FRENCH PHILOSOPHER Auguste Comte probably tried to cram too much into his pithy but seductive maxim when he said that “demography is destiny.” Even so, demographic forces can be relentless in shaping future prospects of nations and therefore can offer powerful clues about national possibilities for future prosperity and geopolitical power.

It is well-known that China’s population is aging. Less well-known and rarely examined is what this demographic shift might mean for the future of Asia’s largest and most rapidly rising power. A graying China will not necessarily be a China of economic stagnation and social turmoil. But understood in the context of the country’s current path of development, China’s aging demographics could be the single most important factor preventing the “Asian century” from being a Chinese-dominated one.

Despite its economic dynamism, East Asia is aging rapidly. Most attention is focused on Japan, considered the “grandfather” of the region. But in terms of ramifications for the future power balance, much more attention should be paid to China. Currently it has a population of 1.35 billion, but this number is expected to begin shrinking slowly by around 2030.

More important is the ratio of working-age people to those over sixty-five, considered aging or formal retirees. In the 1980s, the proportion of the working-age population (fifteen to sixty-four years old) was more than 73 percent of the overall population. Currently at about 68 percent, the working-age population is expected to decline to about 65 percent in 2020 and 60 percent in 2035.

The significance of these numbers becomes apparent when we compare the proportion of working-age people with formal retirees. When China began its market reforms in 1979, there were about seven working-age persons to every retirement-age one. Today, the ratio is about 5.5 to 1. Current projections suggest that by 2035 there will be fewer than 2.5 working persons for every retiree.

The age profile of the working population also matters. Studies show clearly that workers are at their most productive and innovative from their late twenties to their midforties. This has been the basis for China’s “demographic dividend,” the massive productivity generated by the combination of declining fertility levels and a mass of young workers entering the workforce with relatively few familial responsibilities. Productive labor-force capacity has risen faster than population since the 1979 reforms. This trend will be in reverse from around 2015 onward.

There are currently around 120 million Chinese people sixty-five years or older. By 2035, there will be around 320 million, with the overall population only around one hundred million larger than it is today. Even within the working population, in 2035 there will be 1.5 older workers (fifty to sixty-four years old) for each of their younger counterparts (fifteen to twenty-nine years old), which is the direct opposite of the current situation.

These trends are replicated in the pre-working-age generation. For example, the number of new students enrolling in primary schools declined from more than twenty-five million in 1995 to fewer than 16.7 million in 2008. Taken together, and although not as serious as in Japan, these statistics place China firmly in the “aging” category, alongside countries such as South Korea, Australia and the advanced economies of Western Europe.

Moreover, for a number of reasons it is extremely unlikely that these trends can be altered or reversed.

First, China’s aging population is largely the result of a dramatic increase in average lifespan, which has increased from under sixty-five years in 1980 to the current seventy-five years. Moreover, fertility rates have declined, from 2.63 children per woman in 1980 to about 1.5 in 2011. This trend is unlikely to change. Wealthier cities such as Shanghai (reporting a fertility rate of only 0.6, which is probably the lowest of any major city in the world) provide evidence that emerging Chinese elites, like their Western counterparts, are choosing lifestyle and career expectations over larger families. Although the country’s “one-child policy,” in place since 1979, has been enforced unevenly across different provinces, it still has had the effect of keeping the number of childbearing women artificially low. This reality, combined with the widespread Chinese preference for sons over daughters, leads to estimates that there will be a surplus of some forty million men of marriageable age by 2020.

Actual figures into the future could vary slightly from the trend lines. But little can be done about China’s aging demographics over the next few decades. Even if the one-child policy were to be abolished, the aging trend wouldn’t be reversed to any appreciable degree for several decades.

NOW LET’S consider China’s economic-growth model in the context of this aging trend. Premier Wen Jiabao has more than once described his country’s growth model as “unstable, unbalanced, uncoordinated and unsustainable.”

The basis for Premier Wen’s assessment, widely endorsed by Chinese and international economists, is that China must move away from exports and fixed-asset investment (in short, building things) as the dominant drivers of economic growth. From the mid-1990s to early this century, net exports accounted for about half of China’s growth each year. From around 2003 onward, fixed-asset investment drove around 40 percent of GDP growth. In 2009, due to the massive fiscal and monetary stimulus ordered by the government in response to the global slowdown affecting China’s key export markets of America and the euro zone countries, 80–90 percent of growth was the result of capital investment. This is reflected in the increase in formal bank lending used for fixed investment. Such lending jumped from $150 billion in 2001 to $380 billion in 2003, then to $750 billion in 2008 and $1.4 trillion in 2009. (The figures in 2010 and 2011 dropped slightly to around $1.2 trillion.) On the back of increasing bank loans and other bank credit that now amount to around 250 percent of GDP, fixed investment is currently responsible for around 50–55 percent of GDP growth.

Indeed, fixed investment as a share of GDP jumped from a relatively sustainable 35 percent in the 1980s to 45 percent in 2004. Many analysts now believe that fixed investment amounts to more than 60 percent of GDP. Still a poor country, this means that China is pouring far too large a percentage of national savings into building things that are not utilized or wanted by the population, and its households are consuming too little. Even during periods of rapid industrialization in Japan, South Korea and Taiwan during the 1950s, 1960s and 1970s, fixed investment as a proportion of GDP stayed below 30 percent, except for one or two years when it approached 35 percent. To be sure, the movement of rural citizens into cities and surrounding suburbs is always associated with a rise in fixed investment, and China is no different. However, with an urbanization rate of only around 1–1.5 percent each year, we are witnessing the most rapid (and undoubtedly unsustainable) buildup of capital investment in any economy in recorded history.

Economically, the country’s reliance on fixed-asset investment is enormously wasteful. The vast majority of fixed-investment activity is undertaken by centrally and locally managed state-owned enterprises (SOEs), even though domestic private firms are generally two to three times more successful on measures such as return on investment, profitability and economic efficiency. These SOEs dominate all major sectors of the Chinese economy (except for export manufacturing), including commodities, utilities, chemicals, heavy industry, infrastructure, construction, shipping, banking, finance, insurance, media, education, renewables, IT and advanced IT platforms. They also receive around three-quarters of all formal bank loans issued by the state-owned and state-dominated banking sector throughout the country.

This massive SOE bias would make more economic sense if the approximately 120 centrally managed and 150,000 locally managed entities were deserving of such support. Some well-known Chinese state-owned giants such as Sinopec, China Mobile and the China National Petroleum Corporation make enormous profits each year, albeit in virtual monopoly environments within which they enjoy privileged access to capital. Yet, even among better-run centrally managed SOEs, around 80 percent of all profits are generated by fewer than a dozen companies.

The performance of the locally managed SOEs is even more abysmal. According to consolidated estimates of various case studies, 19 percent of SOEs were unprofitable in 1979, 40 percent were unprofitable in 1997 and 51 percent sustained losses in 2006. It is reported that risk-management procedures in this lending have been highly questionable, and an estimated 30 percent of bank loans are extended for “policy” reasons rather than sound commercial considerations. Thus, fears of a growing problem of nonperforming loans (NPLs) would appear to be well grounded.

Indeed, this cycle has been replayed before. Between 1998 and 2005, the government injected more than $250 billion worth of cash to bail out its banks. During the same period, around $330 billion worth of these NPLs were transferred off the books of Chinese banks into specially created “asset-management companies,” with the banks receiving the full worth of the NPLs in return. To date, the average recovery rate of NPLs by asset-management companies is about 25 cents on the dollar.