Abstract: As a result of the shrinking working age population (aged 15 to 59 years), all factors that have driven China’s rapid economic growth over the past 30 years tend to diminish from 2010. The present paper estimates the average annual growth rate of potential output to be 7.2 percent over the 12th Five-year Plan period and 6.1 percent over the 13th Five-year Plan period. Future sustainable growth requires furthering economic reform in related areas to enhance potential growth. This paper simulates two scenarios in which both an increase in labor force participation and improvement in total factor productivity can significantly enhance the potential GDP growth rate. Relevant policy implications are discussed.
Key words: labor force participation, population change, potential GDP growth rate, total factor productivity
I. Introduction
The unprecedented economic growth in China over the past 30 years can be attributed largely to the demographic dividend. That is, growth of the working age population guarantees an adequate supply of labor; a decline in the dependence ratio (the ratio of the dependent population to the working age population) helps to maintain a high savings rate, which is the condition for capital formation; and an unlimited supply of labor prevents return on capital from diminishing, which allows heavy investment to be the main source of GDP growth (Cai and Zhao, 2012).
As is well documented in the economics literature (e.g. Bloom and Williamson, 1998; Williamson, 1998), the demographic dividend is not derived from population size or the growth rate of the population, but from a specific feature of the population age structure. Simply put, an increase in the proportion of the working age population in the total population and a decline in the dependence ratio provide a country an opportunity to situate themselves so that a high savings rate, heavy investment and rapid economic growth can be obtained; the country thus benefits from the demographic dividend. Over the period of fast growth, few would consider the population age structure as a constraint of economic growth in China.
However, the population age structure is ever-changing. As a result of population aging, the working age population stops growing and the dependence ratio no longer decreases; eventually, the demographic dividend will cease to exist. Labor shortage, diminishing return on capital and a decline in the savings rate will lead to a slowdown in economic growth. This is what has occurred in China in recent years, particularly since 2004.
The potential GDP growth rate is determined by supply-side factors, including labor, capital and total factor productivity (TFP). In a growth accounting equation, holding constant the labor force participation rate and the natural unemployment rate (i.e. the non-accelerated inflation rate of unemployment (NAIRU)), a reduction in the working age population will directly reduce the potential GDP growth rate. In addition, the reduced supply of labor, which causes diminishing returns to capital, and the increase in the dependence ratio, which causes a decline in the savings rate, do not support the fast growth of capital formation. Therefore, holding the other factors constant, a reversal of the growth trend of the working age population in China will inevitably slow its economic growth.
In fact, the process of demographic transition has taken place in China much more rapidly than anyone could have expected, and the number of people from ages 15 to 59 years has already decreased. Based on the data of the 6th National Census, the China Development Research Foundation (CDRF, 2012) predicts the trend of the population age structure to change, and show that the working age population, when assumed to be aged 15 to 59 years, started to decline in size in 2011, while the population dependence ratio calculated based on the working age population (aged between 15 and 59 years) began shrinking in the same year. This trend will not be reversed even if there is a moderate relaxation of the one-child policy. Given that the population factor has had such far-reaching impacts on the determinants of China’s economic growth, including labor supply, the savings rate, the marginal return on capital and total factor productivity, such a change in the population age structure is bound to reduce the potential GDP growth rate in China.
Based on the latest population data, the present paper simulates a decline in the average potential GDP growth rate from 9.8 percent over the period from 1995 to 2009 to 7.2 percent during the 12th Five-year Plan period (2011–2015) and 6.1 percent over the 13th Five-year Plan period (2016–2020). Therefore, determining how to sustain economic growth is an important challenge facing China. In light of the properties of the potential growth rate and the experiences of China and the rest of the world, we make the following two suggestions.
First, the government should not seek an actual growth rate exceeding the potential growth rate. Because the potential growth rate is fixed by assuming full employment of existing factors of production, artificial stimulus aimed at lifting the actual economic growth rate above the potential rate would have unhealthy consequences. For example, frequently implemented stimulus plans could cause inflation; overactive industrial policies might result in overcapacity by inappropriately protecting inefficient enterprises and backward production capacity; and regional and industrial policies using heavy subsidies could lead to distortion of prices of production factors, and affect regional industrial structure by impacting comparative advantage.
Second, the potential growth rate can be enhanced through the application of measures to enlarge the supply of labor and capital, and to improve productivity. This requires deepening reforms in various areas, such as the household registration system reform and institutional reform. That is, economic reform is the key to sustaining China’s economic growth. Kharas (2011) points out that it would take 10 years or more for China to see any obvious effects of such reforms, which implies that the Chinese Government should waste no time in initiating urgent reforms, while being ready to accept lower growth rates. However, there exist reform opportunities that could enhance China’s potential growth rate fairly swiftly, which we discuss in the present paper.
While suggesting the slowdown of the potential rate of China’s future economic growth in accordance with the trend of population structure changes, the present paper recommends that policy measures to stimulate economic growth so that it exceeds the potential growth rate should not be taken. Instead, two scenarios are simulated and the results suggest that an increase in the labor force participation rate and improvements in TFP can significantly expand the potential growth rate in the future……
( in China & World Economy ,Vol. 21, Issue 2, pp. 1-14, 2013 )
