Alicia Garcia Herrero
May 3010 min
China is experiencing a rapidly declining fertility rate and increased life expectancy. Most people attribute China’s structural deceleration to its demographics, but the reality is that the still-incomplete urbanization is helping to offset the negative impact of aging on growth. In fact, until 2035, China’s labor force is only projected to contract in the rural areas, while the urban labor force will continue to grow, which is much more productive than in the rural areas. This is why aging will not have a negative impact on growth until urbanization is completed, which is estimated to happen around 2035. From that year onwards, the rapid fall in labor supply will shave off 1.3 percentage points of growth each year. By then, China is likely to grow only 1 percent per year, in line with Japan’s potential growth today. Nevertheless, rapid robotization and artificial intelligence may mitigate the negative impact of aging in economic growth. Robotization has been ratcheted up in China – as well as in Japan much earlier – but neither in Japan’s case nor in China’s have we so far seen productivity increase, on the contrary.
China’s economic growth trajectory has shifted significantly, dropping from a peak growth rate of 10.6 percent in 2010 to 6.1 percent in 2019. The subsequent disruption brought about by the COVID-19 pandemic and the rather muted and continuing recovery beginning in 2023 underscores the trend of structural deceleration in the Chinese economy.
China’s rapidly aging population has been perceived to be a driver behind the slowdown in growth.[1] Our analysis, however, suggests that this is not yet the case. Demographic changes in China have not yet significantly impeded economic growth in China because of the ongoing urbanization process which is due to continue until 2035 when China’s urbanization rate reaches that of developed economies. Continued urbanization for the next decade or so implies that the labor supply will continue to grow in the productive areas of the economy, the cities, even if falling rapidly in the (unproductive) rural areas. Beyond 2035, when urbanization is completed, the fall in the labor supply will inevitably hit the cities, leading to a fall in productivity and, thereby, growth.
China has implemented a range of policy measures to address the challenges of population aging, with a focus on increasing the birth rate and adapting to the aging society. In 2016, the one-child policy was replaced with the two-child policy, and in 2021, a three-child policy was introduced to further boost the birth rate.[2] Additionally, the government has outlined plans to gradually extend the retirement age, with a 2030 long-term objective that aims to utilize the workforce more effectively through small adjustments and flexible implementation.[3]
Furthermore, China has expanded coverage of the basic pension insurance to include migrant workers and flexible employment workers,[4] and it is promoting the establishment of a multi-tier pension system.[5] Efforts to reform healthcare have centered on expanding medical insurance coverage and increasing reimbursement rates. The government has also introduced policies to enhance elderly-care services, including the establishment of community-based care systems and promotion of elderly-friendly technologies and products. While important, these measures are still not widespread, and therefore much more will be needed for China to be able to cope with the economic and social impact of aging.
The Chinese leadership is paying increasing attention to how it can mitigate the aging of the population not only through measures to increase fertility but also by the large-scale use of robots. In the 14th Five-Year Plan,[6] released by the Chinese government in 2021, development of the robotics industry is highlighted as a way to address the challenges posed by the aging population. The plan foresees that robots will powerfully assist in dealing with China’s demographic shift. Accelerated installation of robots in the manufacturing industry will serve multiple purposes, such as alleviating pressures from the shrinking labor force, contributing to the development of high-end manufacturing capabilities, and providing care for the growing elderly population. The question is, of course, what is the cost of such a massive increase in robots and what might be the consequences, especially in the short term, for the existing labor force that will still need to find jobs.
Moving to the potential effects of China’s demographic evolution on both the labor force and overall economic growth, it is important to consider that aging accounts for only about 1 percentage point of the deceleration in the GDP growth rate during the past decade, and it is expected that demographics will continue to have a limited impact in China until the mid-2030s[7] due to the ongoing urbanization process that will allow for an increase in the supply of labor in the productive urban parts of the country. However, beyond the mid-2030s, the economic effects of aging are likely to accelerate, contingent on the pace of urbanization and the growth of labor productivity. This suggests that a closer examination of other structural factors, in particular the relationship between labor supply and productivity, that are contributing to China’s economic slowdown is warranted to fully assess how aging will affect China’s growth in the short and long-run.
General Trends Among China’s Working-Age Population
In 2016, China embarked on a new demographic chapter that is characterized by a significant decline in the birth rate (Figure 1). But in fact, by 2011 China’s working-age population as a proportion of the total population was already decreasing (Figure 2).
However, the impact of this negative population trajectory on China’s economic growth has been offset by the rapid urbanization during the past two decades. As a result, the adverse effects of the aging population have been predominantly confined to the rural areas, which typically exhibit lower productivity levels, while the urban labor supply has maintained its growth trajectory. The influx of workers migrating from the rural to the urban areas significantly bolstered China’s manufacturing and services labor force, without causing an excessive surge in urban wages. This phenomenon is characteristic of the Lewis Model, which outlines how a dual urban-rural economy can bolster growth and development.[8]
Looking ahead, based on the UN World Population Prospects, the pace of aging in China is projected to accelerate over the next thirty years.[9] The fertility rate is anticipated to remain low, and the proportion of elderly individuals (65 years and older) in the population is projected to soar from 13 percent in 2021 to 30 percent in 2050, with the increase particularly prominent among females because of their longer lifespans. However, the impact on the working-age population over the next decade is unlikely to be severe because the continuing decline in the proportion of children in the population will reduce the youth dependency ratio and thus will partially buffer the aging effect. In fact, the proportion of working-age people in the population is expected to decrease only slightly, from 68 percent in 2020 to 66 percent in 2035, a contraction that is smaller than the proportion of over 3 percentage points observed from 2010 to 2020. A more significant impact is expected after 2035 when the declining fertility rate will result in a shrinking working-age population, while the adult population will continue to age. Our estimates suggest that the working-age population as a proportion of the total population will plunge from 68 percent in 2020 to 58 percent in 2050.
The Accounting Effects of Demographic Change on Labor Supply in China
Using the UN World Population Prospects, one can gauge the impact of population aging on China’s labor supply from 2020 to 2035 and from 2035 to 2050, respectively, with especial attention to the differences in the rural and the urban areas. A key assumption to be made is the speed of the urbanization rate.
The first thing to note is that China's demographic dividend reversed course from 2010 to 2020, as the drop in the fertility rate during the 1990s finally manifested as a decline in the working-age population after 2017 (Figure 1). The impact of aging is more pronounced in the rural areas due to the migration of working-age individuals from the rural to the urban regions (Figure 3). Although the elderly population (65 and older) was also migrating to the urban areas, their proportional increase in the urban areas was comparatively moderate. In essence, the urbanization process resulted in a surge in the urban labor supply because children and the elderly were less likely to migrate. In fact, despite the deceleration in the size of the growth of the total labor force, China’s urban labor force continued to grow from 2010 to 2020.
To better understand what may happen in the future, we need to make an assumption about the speed of – and also the limits to – Chinese urbanization. Figure 4 shows that China still has room for urbanization, with 62 percent of the population now living in urban areas compared to the proportion of the population living in urban areas in the developed economies (Figure 3). It remains unclear whether China will reach the urbanization level of Japan (90 percent) or of most of the European countries (80 percent) and the United States. Based on the current pace of urbanization, China may possibly reach those levels by 2035 (Figure 4).
The Impact of Population Aging on Chinese GDP Growth
If we analyze the impact of population aging by comparing the actual GDP growth rate with the counterfactual of no demographic change, we find that demographic change promoted China’s GDP growth by an annual average growth rate of 0.49 percentage point during the first decade of the 2000s. However, between 2010 and 2020 this demographic dividend became a demographic burden, with the population aging effects reducing China's GDP growth rate by an estimated one percentage point each year.
Looking to the future, we need to determine how population aging may affect economic growth. Assuming urbanization continues to be promoted (in line with the guidelines of the current Five-Year Plan [2020–2025] and also the next two five-year plans), the still-relevant increase in the urban labor supply (even if it is falling in the rural areas) should contribute about 0.4 percent per year to GDP growth. Conversely, from 2035 to 2050 the negative effects of population aging on growth will increase significantly, both because the population will age more rapidly and, most importantly, because China will probably have completed its urbanization process. Under this likely scenario, population aging – and the related depopulation – will slice off approximately 1.36 percent of GDP growth annually (Figure 5). This will result in Chinese economic growth of only 1 percent by 2035, which is quite similar to that in Japan during the last few decades.
Potential Mitigating Factors
Population trends are difficult to change, but this is not the case in terms of labor productivity. In fact, the relationship between the two has been analyzed in the economic literature without a clear conclusion. First, a dwindling labor supply might trigger wage increases, leading firms to replace labor with capital (e.g., robots). However, while it is theoretically plausible for the growth rate of investments to speed up as labor costs rise, other factors, including China’s already high debt levels, may restrict funds for further investments. Moreover, additional capital may complicate the shift from labor-intensive to capital-intensive industries by making efficient sectoral allocations more challenging, and resource misallocations might limit the potential of capital-intensive investments to counterbalance the impact of population aging. Second, the integration of robots and/or artificial intelligence might augment labor productivity. Third, a decrease in fertility rates might potentially enhance human capital, resulting in higher labor productivity arising from the trade-off between child quality and child quantity in family fertility decisions. However, this is not what the experience of Japan shows when productivity declined as the population aged. As demand for health care increases, a larger share of employment moves to services (Figure 6) that are generally less productive than manufacturing. Furthermore, policies tend to favor the elderly over the young, with larger expenditures for health care and pensions than for childcare and education, thus producing an additional negative impact on productivity.
Last, from a demand perspective population aging will also impact savings and consumption patterns. China has already signaled its intention to expand domestic consumption as a reliable source of economic growth. Changes in the expenditure structure may also impact China’s labor productivity. However, drawing on Japan’s experience, this may not necessarily be beneficial because labor productivity in the services sector may, on average, be lower than that in the manufacturing sector (Figure 7)
All in all, an increase in labor productivity may reduce the negative impact on economic growth of a falling population, and China seems to be working to bring this about (from installation of robots to innovation, more generally). The key question is whether labor productivity will indeed increase since this has not yet been shown in the data either in China or in Japan.
Conclusion
Based on current population forecasts, the overall impact of population aging on the Chinese economy will likely be negative, as one would expect, but with a very different pattern over the next 10–15 years as compared to the longer term. More specifically, the impact of population aging on China’s GDP growth during our first forecast window, 2020–2035, will be offset – and will not be negative – as long as the Chinese population continues to shift from the rural areas to the cities. In other words, the positive productivity differential in the urban areas versus that in the rural areas, and the fact that depopulation will only continue to occur in the rural areas as long as urbanization continues, will not harm growth in China. By 2035, however, China’s urbanization rate should have reached that of the developed economies, which means that the full impact of depopulation, due to a reduction in the labor force, will negatively affect GDP growth. Our estimate is that the impact will be as much as a 1.3 percent reduction in the annual growth rate, which by 2035 will equate to around 1%.[10]
Having said that, the impact of population aging on the Chinese economy also hinges on the growth of labor productivity. The relationship between population aging and labor productivity is not well established in the economic literature, especially given the rapid technological change. In fact, the transition toward more capital-intensive sectors, the increased use of robots and artificial intelligence, and improvements in human capital may help offset the overall negative impact of population aging on the Chinese economy by increasing labor productivity. Although the role of robots in China is increasing, this does not as yet seem to have had an impact of productivity. Overall, it is too early to determine how Chinese productivity will react to population aging, but so far there has not been any relevant change.
Finally, population trends adjusted for the degree of urbanization are key to understanding where the Chinese economy is heading in the long run. There are mitigating factors on the innovation side, but it is quite difficult to imagine that they will be strong enough to halt China’s rapid economic deceleration.
About the Contributor
Alicia Garcia Herrero is Senior Research Fellow at Bruegel and Chief Economist of Asia Pacific at Natixis.
Photo credit: Rickky1409, CC BY-SA 4.0 <https://creativecommons.org/licenses/by-sa/4.0>, via Wikimedia Commons