From the early-1980s until early this decade, the “demographic dividend” provided by an abundant pool of labor helped drive China’s rapid industrialization and urbanization. The demographic dividend contributed roughly one-quarter of China’s economic growth in the past, according to the estimates cited by the Xinhua news agency. Given that China’s labor force peaked shortly after 2010, the country will need major new technological advancements to raise productivity-per-capita, otherwise the demographic dividend will become a headwind for economic growth.

The scale and speed of China’s aging are unprecedented in human history, as we have often written. It took China only 38 years to see its ratio of 60-and-over population (to total population) rise from 7.4% (1980) to 17.6% (2018). This compares to 56 years for Japan (1934-1990), 91 years for the U.S. (1917-2008), and 105 years for France (1861-1966). At the end of 2012, China’s working age population stood at 69.2% of the total population, but it took only five years for this to drop to 64.9% at year-end 2017. As the ratio of working-age population shrinks, labor will continue to become increasingly scarce—an ironic development considering that the large population historically was viewed as a national burden, as evidenced by the “One Child Policy.”

China has been employing automation in the manufacturing sector aggressively since the early part of this decade. The usage-intensity of industrial robots, defined as the number of industrial robots to the number of workers in the manufacturing sector, grew 230% between 2010 and 2015, according to CASS vice president Cai Fang. The designers and manufacturers of industrial robots from the developed economies, such as Japan’s Fanuc and Germany’s Kuka, have all benefited from China’s unquenchable demand for industrial robots. Given the seismic shift in labor dynamics over the past decade, the labor shortages would have been overwhelming had China not begun adopting industrial robots aggressively.

And, as the service-sector continues to gain share as a portion of China’s overall economy, these labor shortages could get even worse. For example, even though China’s economy has been slowing, this year’s third quarter job-availability ratio registered 1.25 (or 125 openings for every 100 job seekers), the highest level since 2015, as shown in the following chart. The subsequent chart, showing the monthly readings of the service PMI published by Caixin, a financial data and news provider, shows how robust the service sector has been, even while manufacturing has weakened.

Job Availability Ratio, 1Q2015 – 3Q2018 Source: Ministry of Human Resources and Social Security & 13D Global Strategy and Research
China Service PMI Readings, Monthly, Nov. 2015 – Present Source: Caixin & 13D Global Strategy and Research

Artificial Intelligence (AI) is a feasible solution to China’s labor shortage as the service sector accelerates. “The coming wave of automation technology and AI promises new possibilities for replacing or augmenting labor in the non-manufacturing sector (for example, in transportation, communications, retail services, storage, and others),” according to Land of Rising Robots, an IMF report published this year.

Since the first wave of China’s automation was marked by industrial robots replacing labor in factories, it stands to reason that the second wave will be characterized by AI replacing labor in the service sector. Chinese policymakers are well aware that AI has the potential to help the country weather adverse demographic changes.

Last year, Beijing announced a plan to lead the world in artificial intelligence by 2030. And, two months ago, the Politburo held its ninth collective study session on AI, during which Chinese President Xi Jinping emphasized that AI will be a crucial driving force for a new round of technological revolution and industrial transformation.

Shortly thereafter, on November 19th, the National Development and Reform Commission (NDRC) told Security Times that it will collaborate with the related ministries to seize the strategic opportunities for the development of AI. According to the China AI Development Report (2018), as of June 2018, the country had 1,011 companies conducting AI or AI-related functions, accounting for 20.5% of the world’s total.

This has major implications for Chinese companies, especially for those engaged in labor-intensive and service-sector industries. Some of these companies have already begun stepping-up their pace of AI-adoption to boost productivity and investor returns. Ping An Insurance Group (601318 CH, CNY 62.46; 2318 HK, HKD 74.35) is a prominent example. As of year-end 2017, Ping An had a customer base of 166 million individuals and employed 264,288 people to service them. Additionally, in 2017, 40.4% of its new customers were obtained from online channels, versus 22.3% in 2016.

Last year, the company pioneered with a “smart customer service,” which is essentially an AI-powered system. With the assistance of AI, Ping An’s customers can now complete their underwriting and claim processes online in seconds (see WILTW Nov 22, 2018).

Haidilao International (6862 HK, HKD 18.96), an operator of a nationwide franchise of restaurants, is another example. When customers walk into Haidilao’s branch at Dongdaqiao, Beijing, they may think they have entered a futuristic theme park, because robots have replaced humans in doing most of the traditional restaurant work: robotic arms and servers work as waiters, chefs, and even as kitchen helpers. The robot-staffed “hot pot” restaurant is a partnership between Haidilao and Panasonic. The AI-operated restaurant features robots that “will take orders, prepare and deliver raw meat and fresh vegetables to customers to plop into soups prepared at their tables,” according to a report by Bloomberg.

Finally, last month, the official Xinhua news agency introduced the world’s first AI-based anchor, who can report “tirelessly” 24 hours a day/7 days a week, into its TV newsroom. We also learned from our friends in China that many mainland companies are now using AI to make cold calls to new sales prospects.

This AI trend is not limited to China, as many other East Asian economies have jumped on the bandwagon. So much of the region has become increasingly-plagued by chronic labor shortages that using AI to replace unskilled and low value-added labor is rapidly-becoming more widespread.

For instance, Japan—our favorite “laboratory of the world”—is now experiencing the most severe labor shortage in over two decades. According to a joint study by Persol Research and Chuo University, Japan is forecast to face a shortage of 6.44 million workers by 2030. In its annual outlook for Japanese economy this year, the IMF warned that Japan will lose 25% of its GDP in the next 40 years if nothing is changed in the government’s policy. According to a study published by the Japanese government last August, the government believes it is crucial to adopt advanced technologies such as AI and robots to tackle these labor shortages. South Korea is another regional example, as it tops the ranking of the Economist Intelligence Unit (EIU)’s Automation Readiness Index in 2018.

We will discuss the investment implications of the Chinese service sector embracing AI in future issues.