China’s Growth Dilemma: Growing Old before Becoming Rich?

Current trends in China’s demographic transition suggest that the Chinese will likely grow old before they grow rich, which poses many challenges to the current regime. The first challenge is labor shortage. Throughout the period of reform and opening up to the outside world, China has been constantly expanding the base of her economically active population and working population in urban and rural areas. In the era of globalization, capital and goods can flow freely across borders, whereas the flow of labor remains problematic for the regime. China’s comparative advantage, however, lies precisely in its abundance of labor resources. Therefore, China will continue to rely upon its huge labor force to bolster her economic growth for a considerable period to come. The service and manufacturing industries have long been the two key engines for China’s growth. Possessing tremendous growth potential, they will continue to generate considerable labor demand. Moreover, other industries and sectors also need a large amount of labor for their future development.

The PRC’s family planning policy of “raising population quality and controlling population size” was initiated in the late 1970s by the Chinese government. China had—in less than 30 years—imposed a remarkable transition that moved it toward the modern population growth pattern that had taken many developed countries almost a century to achieve. If we measured China’s fertility rate by Total Fertility Rate (TFR), which is a common tool used by demographers, the TFR stood at 5.4 in 1971. Since then, the TFR has plunged to 2, a level below the replacement rate (the replacement rate is usually at 2.1) [1]. China’s population growth rate has been consistently maintained below 10 per thousand since 1998, with a further decline from slightly above 6 per thousand in 2003 to 5.28 per thousand in 2006 [2].

Along with the transition, however, comes a shift in the population age structure: primarily a rapid increase in the proportion of elderly people in relation to the overall population. By UN definition, a country with over 7 percent of its population aged 65 or older is considered an aging society. According to the five most recent Chinese Censuses, the proportion of population aged 65 or older had risen to 7 percent in 2000 from 4.4 percent in 1953, 3.6 percent in 1964, 4.9 percent in 1982, and 5.6 percent in 1990. Thus, based on UN criteria, China had already become an "aging society" in 2000. Moreover, based on estimates from findings featured in the 1% Population Sample Survey conducted in 2005, the proportion of China’s population aged 65 or older has increased to 7.69 percent. To date, China’s population age structure has shifted from a typical pyramid-shaped model dominated by a young population at the base, to an olive-shaped model featuring an increase in the elderly population and dominance of the middle-aged population.

The effect of an increase in the proportion of the elderly population, coupled with a decline in the proportion of the youth population, is a rise followed by a fall in the proportion of the working-age population. The UN predicts that China’s ratio of working-age population to total population will continue to increase until peaking at one billion in 2015 and then begin to shrink afterward. Wang Guangzhou, Professor at the Institute of Population and Labor Economics of the Chinese Academy of Social Sciences (CASS), predicts a similar pattern in structural changes to the Chinese population: The size of the working-age population will peak at 72.1 percent of the total population in 2013, and the total working-age population will climax at 997 million in 2016.

Using three possible growth rates (high growth of 10 percent, medium growth of 9 percent and low growth of 8 percent) and two employment elasticities, we can present six possible scenarios of labor demand, against labor supply (using total working-age population as the labor supply base). The high elasticity scenario equates one percentage point in growth with a 0.297 percent rise in employment (the average level during 1991 to 2003), and the low elasticity scenario equates one percentage point in growth with a 0.230 percent rise in employment (a half standard deviation lower than the former).

Using these scenarios to track growth since 2004, we discover that the net increase of new entrants to the labor market has tended to lag behind the various scenarios of increase in labor demand, and the gap will widen over time.

Although the rise in labor productivity in the agricultural sector continues to release surplus labor into other sectors of the economy, structural labor shortages in terms of region, sector and specific skills are likely to occur from time to time. Though the exodus of rural labor into cities can help bridge the gap for a considerable period of time, this trend indicates that China is increasingly likely to face labor shortages.

The second challenge is an unsustainable pension system. China’s pension system reform has experienced two phases divided by pilot experiment in Liaoning province in the period of 2001 to 2003, which aimed to solve the problems of empty individual account. In the first phase, individual account was only nominal since it was not accumulated for the future use of contributors, instead, it was used to fill up the gap between accumulated and provided pooling pension. After the Liaoning experiment individual account is supposed by the policy to be separated from the pooling fund. However, since the contribution rate is very low, it is not expected to be significant for future use. Therefore, the current pension system in China is by default a pay-as-you-go (PAYG) type.

According to international experiences, a sustainable PAYG system is conditioned on three factors. The first factor is a relatively young demographic structure, that is, a working-age population large enough to support the existing retirees. The second factor is an effective taxation system that enables the state to collect the contributions needed for the pension fund. The third factor is good governance of the fund to ensure that pension funds are correctly invested and provided. The second and third conditions do not yet exist in China, and the first condition—a working population large enough to support those who are already retired—is becoming increasingly problematic.

Therefore, it’s inevitable for this system to produce a huge deficit in order to support China’s elderly. For example, an article by Mckinsey Consulting forecasts a $110 billion deficit by 2010 [3]. As this deficit is accumulated the current PAYG system becomes all the more unsustainable. In fact, if there were no government subsidies and no chance to misappropriate the money from individual accounts by the government, the annual revenue of social pooling fund would not be enough to pay for the present pension system.

The third challenge is brought by changes to the traditional Chinese family structure. Compared to most other countries, the nominal substitution rate of social pension (the percentage of benefit as wage at the time of retirement) is unusually high in China. However, there are several factors that prevent this substitution rate from being sustainable—in the future social pension alone will be not enough to support the number of retirees. First of all, as the overall population ages, the support ratio also increases rapidly and it becomes impossible to retain the rate as high as it is today. Second, as wage rates increase, there needs to be a parallel increase in funds toward pensions in order to keep its real level unchanged. This means that in many years after people are retired, the amount of benefit received by pensioners will still be pressured to increase. Lastly, even when the transition from PAYG system to fully funded system is accomplished, given the relatively low wage rate, the accumulated pension fund from individual account will not be sufficient. Therefore, in addition to a social pension fund, a diversification of resources for senior citizen support is necessary however, as a consequence of the overall increase of income and the changes in family structure, societal values are also changing. The 2005 Population Sampling Survey conducted by the National Bureau of Statistics (NBS) shows a decline in the Chinese family size—the average number of family member was 3.13, compared to 3.44 in 2000, 3.96 in 1990 and 4.41 in 1982. Among families having one person aged at 65 and above, 16 percent were single elderly families, and among families having two persons aged 65 and above, 42 percent were families in which an old couple lives alone. Comparatively speaking, this “only-child generation” is more likely to be spoiled and self-centered—only children are sometimes referred to as “little emperor” or “little princess.” As adults, children of this generation lack inclination to support their parents.

On the other hand, by bringing up an only child, parents have also changed their expectations of being supported by their children. In a survey conducted by the Institute of Population and Labor Economics at the CASS in 2001, different age groups gave different answers to the question “are you willing to be supported by your children financially when you become old?” Of the older age groups, 70 percent replied positively, while only 63 percent of the age groups of 35-54 years old, as only-child parents, gave positive answer. This survey illustrated the trend that the younger the parents are, the less likely they expect to be supported by their child upon reaching old age.

The fourth challenge is brought by employment informalization. Since 1997, the increase in urban employment has been mainly attributed to the expansion in non-public sectors, especially the informal employment sector. While these newly emerged sectors play vital roles in absorbing native and migrant workers in urban areas, they lack incentives to participate in the social pension scheme. This disinclination results in a scarcity of pensions stemming from the private sector and thus creates even more trouble for the future.

For example, there is a difference between the proportion of the retired covered by the current social pension scheme and the proportion of working employees who have participated in the scheme, indicating that the system is unsustainable. In 1990, the coverage rate of pension system was 40.6 percent for the retired and 30.5 percent for the employed. In 1997, when the State Council set forth the unified urban pension scheme (combining social pool and individual account), the participation rates in social pension schemes was 75.6 percent for the retired and 41.7 percent for the employed. This proposal achieved only half of its intended coverage. In 2005, the participation rate in social pension of the retired increased by more than 10 percent to 85.8 percent, however, the change for the employed was a meager 6.3 percent increase to 48.0 percent. It should be noted, however, that in 2006, the pension participation rate for the employed increased up to 49.9 percent [4].

The last challenge is related to the relatively low retirement age. The low legal retirement age regulation and premature retirement greatly enhance the burden of society and families in supporting the elderly. Generally speaking, individuals can decide at what age to retire, a decision that depends on their preferences between work and leisure and between their own consumption and their children’s inheritance. Given the increasing support ratio and pension fund shortage in China, universal early retirement can further aggravate the situation.

According to a survey conducted in 2002, the average retirement age in urban labor market is 57 years old for male workers and 50 years old for female workers [5]. Meanwhile, in 2002, the life expectancy at birth is 70 years for males and 75 years for females. We can therefore estimate that men can expect to live for 13 years after retirement and women for 24 years. Assuming that the number of males and females are approximately equal, the average life expectancy at age of retirement is over 18.4 years, which is close to the average of for Economic Co-operation and Development (OECD) countries. However, by 2020, life expectancy in China will increase to 73 years for men and 79 for women, suppose the actual retirement ages remain as their present levels, life expectancies at age of retirement will be 16 years for men and 28 years for women, averaging 22.3 years and surpassing the present levels in OECD countries. By then, older dependency will be too high to bear.

The aging population is a critical factor in China’s economic development, and there are a variety of ways to achieve sustained economic growth that depends on whether or not sound choices can be made by the leaders in Beijing. First, as the demographic dividend diminishes, it is vital for the Chinese economy to sort out an alternative source of sustainable growth, which requires a transition from inputs-based growth pattern to productivity-based one. Secondly, as the demographic precondition for a PAYG pension scheme is gradually replaced by income precondition supportive of a fully-funded scheme, a transformation of PAYG to fully-funded pension scheme is urgent. Third, since the Chinese elderly still need diversified sources of support, a renaissance of Chinese family values is necessary in order to help families take advantage of intra-family transfers and provide living arrangements in order to support their elderly. Lastly, the author believes that raising the retirement age is not a sufficient condition for solving the increasing old age dependency because the trend of early retirement depends on employment opportunities. Instead, creating more jobs for all age groups through developing labor markets is a fundamental solution that has potential to alleviate China’s growth dilemma.

Notes

1. Cai Fang and Wang Meiyan (2003), “Population Aging and Pension System Reform in China”, Almanac of China’s Population, Beijing: Institute of Population and Labor Economics, Chinese Academy of Social Sciences.
2. National Bureau of Statistics (NBS), China Statistical Yearbook (2007), China Statistics Press, 2007.
3. Pitsilis, E., D. A. Von Emloh and Y. Wang (2002), “Filling China’s Pension Gap”, McKinsey Quarterly, Vol.2.
4. Calculated by the data from National Bureau of Statistics (NBS), China Statistical Yearbook (various years), China Statistics Press.
5. Cai Fang and Xin Meng (2003), “Demographic Transition, Economic Reform and Sustainability of Pension System”, Comparative Studies, No.10, Beijing: CITIC Publishing House.