How Will China's One-Child Policy Change Impact the Economy?

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China’s family planning policy, which became widely known as the one-child policy, was implemented in the 1980s to alleviate social, economic, and environmental problems. While the program included a number of exceptions, the birth rate fell from 2.8 births per woman in 1979 to 1.5 births per woman by 2010, suggesting that it was successful in achieving its goals. The ratio of males to females also reached 1.17:1 compared to global averages of between 1.03:1 to 1.07:1.

The falling birth rate could take a big toll on the country’s economy by decreasing the working age population. Between 2010 and 2030, the United Nations projected that the country’s working age population could shrink by around seven percent, which translates to fewer workers generating tax revenue to cover the rising number of retirees requiring social benefits. These long-term demographic problems mirror those that are already facing countries like Japan.

On October 29, 2015, a communique from the Communist Party revealed plans to abolish the one-child policy in favor of a two-child policy. The policy change has been widely seen as an attempt to remedy these long-term economic problems by generating a so-called demographic dividend—that is, boost the number of younger workers in order to offset the growing number of retirees and ultimately avoid any future demographic problems—but its success remains uncertain.

Will It Matter?

The dramatic decline in the Chinese birth rate following 1979 may seem to suggest that the policy had a big impact, but similar declines occurred at the same time in other Asian countries without the same policy in place. The birth rate in many developed countries has similarly fallen over time for a variety of reasons, including the availability of birth control. As a result, it’s unclear whether the policy had a meaningful cause-effect relationship or was simply a meaningless correlation.

When certain exemptions were introduced in 2013, just 6.7% of eligible families applied to have a second child. These data points suggest that the policy may not have been responsible, at least solely, for the dramatic impact on the country’s declining birth rate. Many couples seem to be choosing to spend their wealth on a better standard of living rather than having children, especially given the rapidly escalating cost of living in urban areas that are becoming densely populated.

There’s also the question of whether or not the country is equipped to handle a higher birth rate in the short-term. After all, Beijing’s maternity wards have been overbooked into the first half of 2016 following the relaxation of certain policies in early 2014, according to IHS Global Insight, which means that some families may wait to make the decision. Any economic decline in the country could also lead many couples to put off the decision.

Short-term Pain

The Chinese economy may have to wait two decades or so for the impact of the two-child policy to be felt in any meaningful way. After all, the most significant problems arise when the retirement age population grows faster than the working age population. With the new policy in place, the economy will realize the benefits when the children born following 2010 begin to join the workforce to help offset the growing number of individuals retiring.

The benefit of a high birth rate is the creation of a demographic dividend, but these children become dependents before they become workers. While dependents can help stimulate economic spending in some ways, many parents feel compelled to spend money on basic needs rather than luxury goods. Many companies that produce baby goods have already seen their prices rise following the announcement, but the rest of the economy may see less income.

The real benefit comes into play down the road when these children become working age and are able to contribute to the economy on their own. In a 2011 paper, the International Monetary Fund found that a substantial portion of growth experienced by India since the 1980s is attributable to its age structure and changing demographics, with the country expected to surpass China as the world’s largest by 2025. China is likely aiming for much of the same over the long run.

Impact on Investors

The United Nations believes that the two-child policy will add an extra 23.4 million people to the Chinese population by 2050, but it's uncertain whether that will be enough to change the working age population to non-working age population ratio, which has been an economic drag.

International investors may want to adjust their expectations for China's economic growth to account for these potential declines. Since the same problems are already affecting many developed economies, including Japan, investors may get a better glimpse of how these trends will impact their portfolio before they materialize in China.

The best solution for investors, as always, is to ensure that their portfolio is properly diversified, which helps mitigate the negative impact that any single country could have on an overall portfolio.