Why China Will Grow Rich Before It Grows Old


THE announcement of the relaxation of China’s one child policy created great discussion in China and internationally. But its significance was widely misunderstood. Contrary to myth, the increase in China’s labor supply plays little role in China’s rapid economic growth. In reality, 96 percent of China’s economic growth comes from factors other than a rising labor supply. Therefore, there is no reason why China’s economy should slow significantly because China’s working age population stopped growing in 2012. The mistaken view, sometimes expressed, that China will grow old before it becomes rich is therefore the reverse of the reality: China will grow rich before it grows old. To demonstrate clearly why, first the facts will be stated and then their implications analysed.

Even an elementary back of an envelope calculation shows why increases in China’s working-age population have made only a relatively small contribution to China’s economic growth. Indeed, this is so immediately clear that it is somewhat of a puzzle that the myth ever existed in some quarters that China’s growth depended essentially on increases in labor and therefore that China’s economic growth faces a serious “demographic challenge” due to no increase in the working-age population.

From the beginning of reform in 1978 up to 2012, the average annual increase in China’s population aged 15-64, the international definition of working age, was 1.7 percent. Over the same period the annual average increase in China’s GDP was 10.2 percent – almost six times as fast. The increase in China’s working-age population was therefore only 17 percent of the rate of increase of China’s GDP – showing clearly that the rate of growth of population could not possibly explain, or be the main reason for, China’s rapid economic growth.

Looking at the trends in more detail shows still more clearly that population trends did not determine China’s economic trajectory. Taking five-year moving averages for changes in working-age population and GDP to remove the effects of short-term fluctuations, China’s average annual growth of working-age population was 2.8 percent in 1983, five years after the beginning of reform. By 2000 this had fallen to 1.6 percent, and by 2012 it was only 0.6 percent. The growth of China’s working-age population was therefore consistently falling.

But China’s GDP growth showed the exact opposite trend. Annual average GDP growth was 8.1 percent in 1983, 8.6 percent by 2000, and 9.3 percent by 2012. Therefore while the growth of China’s population was falling its economy was accelerating! This shows clearly that changes in China’s labor supply were not the prime cause of its economic growth.

Making exact calculations shows the situation even more graphically. It might be naively imagined that as China’s working-age population grew at 17 percent of the rate of its GDP increase, increases in labor also accounted for 17 percent, which is under one fifth, of the increase in China’s economic growth. This contribution might seem surprisingly small to those who believe increases in working-age population were a major factor in China’s economic development, that China’s growth rate must therefore now necessarily fall sharply, and that China will “grow old before it grows rich.” But in reality even 17 percent is an exaggeration of how much increase in the labor supply contributed to China’s economic growth.

The reason for this is that the increase in the amount of time actually worked grows more slowly than the increase in the working-age population. This is because the period of time spent in education rather than work tends to increase, vacations tend to get longer, reducing the number of days worked, and other factors.

To show the effect of this, the chart shows the sources of China’s GDP growth in 1990-2010 – the latter accor-ding to the latest date for which international comparisons are available. As can be seen, 64 percent of China’s growth was due to investment increases, 30 percent to increases in productivity, and only 6 percent to increases in labor. China’s rapid economic growth was therefore overwhelmingly driven by increases in investment and increases in productivity, with increases in the labor supply playing an extremely small role. Given its growth rate, eliminating the entire increase in labor into China’s economy would have taken only half a percent from China’s GDP growth.

But even that 6 percent number slightly exaggerates the role of increases in labor supply in China’s economic growth! Increase in labor contributions to economic growth take place due to two processes. The first is a rise in the number of hours worked as the workforce gets bigger (the increase in labor quantity). The second is the improvement in skills and education – a skilled worker creates more value than an unskilled one (the increase in labor quality).

The increase in China’s labor quality is 2 percent per year, in line with the average for developing countries. This affords a modest scope to increase with higher expenditure on education and skills – the average increase in labor quality in a developed economy is 3 percent a year. Only 4 percent of China’s GDP growth comes from increases in the quantity of labor, which are affected by demographics.

In short, increases in China’s labor supply, due to expansion of the working-age population, accounted for only 4 percent of China’s total GDP growth – less than half a percentage point of annual GDP growth!

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