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Home Policy & Regulations

Can an Aging China Be a Rising China?

USCBC by USCBC
April 1, 2011
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As China’s demographics shift in the coming years, the country must prepare for slower growth and greater risks of instability.

by Richard Jackson

China stands on the threshold of a stunning demographic transformation with profound implications for economic growth and social and political stability. For the past three decades, China’s unusually favorable demographics, with a record share of the population of working age (age 20-64), have helped living standards skyrocket. Beginning around 2015, however, the demographic climate will change abruptly. According to the United Nations (UN), the elderly (age 65 and older) share of the population, which was only 8 percent in 2010, will double to 16 percent by 2030 and triple to 24 percent by 2050. Within 25 years, China will have an older population than the United States (see Figure 1).

As China ages, it will have to overcome many of the same obstacles to economic growth that confront developed countries, from rising old-age dependency burdens to a graying workforce and declining savings and investment rates. But one important difference makes China’s aging challenge even more daunting: Today’s developed countries became affluent societies before they became aging societies, but China’s age wave will arrive in a society that is still developing and modernizing—and that has not yet fully implemented the social protections of a modern welfare state.

The weak social insurance system means China may face less fiscal pressure from an aging population than today’s developed countries, but it also means China may face greater social stress. Only a small fraction of China’s workforce earns benefits under a public or private pension system. Most elders still depend heavily on their extended family for support. Yet traditional family support networks are already unraveling as China urbanizes and modernizes, and these networks will soon come under intense new demographic pressure as the population ages and family size declines. An aging crisis of potentially immense dimensions looms in China’s future if the country fails to prepare.

jackson-charts-1-and-2

China’s demographic tipping point

China owes its economic success to many factors, from sound macroeconomic management to massive investment in human capital. Development economists agree, however, that China’s favorable demographics have played a crucial role in underpinning its economic rise.

As recently as the early 1970s, China’s fertility rate hovered around 5.0 lifetime births per woman, about the developing-world average at the time. Due in part to the one-child policy, the fertility rate by the mid-1990s plunged to 1.8, where it remains today. When fertility rates first fall, societies generally enjoy a period of “demographic dividend,” in which the overall dependency burden declines and the share of the population of working age rises. All other factors being equal, a larger share of the population in the working years means a higher per capita living standard. In addition, declining fertility can alter economic behavior in ways that accelerate the pace of improvements in living standards. Labor-force participation may increase because having fewer children frees up more time for adults—especially women—to participate in the market economy. Savings rates may rise, as more of the working-age population enters the higher-saving middle-age years. Declining family size and rising life expectancy also strengthen incentives to invest in the “quality” of children, and thus the future workforce.

Economists who have studied China’s demographic transition agree that these dynamics have significantly boosted economic growth. Since 1975, China’s total dependency ratio of children and elderly per 100 working-age adults has fallen from 114 to 56, one of the largest declines of any country in the world (see Table). Meanwhile, the working-age share of the population has risen from 47 percent to 64 percent. Many studies have concluded that the age structure shift accounts for one-quarter to two-fifths of China’s per capita gross domestic product (GDP) growth since the mid-1970s.

The period of demographic dividend is coming to an end, however. In five years, China’s enormous “Red Guard” generation—which was born before the country’s fertility decline and came of age during the Cultural Revolution (1966-76)—will begin to reach old age. As this occurs, the relative increase in the number of elderly adults will overtake the relative decline in the number of children, the total dependency ratio will bottom out and rise again, and the working-age population will peak and begin to decline. The positive economic effects of the demographic transition will reverse when China reaches this tipping point. Though demographics have been leaning strongly with economic growth so far, they will soon lean against it.

jackson-table

Risk of slower economic growth

China’s deteriorating demographics are unlikely to halt the country’s economic rise, but they will almost certainly slow it. To begin, the changing demographics will negatively affect employment growth. Over the past three decades, China’s working-age population has expanded at the average annual rate of 2 percent. By the 2030s, this population will be contracting by 0.7 percent per year (see Figure 2). Unless labor-force participation or productivity growth increases, GDP growth will inevitably slow.

A skills mismatch

Contrary to conventional wisdom, the scope for internal migration to bridge the employment gap is limited. Until recently, China was able to shift millions of underemployed workers from non-market rural sectors to full-time, low-skilled manufacturing jobs each year, generating a large and instantaneous boost to GDP growth. But migration cannot indefinitely remain a major source of economic growth since China is rapidly losing its competitive advantage in low-skilled manufacturing. As China’s industries move up the global value-added scale, a mismatch is emerging between the skills of the remaining rural labor surplus and the demands of the jobs being created in economic growth sectors.

Lower savings rates

The coming demographic shift may also slow growth by lowering savings and investment rates. This prospect may seem remote now, given that China is awash in excess savings, running large current account surpluses, and accumulating massive foreign exchange reserves. Yet numerous studies have confirmed that the classic lifecycle motivation for savings—accumulating assets during the working years to be drawn down during the retirement years—functions more powerfully in China than in developed countries. This is in part because China’s social insurance system is still underdeveloped and in part because the Confucian ethic that traditionally allowed elders to rely on their children for support is weakening. As China’s population ages, more elders will have to draw down their savings to support themselves in retirement. As a result, household savings rates, which have risen dramatically in recent decades as youth dependency has declined, could fall just as dramatically once elder dependency begins to climb.

Curtailed foreign investment

The decline in domestic savings could be accompanied by a decline in the availability of affordable foreign capital. Most of today’s high-income countries also have aging populations, and most have expensive pay-as-you-go pension and health benefit programs, whose costs are projected to climb steeply in the coming decades. (For example, the total cost of public old-age benefits in the United States will increase by 7 percent of GDP over the next three decades, according to Center for Strategic and International Studies projections.) These countries therefore may also experience a sharp drop in savings rates, both private and public, which could curtail the massive inflows of foreign direct investment (FDI) that have played a central role in fueling China’s economic growth.

Weak capital markets

Given the potential FDI decline, China’s economic growth will have to depend increasingly on allocating domestic savings to the most productive investments—but the country’s underdeveloped capital markets are its greatest economic weakness. Though China’s labor and product markets are now more liberal than those of many developed economies, reform of its capital markets has lagged. Most of the capital in China is still allocated by the government through state-owned banks. As a result, banks shower many large enterprises favored by the government with investment funds despite poor expected returns and prospects, while many small unnoticed enterprises with excellent expected returns and prospects are starved for funding.

China’s underdeveloped capital markets have not significantly hindered economic performance over the past three decades, because the large FDI inflows and mass internal migration of workers from rural to urban regions have generated much of GDP growth. The migration led to a huge leap in worker productivity, even when the firms offering the jobs were not accountable to financial markets. In the decades to come, however, gains in productivity and living standards will increasingly depend on workers with good jobs finding better jobs—and on firms with established markets finding innovative ways to win new markets. In other words, China’s development agenda will depend more on the efficiency of its capital markets.

Larger old-age dependency burdens

Even as economic growth slows, China will need to transfer a rising share of economic resources from working-age adults to nonworking elders. China had 7.8 working-age adults available to support each elder in 2010. According to UN projections, this ratio is due to fall to 3.8 by 2030 and to 2.4 by 2050, which means that the average burden borne by each worker will more than triple. Though much of this burden currently falls on families, in a rapidly aging and developing China a rising share is bound to appear in public budgets and higher tax rates. China now spends only 3 percent of GDP on public pensions, but a pension system that offers all workers the same average benefit as the current basic pension system would cost at least 10 percent of GDP by 2030 and at least 15 percent of GDP by 2050. The rising cost of healthcare for the elderly would come on top of this.

Risk of growing instability

The greatest concern raised by China’s changing demographics is not the prospect of slower economic growth itself, but the potential for slower growth to trigger a social and political crisis. By the 2020s, demographic trends may weaken the two principal pillars of the PRC government’s political legitimacy: rapidly rising living standards and social stability. The stresses of breakneck development so far have been bearable in a youthful China with rapidly rising incomes, but the stresses may become less tolerable in an aging China where economic growth is slowing.

Though the West’s industrial revolution unfolded over a century or more, China’s is taking place within a single generation. When the PRC government launched economic reform in 1978, many urban workers lost the cradle-to-grave social protection they enjoyed under the planned economy. Tens of millions of migrants have since moved from traditional agricultural villages to bustling manufacturing hubs, where they have joined a rootless “floating population” estimated to number at least 150 million. Urbanization is weakening the extended family, worker mobility and turnover rates are rising, and the income gap between the rich and poor is widening.

The rapid aging of China’s population could act as a multiplier on the stresses of rapid modernization. Less than one-third of China’s workforce currently earns formal retirement benefits. Despite China’s lofty national savings rate, few workers are accumulating sufficient financial assets to support themselves in retirement. The majority will have to rely on their children, the most traditional form of old-age insurance. Yet many of these workers will have only one child—and that child will not always live nearby. As a result, tens of millions of today’s low-wage migrant workers in China’s cities may age into tens of millions of indigent elders who lack pensions, healthcare, and extended families. Meanwhile, China’s rural regions may be left with entire towns populated only by elders without children to support them.

Room for optimism

None of this is to say that China’s rags-to-riches story is fated to end poorly. Though China’s demographics will soon begin leaning against economic growth, the age wave will not arrive in full force until the mid-2020s. By then, China’s economy will likely have overtaken the US economy in absolute size, at least measured in purchasing power parity dollars that take into account differences in living standards.

As for social instability, the PRC government is acutely aware of the risks that deteriorating demographics and slowing economic growth may bring. The government’s emphasis on building a “harmonious society” and repairing the social safety net reveals how seriously it takes the danger of social upheaval. Over the past few years, PRC leaders have launched initiatives that have begun to push China’s retirement system in the right direction. They have increased efforts to broaden participation in the existing basic pension system for urban workers, design a new rural pension system, and lay the groundwork for a system of private pensions known as enterprise annuities. After years of hesitation, the government also seems to have recognized that rapid population aging has become a greater threat than rapid population growth—and is starting to relax the one-child policy.

What the demographic trends do suggest is that widespread expectations of continued double-digit growth in China may be unrealistic, even in the near term, and that there are far greater risks to growth and stability in the long term than is generally appreciated. These trends leave room for optimism about China’s future, but that optimism must be tempered by a realistic assessment of the significant challenge that lies just over the horizon.

[author] Richard Jackson ([email protected]) is a senior fellow at the Center for Strategic and International Studies in Washington, DC, where he directs the Global Aging Initiative. [/author]

Tags: AgingDemographics
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