Why China’s shrinking population and prices are a concern

23 January 2024
China’s issues

What happened last week?

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Retail spending in America rose at its strongest pace in three months in December, as consumers set aside any worries about inflation and interest rates, and filled their shopping carts for the holidays. US retail sales, which are adjusted for seasonal differences, but not for inflation, rose by 0.6% in December, compared to the month before – a notable jump from the 0.3% pace seen in November and considerably more than the 0.4% expected by economists. It seemed like a fitting end to a year when surprising economic resilience was a theme, mostly fueled by Americans’ continued willingness to spend. And it suggests that the US consumer is entering 2024 in good shape.

In a sign of the times, Microsoft overtook Apple as the world’s most valuable company. Although the software giant has briefly taken the lead a handful of times since 2018, investors expect it to hang onto the crown this time around, bolstered by the firm’s expanding venture into AI. Microsoft, of course, has a big stake in ChatGPT-maker OpenAI, and has funneled cash into research and development, industry partnerships, and strategic acquisitions of firms like LinkedIn and GitHub, all in the pursuit of data and AI expertise. And that’s paid off: Microsoft has successfully rolled out AI solutions across its own business and has turned its Azure division into the go-to cloud service for AI-curious companies.

Inflation in Britain unexpectedly found new heat in December for the first time in ten months, prompting traders to scale back their aggressive bets on lower interest rates. Consumer prices increased by 4% last month from a year ago – up from a 3.9% rise in November. Economists were expecting a small dip to 3.8%. Services inflation, which is closely monitored by the central bank as a more telling measure of price pressures at home, also climbed, to 6.4%, from the previous 6.3%. Finally, core inflation, which excludes volatile food and energy prices, held steady at 5.1%, bucking expectations for a fall.

This inflation uptick comes despite a notable slowdown in wage growth toward the end of last year. Average annual growth in regular earnings, excluding bonuses, in the UK was 6.6% in the three months to November – in line with expectations and a fall from the downwardly revised 7.2% in the period through October. Annual growth in total pay, meanwhile, slowed to 6.5% after hitting a record 8.5% in July. But here’s the bright spot: with the pace of consumer price gains falling more quickly, earnings continued to grow in real (i.e. inflation-adjusted) terms, easing the tight financial squeeze on Brits that has prevailed over the past two years.

The Chinese economy grew by 5.2% last year – a marked improvement from its meager 3% growth in 2022, when it was under the government’s strict zero-Covid restrictions. Last year’s growth matched economists’ forecasts but exceeded the government’s official target of “around 5%”, which was its lowest goal in decades. The real estate sector, which has been plagued by a debt crisis for three years, remained in distress throughout 2023. Investment in property development dropped by 9.6% last year compared to the one before, while new home prices slid 0.4% in December from the previous month – the steepest decline since February 2015.

Adding to China’s problems, its population continued a historic decline in 2023, with the number of people in the country falling for the second year in a row, to 1.41 billion. It was a drop of over 2 million people – about twice the decline seen a year earlier when the Chinese population shrank for the first time since 1961. The country saw 11.1 million deaths in 2023, the most since 1960, and saw the number of births drop to a record low of nine million. China’s shrinking – and rapidly aging – population is expected to bring further troubles to the country’s flagging economy, in part by shrinking the size of the workforce that drives growth and funds pension systems.

This week’s focus: Utterly deflating

A declining population is China’s long-term challenge, but it’s got a more immediate one too: deflation. Consider the so-called “GDP deflator”, which compares the size of the economy in nominal and real (i.e. inflation-adjusted) terms. This measure offers a more comprehensive view of inflation than consumer prices alone, because it takes into account price changes for all goods and services produced within an economy. So here’s the bad news: China’s GDP deflator contracted by 1.5% in the fourth quarter, after shrinking by a roughly similar amount in the previous two quarters. That’s its longest slide since 1999.

Prolonged deflation – a result of China’s weak domestic demand, ongoing property crisis, sluggish job market, and falling exports – is a big risk for the country because it can lead to a downward spiral of economic activity. Anticipating further price drops, consumers might delay purchases, dampening already weak consumption. Businesses, in turn, might lower production and investment because of uncertain demand. What’s more, falling prices lead to lower corporate revenues, potentially hitting wages and profits. Finally, during times of deflation, prices and wages fall, but the value of debt doesn’t, which adds to the burden of repayments and raises the risk of defaults.

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