Aging: A threat to People’s Republic of China’s growth

By Yolanda Fernandez Lommen on Thu, 21 February 2013

Aging can adversely affect economic performance, demanding changes in social and economic policies to address the challenge. While the best-known dimension of aging relates to fiscal sustainability due to spiraling health care and pension costs, the repercussions are wider. More worryingly, aging will ultimately constrain economic growth because labor supply shortages result in lower GDP growth in the absence of increases in total factor productivity.

Aging in People’s Republic of China (PRC) is particularly complex because the population is aging quickly, but at a relatively low level of per capital income. The labor market is imperfect; shortages of qualified workers hinder development because new skills demanded to meet the needs of economic modernization and restructuring are scarce. Structural constrains, including limited access to financial products and services, restricted labor mobility, and weak safety nets compound the difficulties of aging at an earlier stage of development. 

During the last three decades, a dramatic increase in life expectancy in PRC, coupled the one-child policy, has prompted the greatest demographic transition in the world, which has supported economic growth by adding about 2 percentage points a year to GDP. However, the speed of the transition has resulted in a premature aging society. Dependency ratios are increasing, and the demographic dividend, the boost caused by a growing proportion the working-age population, has vanished. By 2050, about 30% of the population will be above 60 years of age, against a world average of 22%. 

A poor safety net, with most elderly depending on weakening family support as traditional values change alongside economic modernization, magnifies the challenge. Aging is already impacting PRC. Last year the labor force declined for the first time. However, aging has not yet been added up to the policy agenda, but it should and soon.

Developed economies were the first to age decades ago. Their governments approached the problem by adopting innovation-driven growth models to offset the losses induced by falling labor supply in aging societies. Innovation-driven growth is high in the new leadership’s reform agenda, but bold reforms are needed to unleash the economy’s potential. 

To this end, policies toward greater labor mobility in PRC will increase productivity growth. However, the restricted geographical mobility of labor induced by the household registration system or hukou is compounded by skill shortages and mismatches that impede PRC’s movement up the value chain, which is essential to foster innovation-driven growth, and the key to avoid the middle-income trap

For that reason, efforts to enhance labor mobility should be accompanied by measures to increase labor productivity to counterbalance the impact of aging. Deficits in the labor force due to aging and skill shortages will erode the country’s competitiveness, reducing PRC’s exports and economic growth. Substantial investments in research and development, and a twist in education policies toward student-centered education, will be vital to support innovation-driven growth and foster labor productivity.

More is needed. Addressing the need of a graying society in PRC requires large-scale reforms to upgrade old-age support. This implies significantly increasing budget resources, and developing a program for old-age income and health care support financed by tax revenue. Low levels of coverage and the structural and financial weaknesses of the current pension scheme also demand changes. But strengthening the pension system will not be possible without greater financial liberalization. A more sophisticated financial system, including larger variety of investment options and less restrictive regulatory framework, would lay the foundations for the establishment of private pension funds to complement government efforts.