A maturing problem

The structure of labor markets, savings patterns and migration flows will all change in an aging society. 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 China is particularly complex because the population is aging quickly, but at a relatively low level of per capita income. Furthermore, the labor market is imperfect; shortages of qualified workers hinder development because the new skills demanded to meet the needs of economic modernization and restructuring are scarce.

Structural constraints, 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, life expectancy in China has improved dramatically. Simultaneously, the fertility rate has declined sharply, underpinned by the one-child policy. The combination of these two trends has prompted the fastest demographic transition in the world. This has supported economic growth in China by adding about two percentage points a year to GDP.

However, China has been an aging society since 2000 due to the speed of that demographic change. Dependency ratios are increasing and the demographic dividend – the boost caused by a growing proportion of working-age people – is expected to start to decline in 2015. The working-age population will peak, and labor shortages will start exerting pressure on the labor market.

By 2020, aging will add 10 million new senior citizens each year, but subtract seven million adults from the working-age population. As a result, by 2050, about 31% 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.

Developed countries were the first to age, and approached the problem by shifting from input-driven growth models to ones driven by productivity innovation. This could be achieved through rebalancing the growth pattern, in particular by developing the services sector, while intensifying efforts toward universal social security coverage. In this process, it is essential to make growth inclusive, as the strain induced by widening income inequality could escalate to unsustainable levels in a rapidly aging society.

To this end, policy actions conducive to greater labor mobility in China will reinforce productivity growth. Existing institutional barriers – such as hukou and restrictions on the portability of social benefits – hinder natural migration flows and deter urbanization, resulting in an inefficient allocation of labor. Simulations suggest that transferring a larger share of the labor force employed in agriculture into other sectors could add several percentage points to GDP growth and help address the impact of aging.

The restricted geographical mobility of labor is compounded by skill shortages and mismatches that impede China’s movement up the value chain, which is crucial to the sustainability of growth.

Efforts to enhance labor mobility should be accompanied by measures to increase labor productivity. Deficits in the labor force due to aging and skill shortages will erode the competitiveness of low-end, labor-intense manufacturing, which in turn will reduce China’s exports and economic growth. International experience suggests that substantial investment in research and development is needed to climb the value chain and increase productivity growth.

To promote innovation-driven growth, education policies should also encourage a shift from rote and exam-based learning toward student-centered education, and should strengthen links between education and vocational training and the labor market.

These reforms will help to counteract the impact of aging. However, more will be needed: Addressing the needs of a graying society in China 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 further reform. But strengthening the pension system will not be possible without greater financial liberalization. A more sophisticated financial system, including a larger variety of investment options and a less restrictive regulatory framework, would lay the foundations for the establishment of private pension funds to complement government efforts.

In October, the fifth plenary session of the Party’s 17th Central Committee set the basis for a new development agenda for the next five years, examining and approving proposals for formulating the 12th Five-Year Plan.

According to the plenum’s communiqué, policy-making in the next five years will pursue a new economic model driven by a more balanced contribution of investment, consumption and exports, with the services sector playing a key role.

Economic growth will be accompanied by improved social security standards aimed at narrowing the income inequality gap, and at improving people’s livelihoods in urban and rural areas. In this context, urbanization and the progressive relaxation of the hukou system are key steps toward making growth inclusive and sustainable.

Such reforms would help to mitigate the impact of aging on economic growth, but they are not enough. More specific measures are needed to address the enormous challenge of a graying society in China today.