China And Japan Decouple Amid Demographic Decline

Some rivalries stand the test of time: the Yankees versus the Red Sox, Barcelona versus Real Madrid, McDonald’s versus Burger King. In East Asia, the rivalry between China and Japan has long dominated geopolitics and economics. However, over the past five decades, the governments of both countries put aside political animosity and instead prioritized trade with one another to facilitate economic growth. In 1972, trade volume between the two countries stood at less than $3 billion USD in current dollars. Fifty years later, trade volume has grown 100 fold to $300 billion spread across a multitude of industries such as computers, heavy machinery, broadcasting and automobiles. Japanese conglomerates exported materials and machinery for China’s infrastructure as well as its nascent consumer electronics market, seizing the opportunity created by China’s 1996 policy of “grasping the large, letting go of the small” which saw the government relinquish control over smaller enterprises in a bid to spur privatization and growth.

Integration into Japanese supply chains  over the past half-century helped transform China into the world’s second largest economy, permanently altering the balance of power in East Asia between the two nations and fueling the assertiveness of China’s leadership on the world stage through so-called „wolf warrior diplomacy.“ In recent years, rising tensions between the two—over Taiwan, the disputed Senkaku Islands and US-China frictions—have led to the partial decoupling of their economies at a time when they might need each other more than ever to confront similar demographic challenges. The number of Japanese companies operating in China has decreased by 11% over the last decade and the number of Japan’s businesses listed in the Nikkei index that have a strong dependency on China has fallen. By the same token, China’s President Xi Jinping has turned away from integration with the global economy and towards nationalist, autarkic policies in certain strategic economic sectors like chip manufacturing.

Despite the immense historical, cultural, economic and political differences between Japan and China, both now face the same demographic challenge: a declining and aging population that promises to drag down their economies.Japan’s birth rate now sits at 1.37 births per woman after falling for a decade, well below the 2.1 replacement level required to maintain existing population levels. This, combined with low levels of immigration, have shrunk Japan’s population annually since 2010 and its current population of 125 million people is projected to dwindle to 106 million by 2050 and 75 million by 2100. To complicate matters, Japan’s shrinking population is also becoming disproportionately elderly (age 65 and above). As of 2020, the elderly citizens make up to 28.8% of Japan’s population and will require ever-greater resources for medical care, support, and help with daily living. This growing burden will fall on a dwindling working-age population, likely prompting a fiscal crisis. At the same time, much of Japan’s internal consumption spending is likely to flatline or fall off a cliff. Japanese corporations selling consumer electronics, automobiles, and other standard products will find it harder to sell as much to a smaller pool of consumers, making export markets like China even more valuable to their businesses.

China, for its part, dove head first into a demographic decline of its own making with the infamous one-child policy. Instituted in 1980, the policy not only succeeded in creating a drastic reduction in the fertility rate to 1.67 births per woman, but also created an enduring cultural expectation and standard of a one-child family. As China’s economy grew and the standard of living increased, the government did not revisit or amend this policy until 2015. In 2016, a new two-child policy was announced but the resulting spike in birth rate lasted for only one year and has since fallen below Japan’s to just 1.18. In 2023, China’s population suffered from its first recorded decline in 60 years (although the Chinese government may have been overcounting the population for some time previously).

China faces many of the same economic challenges from its demographic crisis as Japan, only with far less room for maneuver. While China’s GDP per capita has grown from $959 USD in 2000 to $12,500 USD today, it is still a developing country that has a much lower GDP per capita and standard of living than most developed countries. China’s phenomenal economic rise over the past 50 years was fueled in part by favorable demographics: because the country had so few retirees compared to its working age population, the government could devote more resources to investing in infrastructure and also enjoyed a larger tax base. But that demographic advantage is now becoming a liability as China’s pension system is strained by an influx of retirees beginning at ages 60 for men and 55 for women.

As time goes on, China may have bested Japan at aging itself out of economic growth. Previous predictions that China’s economic and demographic headwinds were less serious than Japan’s turned out to be mistaken. As China and Japan begin decoupling economically from one another, it is worth asking if they might not be stronger together since they face similar challenges.