict as its name implies. Once all its exceptions are taken into account, it permits about 1.47 children per woman. If the policy were relaxed dramatically, would China’s population explode again? Clint Laurent of Global Demographics, a research firm, is often asked this by clients, some of whom hope to profit from a baby boom. But he has to disappoint them. He says the best contraception is “affluence and education”. Many Chinese women would not have a second child even if they were allowed to. And if all restrictions were lifted, the fertility rate would probably settle at about 1.62, according to S. Philip Morgan of Duke University and his co-authors.

While the government is likely to relax the one child rule in the next couple of years, even it seems to know it’s best approach now is to encourage more people to move to cities and take up more productive jobs. It’s something that the new leadership in Beijing seems keen on – namely the next premier, Li Keqiang, who keeps stressing it in his speeches.

But there’s urbanisation, and there’s urbanisation. The important thing is how exactly the government goes about encouraging it. Wei argues that the historical approach of pouring money into infrastructure has run its course and is of much less use today.

She writes:

Following Mr Li Keqiang’s high-profile remarks on urbanisation, market sentiment has warmed up again to infrastructure expansion. In our view, China’s old way of thinking may turn out to be a big impediment to its future urbanisation. The Chinese government diverted most of its fiscal resources towards hard infrastructure in the past decades, and overall economic policies were set to encourage production often at the cost of consumption. While the benefit of this strategy clearly outweighed the cost at the early stage of China’s industrialisation, the net gain has declined quickly in recent years.

Instead, the government must reform the social security system, remove obstacles to labour mobility and help urban job creation.

Reform of the Hukou system is at the top of Wei’s list. Currently, only one in three city-dwellers have a Hukou, a local household registration, which allows them various welfare benefits. Migrants are mostly prevented from getting one. They also have to accept much lower pay than those with a Hukou, meaning that their disposable incomes are far smaller, lowering demand in the economy. One of the consequences of all this, is that the coastal cities have seen labour shortages, given the relatively high cost of living, and the low wages for migrants. Allowing more workers to get a Hukou would help alleviate these, and boost demand, but it would be a large fiscal commitment by the government, as Wei says:

Policymakers need to create the right incentives for rural residents to move to the city, which include reasonable compensation for land usage rights and strengthening of the social safety net. Both will be very costly for local governments. For instance, the annual pension payout for rural retirees was 900 yuan in 2010, merely 5% of what was offered to their urban peers. According to a 2012 report from the Chinese Academy of Social Sciences, the fiscal cost of relocating one farmer to the city is estimated at 100 thousand yuan. Given the projected urbanisation trend and the number of migrant workers who do not have urban Hukou, the government may need to pour 40 trillion yuan into this project, equivalent to 20-25% of the total on-budget fiscal revenue by 2020 (SG estimate).

On the one hand, farmers should receive a bigger share of land sale revenues; and on the other hand, more has to be spent on social security and public services. With new tax sources slow to develop, funding for infrastructure has to give. Local governments will probably struggle for some time in the face of this fiscal challenge. Actually, if local governments continue to adhere to the old thinking of infrastructure-driven urbanisation, further fiscal tensions will likely surface. We think this factor may well dampen the growth momentum as soon as the second half of this year.

In other words, the government probably can’t afford to keep ploughing money into infrastructure and reform the social security system, and if they have to make a choice, it’s more productive to focus on extending social benefits and freeing up labour movement, which will both help productivity and demand.

Research quoted by the Economist nicely backs up this idea:

Xin Meng of Australian National University has surveyed thousands of migrants in 15 cities. On average, they first left their rural homes almost nine years ago. If cities could persuade them to stay twice as long, she points out, they would, in effect, double the supply of migrant labour. But that would require land reform, so that they could sell their rural plots, and reform of China’s household-registration system, so that migrants could settle with their families in cities and use public services now reserved for registered urbanites. When asked how long they would remain if restrictions on migration were relaxed, 62% said they would stay “for ever”.

Related links:
Peak toil – The Economist
Li Keqiang Urges More Urbanization to Support China’s Growth – Bloomberg
China myths: The rapid march towards urbanisation – FT Alphaville