If you follow business news at all you have probably read these words: “China is Dubai times 1,000 – or worse”. Jim Chanos and several other 'China bears' foresee doom in China’s economic future. They argue that eased credit has led to asset bubbles, particularly in real estate. Hence they call for shorting China’s economy, with the belief that the country is set to experience a disastrous crash. But there is at least one glaring omission in the bears’ analysis: they fail to account for changes in China’s demographics and its tremendous potential to impact the economy.

How important are demographics? A paper published in 2005 by the US Federal Reserve suggests that a nation’s working age population, ages 25 to 64, may ultimately determine shifts in real estate prices. Remarkably, the model employed here accurately anticipated the real estate boom and busts of Japan’s market in 1974 and 1990, the movements in prices in the US, Great Britain and Ireland, and even foreshadowed the current collapse in real estate prices recently experienced by these countries.

Just as the populations of the United States, Japan and Great Britain were influenced by the Second World War to create a generation of baby boomers, so too have events in China influenced its demographics. At the end of the Great Leap Forward in 1961, there was a surge in the birth rate, which gradually subsided due to family planning measures implemented by the government. This generation then began having children in the 1980s, creating another spike in births despite the implementation of the One Child Policy in 1979.

Those born during the spike of the 1980s are now entering working age. The result is that the working age population in China is now at a historic peak. Numerous Chinese people turning 25 are entering a period in life where most finish their university studies, find jobs, get married and buy houses – in China often with the financial assistance of their parents, likely of the previous boom generation. If the logic of the Federal Reserve’s paper holds for China as it did for other countries, the substantial increase in working age citizens is likely the main driver behind China's real estate prices.

Source: UN Population Division; THE BEIJING AXIS Analysis

Furthermore, people in China are increasingly moving from rural areas to cities. This is certain to continue, as China still has a low rate of urbanisation compared with most countries. As of 2008, only 43% lived in cities compared with 82% in the United States. The drastic rise in the real estate prices of Beijing and Shanghai are likely an indication of increased demand due to the trend toward urbanisation rather than evidence of a calamitous property market bubble.

Another point the paper makes is the influence the working age population has on real interest rates. Through a tendency known as 'consumption smoothing', people tend to save when they are more productive during their working years in order to consume when they are less productive – retirement. Not only are savings invested in assets with fixed returns, but also in riskier assets such as stocks. However, in China there are capital controls in place which not only include legal barriers for equity purchases by foreigners, but even more so restrict Chinese citizens from purchasing shares abroad. The result is that China’s working age population – at an all time high, in a country with one of the highest savings rates in the world – is largely confined to domestic equity markets, perhaps driving up prices to what may be perceived as bubbles.

The China bears who recommend short selling Chinese stocks should take note. The negative effects from eased credit conditions in China, although not completely unlikely, have yet to be seen. As for now, there are around 740 million reasons – the current number of China’s working age population – to be optimistic about China’s economic future.

Photo: Shirin Neshat, New York magazine