China’s Decrepit Population

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Friedrich Wu

China’s government finally appears to be acknowledging the urgent challenges presented by the country’s aging population. On December 12, it released a cabinet-level White Paper on the problem – the first of its kind ­– in an effort to grapple with the prospect of rising social-security and healthcare costs, a tightening labor market, and other potential obstacles to continue rapid economic growth.

Looking back, it is ironic that the Chinese government’s draconian “one-child” policy, imposed in 1979, was implemented at the same time as the “open door” policy, aimed at capturing labor-intensive foreign manufacturing investment. While both policies must be regarded as successes, over the years the family planning program has contributed to an aging population that may diminish China’s attractiveness as a low-cost, labor-intensive manufacturing hub.

During the nearly three decades since the “one-child” policy was introduced, live births have dropped from 22.5 million per year in the early 1980’s to around 16-17 million by the middle of this decade. Moreover, with the number of elderly growing as a result of rising life expectancy, this low birth rate has pushed the share of those aged 65 and above from 4.9% of the total population to 7.7%.

According to the United Nations Population Division’s (UNPD) “medium-variant” projections, without reform of the “one-child” policy, the share of China’s population aged 15 and below would decline from 24.8% in 2000 to 15.7% in 2050, while the share of those aged 65 and above would soar from 6.8% to 23.6%. With fewer children to replenish the workforce, the working-age cohort of those 15-64 years old would shrink from 68.4% to 60.7%. The elderly would thus account for a far greater share of China’s population than in other large emerging economies, such as Brazil, India, Indonesia, and Mexico.

China’s demographic trends hold several adverse implications for its economy. With a rapidly aging population and a shrinking workforce, tax revenue will contract, while expenditure on pensions and health care will expand, undermining the fiscal position. Various estimates by private-sector economists and World Bank officials suggest that the government’s accumulated “net implicit pension debt” could balloon to 75-110% of GDP.

Furthermore, the decline in the working-age cohort would squeeze labor supply, fueling wage growth and eroding the country’s economic competitiveness. Already, in the Yangtze and Pearl River Deltas, where manufacturing activity is the densest, labor shortages have appeared. In 2004, for example, Guangdong Province had to raise the mandatory minimum wage by as much as 20% to attract workers from other regions. To hire and retain skilled workers, many foreign-invested enterprises routinely pay above the minimum wage.

But some foreign manufacturers, seeking to cap rising labor costs, are shifting production from China to cheaper destinations such as Vietnam, where average monthly wages for factory workers is $50-60 – half that of China. Foreign direct investment (FDI) in Vietnam grew by 40% in 2005, led by investors from Japan, South Korea, and Taiwan. China’s inward FDI fell 1.2% in the first seven months of 2006, after a 0.5% decline in 2005, while combined investment from Japan, South Korea, and Taiwan plummeted 31% in the first half of 2006, compared to the 6.5% decline in 2005.

These figures are only the early warnings of an emerging trend. In the long run, as labor shortages become acute, China will need to relinquish some low-end, labor-intensive manufacturing activities, which will translate into decelerating export performance and lower economic growth.

Aside from abandoning the “one-child” policy, China could avoid this outcome by climbing the value chain in manufacturing and services, as Hong Kong, Singapore, South Korea, and Taiwan have done. However, for China to succeed, higher investment in research and development, together with a fundamental overhaul of the educational system, is essential.

According to OECD estimates, China’s current expenditure on R&D amounts to only 1.3% of GDP, compared to 3.2% in Japan and an average of 2.5-2.6% in South Korea, Taiwan, and the United States. Although the government recently announced that it intends to increase R&D spending to 2% of GDP by 2010, this remains below the OECD average of 2.2%.

As for China’s backward educational system, the large number of university graduates is offset by their overall sub-standard quality. According to a recent survey by McKinsey & Company, of the more than three million graduates churned out by China’s universities and colleges every year, less than 10% are suitable for employment with international companies, owing to their deficiencies in practical training and poor English.

In view of these systemic weaknesses, China’s ability to overcome its labor deficit by shifting to an innovation- and productivity-driven economy remains dubious.

Friedrich Wu is a Senior Research Associate at the National University of Singapore’s East Asian Institute.

Copyright: Project Syndicate, 2006.
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