This article was first published in China Daily on April 11, 2024.

In just a few decades, China has undergone a remarkable transformation, evolving from an agrarian society to a global economic powerhouse. An important factor contributing to China’s ascent was the demographic dividend — a reduction in the dependency ratio that propelled rapid economic growth.

But China’s demographic profile is now transitioning from being a dividend to a drag on the economy. This shift carries profound implications for the country’s economic trajectory.

China’s journey to economic prominence was in part facilitated by a set of policies that shaped its demographic landscape. China implemented the stringent family planning policy in the 1970s. As a result, the total fertility rate (TFR) plummeted dramatically from 5.7 in 1969 to 2.7 in 1978. With the introduction of the one-child policy in 1979, the TFR fell below the replacement rate of 2.1 in the early 1990s, and further declined to 1.6-1.7 between 2000 and 2020.

The decline in the fertility rate resulted in slower population growth and a reduction in the young dependency ratio, giving rise to what economists call the “demographic dividend”. This era of favorable demographics contributed to higher savings rates, an increase in women’s participation in the labor market, and improved education and health outcomes.

From tailwinds to headwinds

However, the once-favorable demographic winds are shifting direction. China’s working-age population peaked in 2013 while its population peaked in 2021. With fertility rates plunging to 1.09 in 2022, China witnessed its first population decline in more than six decades — in actual terms, the population declined by 850,000. And the aging population is becoming a demographic burden, with the number of people aged 60 or above increasing from 14.3 percent of the total population in 2010 to 19.8 percent in 2022.

Although demographic shifts unfold gradually, once the process starts, it often becomes unstoppable. In the coming decades, the large number of post-1960s baby boomers will propel China’s rapidly aging process.

According to United Nations projections, the proportion of China’s old-age population in the total population is expected to double to 30.1 percent by 2050. This surge will increase the old dependency ratio from 20 percent in 2022 to 51 percent in 2050 and the total dependency ratio from 45 percent in 2022 to 71 percent. The UN’s baseline projection foresees a 7 percent reduction in the total population to 1.31 billion by 2050, with more pronounced declines expected in the youth and working-age populations.

The trend of declining fertility rate has persisted for the past decade despite the abandoning of the one-child policy in 2013, and further easing of the family planning policy in 2016 and 2021.

China’s TFR stood at 1.5 in 2019, nearing the threshold of the “low fertility trap”. The UN’s “medium-fertility” baseline projection envisions a modest increase in China’s fertility rate from the current trough of about 1.1 to 1.39 in 2050 and 1.44 in 2100. Such projection may look overly optimistic in light of the experience of the other ASEAN+3 economies where the already very low TFRs continue to fall.

The impact on future growth

As the population ages, overall workforce participation is expected to decline. However, the implications of an aging society extend beyond the volume of labor supply, because it has the potential to undermine productivity. The advantages of having older and more experienced workers could be counterbalanced by diminishing sharpness of knowledge and skills, and the health challenges associated with aging. Also, limited job mobility among the older workforce could impede the transfer of knowledge and technology.

Studies have consistently shown a negative correlation between the age of the workforce and overall productivity. The International Monetary Fund estimates that China’s aging workforce could curtail the country’s total factor productivity growth by 0.3 percent a year from 2020 to 2050.

An aging population also poses a challenge to investment prospects, as it could lead to a lower return on capital relative to labor, depressing corporate investment. In China, where the overall population is declining and urbanization decelerating, these demographic shifts may dampen the demand for investments in the key drivers of growth, that is, housing and infrastructure.

To better evaluate China’s future growth potential amid these demographic changes, it is important to look into the impact of demographic shifts on labor, capital and productivity.

According to the UN’s projection, China’s working-age population will decrease by 22 percent between 2022 and 2050, or at an annual rate of 0.9 percent, potentially subtracting half a percentage point annually from the GDP growth rate between 2023 and 2050. But a counteracting force to the GDP decline may emerge through strategically investing in education and health.

Population aging is expected to diminish the return on capital, thereby dampening enterprises’ incentive to invest. This, combined with the rebalancing China’s growth from investment-driven to innovation- and consumption-led development, is poised to substantially reduce the role of capital in overall economic growth compared with the past decades.

Since China still lags behind the global productivity frontier, it has substantial potential to catch up. But the shift from industry to services, coupled with the diminishing efficiency gains from market-oriented reforms, is expected to reduce China’s productivity growth.

Moreover, geopolitical tensions may exacerbate this challenge by affecting China’s economic relations with the developed world, impacting technology transfer and learning.

Our analysis indicates that China’s total factor productivity growth was about 2 percent per year in the 2010s. Factoring a modest deceleration to 1.7 percent in total factor productivity growth from 2023 to 2050, China’s potential GDP growth is projected to average 3.2 percent, indicating a gradual deceleration, that is, declining from 4.9 percent in early 2020s to 3.7 percent by 2030 and further easing to about 2.4 percent in the 2040s. That China is expected to face challenges in sustaining higher growth rates, as in the past, signals a new era for the country’s economy.

Country navigating uncharted waters

As China confronts demographic challenges and strives to sustain growth, adopting a comprehensive policy approach is imperative. Several key measures warrant consideration.

While pronatalist policies might yield modest results, initiatives to reduce housing and education costs for raising children are essential. Policymakers should consider according priority to improving economic security for young people and building social infrastructure to support child rearing.

Labor force participation can be boosted by raising the retirement age and making flexible post-retirement work arrangements for people. And policies supporting work-life balance for women will further contribute to higher labor force participation.

In order to offset the impact of a shrinking labor force on productivity, the authorities should leverage automation. Investments in research and development, along with the application of robotics, will not only enhance productivity but also bolster competitiveness.

Essential to enforce structural reforms

It is necessary to implement structural reforms including encouraging innovation, promoting market competition, reducing regulatory burdens and fostering global collaboration to sustain growth.

Addressing China’s demographic challenges requires a nuanced and strategic policy response to mitigate economic slowdowns and foster sustainable growth. Proactive measures can lay the foundation for a new era of economic prosperity, one that is intricately connected with the global economy. The stability and dynamism of the Chinese economy play a pivotal role in the global economic landscape and exert a major influence on the overall health and growth of the global economy.