Will The China Shock Operate In Reverse?

Everyone knows that China’s economy has had explosive economic growth in recent decades, with tidal effects through the rest of the global economy. In fact, China’s economy has come so far and so fast that some of the main shocks it has caused in recent decades may be about to move into reverse. At least, that is the provocative thesis of Charles Goodhart and Manoj Pradhan in “Demographics will reverse three multi-decade global trends,” written as Bank of International Settlements Working Paper No 656 (August 2017). They write:

“The global economy over the last 35 years has experienced three significant trends; a decline in real interest rates (supporting asset prices), a drop in real labour earnings in advanced economies (AEs), and, perhaps most startling of them all, a meteoric rise in inequality within countries alongside a drop in inequality between them. All three trends have been researched extensively, but individually, locally and independently from one another. We argue that such an analysis is the wrong approach. Instead, we believe all three trends need to be examined together in a global context. Specifically, we argue that demographic developments over the last 35 years have driven falling real interest rates, inflation and wages, and rising inequality within countries as well as some of the falling inequality between AEs and emerging market economies (EMEs). Can demographics really explain all three trends? If we include the integration of the gigantic labour forces of China and eastern Europe into the global economy, then global demographic dynamics do help to explain all three trends. But if that is correct, then the demographic reversal that the global economy will witness over the coming decades will also reverse the fall in real interest rates and inflation, while inequality will fall.”

It’s useful to spell out these connections in more detail. As just noted, they include both China and eastern Europe as central parts of their explanation, although China plays a bigger role. The argument rests on two sets of interrelated changes in global labor and capital markets.

In global labor markets, when China and eastern Europe entered global trade in force in the late 1990s and early 2000s, it affected labor market prospects across the high-income countries. However, that process of labor market entry has now run its course, and in the future, the growth of workers in China, eastern Europe, and other emerging markets will actually decline a bit. Here’s a figure showing the labor shock from China and eastern Europe: