According to the latest data, there were just 1.41 billion people living in China at the end of last year – some 850,000 fewer than at the end of 2021. It was the first decline in the country’s population in over six decades – and the start of a trend that experts expect to continue for some time. Here’s how it’s likely to impact demand for artificial intelligence (AI) and how to turn that into an investment opportunity.

How did China’s population end up shrinking?

The short answer: fewer births and more deaths. There were just 9.56 million babies born in China last year – the fewest since at least 1950, despite efforts by the government to encourage families to have more children. Meanwhile, there were 10.41 million deaths in the country. That meant China’s population dropped for the first time since 1961, the final year of the Great Famine. The uptick in deaths due to Covid played a role, sure, but the main culprit is a sharp drop in births over the past five years.

China's population shrank last year as births continued to fall and deaths in the aging country continued to rise. Source: Bloomberg.

Chinese authorities blame the drop in births on people’s unwillingness to have children, decisions among couples to delay marriage and pregnancy, and an overall fall in the number of women of childbearing age. Most importantly, they said the drop is the beginning of a new trend.

What’s even more amazing is that the population plunge came much faster than previously expected. As recently as 2019, the United Nations was forecasting that China’s population would peak in 2031 – and then decline. But last year, it revised that forecast, estimating a peak at the start of 2022.

China’s population peaked last year and is forecast to steadily decline from now. Source: Bloomberg.

China is now following in the footsteps of other countries in East Asia, like Japan and South Korea, which have seen their birth rates plummet, and their populations age and shrink as they’ve become wealthier and more developed. Japan is particularly noteworthy: the country entered three decades of economic stagnation in the early 1990s that coincided with its aging demographics. Just this week, Japan said it would put in place urgent measures to increase its birth rate, warning that the country was struggling to maintain societal functions and saying it was “now or never”.

How will a shrinking population impact China’s economy?

The repercussions here are wide-ranging and long-term – and extend across China’s labor market, demand for products and housing, the country’s public finances, and more. They’ll ultimately cut into the long-term growth potential of the country’s economy while also fueling further doubts on whether it can overtake the US’s in size.

In the labor market

Last year, 62% of China’s population was of working age, which the government defines as people aged 16 to 59. That’s down from around 70% a decade ago. And that’s expected to continue to fall.

Bloomberg Economics predicts the group will slump to about 650 million people in 2050, from 910 million in 2020. This matters because, broadly speaking, there are two main sources of economic growth: growth in the size of the workforce and growth in the productivity (output per hour worked) of that workforce. So put simply, a decline in China’s workforce will directly dent economic growth unless the drop can be offset by productivity gains (more on that later).

What’s more, as the pool of available workers shrinks, their hourly wages will increase – and that will fuel inflation in China. That won’t be good for the country that has become known as "the world's factory" partly due to its cheap labor. If factories relocate to countries with cheaper labor (think Bangladesh, India, Vietnam, and so on), then China’s manufacturing activity – and, by extension, its economy – will take a hit.

In housing and products

Fewer people will mean less demand for goods and services at a time when China is trying to transition its economy from investment-led growth to consumption-led. What’s more, with fewer people starting families, there will eventually be a hit to long-term demand for houses. That could further drag down China’s real estate sector – a crucial growth engine that accounts for nearly one-third of the country’s economy.

In public finances

Projections show that 25% of China’s population will be 60 or older by 2030, up from about 18% today. That aging population puts the country’s public finances in a tough spot: reducing the government’s income (from taxes) while increasing its expenses (through healthcare and pension programs). Put together, the combo will strain China’s public finances and dent its ability to splash out on growth-generating projects like infrastructure, education, defense, and so on. Government spending is a big part of the Chinese economy, accounting for more than 15% of its economic output every year since 2011.

Is there an opportunity here?

Suppose China wants to keep growing at a healthy rate and achieve a politically motivated goal of having its economy overtake the US’s in size. In that case, it would have to offset the decline in its workforce with productivity gains – that is, an increase in the economic output per hour worked. China could do that in several ways: for example, by increasing access to the latest equipment, relying more on automation technology like robotics and artificial intelligence (AI), investing in education and training, improving infrastructure, encouraging business growth and innovation, or boosting research and development.

Of the lot, technology is arguably the most important in improving productivity. Think about how much we can do today using computers compared to a few decades ago, and how much that’s boosted economic output per hour worked. And in an economy where the workforce is declining, think about how much you could offset those declines with automation technology like robotics and AI.

If you want to convert China’s shrinking population into a long-term investment opportunity, you probably want to screen for firms in the automation sector with major exposure to the country. An easy way to tap into a diversified portfolio of these firms is via the Global X China Robotics And AI ETF (exchange: Hong Kong; ticker: 2807; expense ratio: 0.68%). With investor interest in AI skyrocketing and ChatGPT taking the world by storm, stocks in the AI sector could be poised to broadly benefit. What’s more, Stéphane recently wrote more about why this might be a good time to invest in China, here.