Chinas One-Child Policy Is Crippling Industry

Lin Chang Jie is battling to save his family’s business, which makes towels, cushions, and robes in the eastern Chinese city of Ningbo. The main threat he faces is a dwindling supply of workers, which forces him to pay higher wages. “I have to find a new way,” says Lin, 29, who is attempting to transform his Dejin Textile into an online fashion retailer in order to shrink headcount and keep the business from closing. “Wages are going up, up, up,” he says. “If we don’t like somebody’s work we can’t say anything, in case they leave.”

Manufacturers such as Lin are caught in a demographic trap. China instituted a one-child policy in 1979 to constrain population growth and foster prosperity for the next generation. The byproduct of that policy is an accelerating decline in the pool of young and largely unskilled labor that is the mainstay of mainland factories churning out low-margin goods such as clothes, toys, and furniture. United Nations projections show that the country is at a tipping point: The number of 15- to 24-year-olds is set to fall by 62 million people—or more than 27 percent—to 164 million people, in the 15 years through 2025.

The resulting upward pressure on wages is forcing mainland companies to upgrade to higher-value products, as Japan did in the 1960s and ’70s. China may have as few as five years to make the transition to avoid a slump in economic growth, according to Mingchun Sun, an analyst at Daiwa Capital Markets in Hong Kong and a former economist at China’s State Administration of Foreign Exchange, part of the central bank. He says growth may decline from 2016 to 2020 as low-cost producers fail and investment falls away.

“This is the big issue in China on which everything will turn,” says Barry Eichengreen, an economics professor at the University of California at Berkeley. A former senior policy adviser to the International Monetary Fund, Eichengreen contributed to the 2010 book Emerging Giants: China and India in the World Economy. “China needs to really accelerate this transition,” he says.

It’s been slow going so far: Products that China’s customs agency doesn’t classify as high-tech, such as clothes, shoes, and furniture, made up about 68 percent of exports last year, or $1.09 trillion, little changed from their 71 percent share in 2005. Exports in China account for over a fifth of gross domestic product, more than double the proportion in the U.S.

Only five economies—Japan, South Korea, Taiwan, Hong Kong, and Singapore—have graduated from middle-income nations to developed country status while maintaining relatively high growth rates, according to Nobel laureate Michael Spence, a professor of economics and business at New York University’s Stern School of Business. In a recent report, Morgan Stanley (MS) likened China’s income growth and stage of economic development to Japan in 1969 and South Korea in 1988.

While the majority of China’s companies have yet to upgrade, advanced industries such as aviation, medical instruments, software, computers, and telecommunications are taking root, aided by government incentives. In fact, high-tech exports have more than doubled since 2005, to $492 billion last year. In August the government unveiled plans to set up a special zone, covering nine cities in the Pearl River Delta, to help companies upgrade. “Technological development will decide the future of China,” Premier Wen Jiabao wrote in an article published last month in Qiushi Journal, the magazine of the ruling Communist Party.

One Chinese company that’s successfully moved up the value chain is Sany Heavy Industry, based in Changsha, the capital of the southern Hunan province. Twenty-two years after starting as a welding factory, Sany, which sells products such as concrete pumps and road rollers in 120 countries, has four billionaires on the board and more than 68,000 workers. The company supplied a pump that helped cool one of the Japanese nuclear reactors crippled by the Mar. 11 earthquake and tsunami. And in June it opened an industrial park in Bedburg, Germany. “For ages people believed that Chinese can only make stuff like toys, clothes, and hand torches—all cheap and of bad quality,” says Sany Senior Vice-President Zhao Xiangzhang. “Our dream is to change this bad image.”

Cai Fang, a member of the Standing Committee of the National People’s Congress, says China’s leadership has not yet fully accepted that the so-called demographic dividend is being exhausted. He’s referring to the economic benefit a country captures after its birthrate falls—creating a few decades when there is a higher proportion of working-age citizens and less need to spend on children and education. Cai, a director of the Institute of Population and Labor Economics at the Chinese Academy of Social Sciences, says advisers are lulling China’s policymakers into complacency with arguments that the dividend can last 20 years or more.

Lin has no such illusions. His Dejin Textile is readying a new line of women’s clothes to be sold online and in two local stores. It’s a “huge risk” that he admits keeps him awake at night. “In five years,” he says, “we may have a very big retail business. Or we may be closed.”

The bottom line: Chinese manufacturers need to move up the value chain to combat upward pressure on wages brought on by labor shortages.

Bloomberg