The Implications of Family Planning Policies on Economic Growth in the People s Republic of China

Transcription

1 The Implications of Family Planning Policies on Economic Growth in the People s Republic of China Bachelor s Thesis Supervised by the Tilburg School of Economics and Management Prof. Dr. H.P. van Dalen Author :Joost Antonius Kamphuis ANR : Date :June 1st, 2012 Wordcount :7532 1

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3 Abstract This BSc thesis aims to provide an overview of the consequences the People s Republic of China s family planning policies have had since the implementation in the 1970 s. The economic impact of falling fertility rates will be studied in the theoretical framework of the Solow Model. Moreover, existing literature will be reviewed to identify the impact falling fertility rates, and the so called demographic transition, have had during the period of opening up in the People s Republic of China. Furthermore, the family planning policies will be linked to population ageing. Finally, policy options for the People s Republic of China s government to respond to the phenomenon of population ageing will be proposed. Keywords: Economic Growth, Demographic Transition, Population Ageing, Population Growth, Human Capital. 3

4 Table of Contents List of Figures 6 Chapter 1: Introduction Background and Relevance of the Topic Research Design and Questions Thesis Structure 8 Chapter 2: Demographic Trends over the Past Decades The Demographic and Fertility Transition Driving Forces of the Demographic Transition Fertility Rates in the People s Republic of China The Ageing Population Structure of the People s Republic of China The Life Expectancy in the People s Republic of China Age Structure of the People s Republic of China Conclusion 18 Chapter 3: The Impact of Declining Population Growth in a Theoretical Framework The Basic Solow Model The Solow Model with Population Growth Theoretical Analysis of the Solow Model Conclusion 23 Chapter 4: Consequences of Population Ageing in the People s Republic of China Ratio of Working-Age Population to Non-Working-Age Population How does Population Ageing, Resulting from the Lower Fertility Rates, Affect Economic Growth in the People s Republic of China? Labour Supply Savings Human Capital Population Ageing in the People s Republic of China: Curse or Blessing? Conclusion 34 4

5 Chapter 5: How Can China Respond to the Consequences of its Lower Fertility Rates Increase Current Working-Age Population Migration and Free Labour Mobility Retirement Reforms Affect the Fertility Rates Alleviating the Family Planning Policies Increase the Productivity of Labour Increased Investments in Human Capital The Twelfth Five Year Plan Conclusion...41 Concluding Remarks...42 List of References

6 List of Figures 2.1 The Model of Demographic Transition over Time Total Fertility Rate Developments in the People s Republic of China, Life Expectancy at Birth in the People s Republic of China, Fraction of Elderly in the People s Republic of China, Median Age Level in the People s Republic of China, The Solow Model Incorporating a Decline in Population Growth Ratio of Working-Age-Population to Non-Working-Age Population in the People s Republic of China Average Pattern of Life-Cycle Income and Consumption Total Dependency Ratio and Number of Young and Elderly Dependents in the People s Republic of China, Age-Sex Structure of the Population of the People s Republic of China,

7 Chapter 1: Introduction 1.1 Background & Relevance of the Topic The phenomenon of the Chinese economic miracle is a widely discussed and documented topic. The People s Republic of China has experienced an enormous transition from a developing country after the end of World War II towards an upper middle income economic giant nowadays. Annual GDP growth rates in China have been over 8 percent, on average, over the period of The abundance of cheap and young labour has been one of the key factors in the People s Republic of China s engine to growth. This supply of cheap labour is, however, forecasted to fall in the near future because the People s Republic of China s economic development has been accompanied by a rapid demographic transition fuelled by government policies. As a result, the People s Republic of China s population is ageing rather rapidly compared to the populations in other countries at its stage of development. The impact of the government policies and its consequences will be the focus of this bachelor thesis. 1.2 Research Design and Questions This BSc thesis aims to analyze the economic impact of the family planning policies introduced in the People s Republic of China by conducting literature review. Distinction will be made between the impact these policies have had so far, and their future impact. The central research question is formulated as follows: What Are the Economic Consequences of the People s Republic of China s Family Planning Policies? 7

8 1.3 Thesis Structure This BSc thesis is structured as follows. Chapter two will identify the demographic trends that the People s Republic of China has experienced over time. Moreover, this chapter will introduce the context of decreasing fertility rates which has had a significant impact on the demographic transition. Chapter three will provide a framework in which the theoretical impact of lower fertility rates can be studied. Chapter four will discuss the consequences of the family planning policies, and chapter five will consider how the People s Republic of China can respond to these consequences. 8

9 Chapter 2: Demographic Trends over the Past Decades The People s Republic of China (PRC) was proclaimed by the Chinese Communist Party on October 1 st of 1949, and has experienced a rapid economic and demographic transition over the past decades. In this second chapter the demographic trends that have occurred in the People s Republic of China over the last decades will be sketched, and the phenomenon labelled as demographic transition will be discussed. This demographic transition is believed to be significantly accelerated by the People s Republic of China s Family Planning Policies. The People s Republic of China s wan xi shao ( later, longer, fewer ) campaign during the early 1970 s, and the introduction of it s one-child policy in 1979 were meant to reduce the growth of the Chinese population. Croll et al (1985) argue that the PRC s Communist Party, at that time, believed that the goals of any development strategy in China were bound to fail, unless the number of people to be fed, housed and clothed was reduced. In this second chapter the demographic trends that have occurred in the People s Republic of China over the last couple of decades will be sketched, and the phenomenon labelled as Demographic Transition will be discussed. 2.1 The Demographic and Fertility Transition The Demographic Transition model explains the process of a country starting with high death and birth rates in its early stage of economic development moving towards low death and birth rates during later stages of development. This transition, and its impact on countries and their populations, has been widely studied. 9

10 Figure 2.1: The Model of Demographic Transition over Time Source: Bloom, Canning, and Sevilla (2003): The Demographic Dividend Note: Some adjustments have been made to figure 2.5 of their paper. The demographic transition from high death and birth rates over multiple stages towards the final stage in which both birth and death rates are low can be graphically represented (see Figure 2.1). These four different stages are characterized by changing patterns of the death and birth rates. Stage 1 depicts the situation with high birth and death rates and this situation has been the case throughout the biggest part of human history. During stage 2 and 3 it can be seen that death rates start to fall because of, for example, health care improvements in the case of infectious diseases. These innovations cause population to increase because birth rates remain constant during stage 2. However, during stage 3, birth rates do start decreasing while death rates continue to drop. Finally, stage 4 displays the 10

11 case of contemporary developed countries where birth and death rates are again close to each other, however, at low levels. 1 Although this model is based on the experiences by western European countries, it can contribute to the understanding of overall patterns of population growth in all parts of the world including the People s Republic of China Driving Forces of the Demographic Transition In this section some of these factors that have been identified over the last decades, will be examined. The factors that play a role in the demographic transition and contribute to the decreasing birth and death rates are diverse and consist of both micro and macro-level factors according to Grant et al (2004). The micro-level factors are: women s increased level of participation in labour markets and corresponding income, women s choices to pursue higher education, and decisions on marriage, family structures and childbearing in general. Hirschman (1994) also mentioned contraceptives used by married couples and the increase in available effective information on the means of how to control fertility as contributing factors. Whereas Becker (1960) argued that the drop in fertility was a consequence of increased levels per capita income, resulting in increased opportunity costs of the time parents spent on raising their children. These parents did experience positive income effects; however, this positive effect was dominated by the negative substitution effect according to Becker. Furthermore, Becker argued that the income elasticity with respect to child quantity is lower than the income elasticity 1 Kevin McCarthy, RAND Corporation World Population Shifts: Boom or Doom? 11

12 of parents with respect to child quality, resulting in decreasing fertility and increased investment in each child. Becker s theory is not supported by facts according to Galor (2004, 2010), who underpinned his criticism with research by Maddison (2001), Clark (2003) and Fernandez-Vilaverde (2004). Galor comes up with several factors with proclaimed impact on the demographic transition. Firstly, he labels the increased demand for human capital over the course of economic development and investment in education as dominating forces and main triggers in the decrease in fertility. Furthermore, Galor identified several reinforcing mechanisms that caused fertility to decline; among these are the decline in child labour and the increased life expectancy. This increasing trend in the life expectancy, together with the declining fertility rates discussed in the upcoming section 2.2, will be discussed jointly in Section Fertility Rates in the People s Republic of China Data on fertility rates are provided by multiple organisations, most notably the United Nations Population Division and the Chinese National Bureau of Statistics, although obtaining free reliable annual data was rather challenging. The World Bank, however, did have annual data on fertility rates and these are shown in Figure 2. 12

13 Fertility Rate Figure 2.2: Total Fertility Rate Developments in the People s Republic of China, Year Source: Created by author with World Bank data The fertility rate peaked in 1966, according to the World Bank data, at a level of 5,914 children per woman in the People s Republic of China. After the introduction of the family planning policies this fertility rate declined steadily to a level of 3,439 in 1976, and in 1986 an even lower rate of total fertility equal to 2,629 was reached. A clear downward sloping trend is apparent (see Figure 2.2) from the start of the 1970 s, and this coincides with the start of the ''later, longer, fewer'' campaign in the early 1970's. This campaign was aiming to achieve later marriage, later age of woman at first birth, fewer births, and longer inter-birth intervals (Banister et al (2010)). 2 The People s Republic of China s one-child policy was achieved with the help of administrative and economic incentives for one-child families, and, at the same time, penalties for 2 Banister, Bloom, and Rosenberg, Program on the Global Demography of Aging Population Aging and Economic Growth in China. 13

14 couples with out-of-plan births and people who failed to meet family planning quotas. 3 The decline continues after the formal introduction of the People s Republic of China s one-child policy in 1979, although with a period of increasing fertility rates in the mid 1980 s. This period of increasing fertility rates in the mid 1980 s can be attributed to the alleviation of some specifics of the family planning policies, according to Merli and Smith (2002). However, the family planning policies were quickly tightened again after China experienced increasing fertility rates in the mid 1980 s. 4 Fertility rates have been steadily decreasing again after the mid 1980 s, as can be seen in Figure 2.2. The declining trend in fertility rates, as mentioned before, continued during the 1990 s and the first decade of the twenty-first century. The last available data at the World Bank, from the year 2010, reports a fertility rate level of 1,598 which is significantly below the replacement level equal to 2,1. All in all, it can be concluded that fertility rates have decreased drastically over the course of the last decades. China s 2010 rate of 1,598 is almost four units lower than its peaking level, over the World Bank data period , of 5,914 in Fertility rates will continue to be of importance for China s economic performance and its future role will be discussed in chapter five. In section 2.3 the ageing population structure of the People s Republic of China will be discussed. 3 Merli and Smith Has the Chinese Family Planning Policy Been Succesful in Changing Fertility Preferences? Demography 39: Hardee-Cleveland, K. and J. Banister "Fertility Policy and Implementation in China, " Population and Development Review 14:

15 2.3 The Ageing Population Structure of the People s Republic of China The ageing of the population in a country can be captured and described by a number of variables. This section will consider the median age, life expectancy, and the age structure of the People s Republic of China because these factors can be helpful in sketching the process of population ageing The Life Expectancy in the People s Republic of China The life expectancy, together with the fertility rate, has an influence on the fraction of elderly relative to the rest of the population of China, and these consequences will be discussed in chapter four. The life expectancy of the population in the People s Republic of China has been increasing rapidly and continuously since the beginning of the 1960 s (see Figure 2.3). The life expectancy of a child born in 2010 is 73 years, whereas this was only 46 years for a child born in 1963 according to data by the World Bank. This can be partly explained, among other factors, by higher levels of income per capita resulting from economic growth, and health care improvements resulting in lower child mortality rates over time. 15

16 Life Expectancy at Birth, years Figure 2.3: Life Expectancy at Birth in the People s Republic of China, Year Source: Created by author with World Bank data Age Structure of the People s Republic of China Over the same period, the fraction of elderly, people aged 65 and above, as part of the total population has been steadily increasing (see Figure 2.4). The combination of a downward trend in fertility and the upward trend in longevity, as can be seen in Figure 2.3, is expected to increase the share of elderly significantly over the next forty years (to around 30 percent in 2050) according to a 2009 forecast by the United Nations. 16

17 Age Percent Figure 2.4: Fraction of Elderly in the People s Republic of China, Year Source: Created by author with World Bank data The increasing median age is a consequence of the family planning policies in the early 1970 s (see Figure 2.5), and it shows the direct link between falling fertility rates and resulting increasing median age level. This effect is labelled as population momentum by Banister et al (2010). Figure 2.5: Median Age Level in the People s Republic of China, Year Source: Created by author with United Nations (2009) data 17

18 2.4 Conclusion Chapter two provides an overview of the demographic transition that the People s Republic of China has experienced. Moreover, the impact of the decreasing population growth, as a result of the family planning policies, has been identified in the data. The total fertility rate has dropped significantly since the introduction of the family planning policies, and the fraction of elderly Chinese people has been rising as a result of increased longevity and the lower fertility rate. Chapter three will provide a theoretical analysis of the impact of a permanent drop in fertility rates in the People s Republic of China. 18

19 Chapter 3: The Impact of Declining Population Growth in a Theoretical Framework Population has a twofold impact on economic growth as said by the old saying with every mouth God sends a pair of hands. Population growth affects both the productive capacity and the consumption needs of an economy. This thesis aims to analyze the consequences of the permanent declining trend in the population growth of the People s Republic of China on its economy. This chapter will discuss the impact in a theoretical framework, using the basic Solow Model named after Robert Merton Solow, the Nobel Prize-winning economist. Use is made of this specific model because of its ability to analyze the economic effects, of a fall in the population growth rate, in a clear matter. The Solow model is a simple model with strong assumptions that uses a Cobb-Douglas production function with a focus on one single factor; the amount of capital per worker which affects the level of income per capita. 3.1 The Basic Solow Model The Solow model relates to the accumulation of capital per worker, this level is affected by two factors in the basic form of the model: depreciation of capital and the investment in the capital stock. Depreciation negatively affects the level of capital per worker available due to the result of the wear and tear of old capital. Investment, on the other hand, has a positive impact on the level of capital per worker as it causes the amount of capital to rise The Solow Model with Population Growth Besides these two factors, the growth rate of the population also interacts with the amount of capital per worker. A 19

20 positive level of population growth, other things being equal, would result in a lower level of capital available per worker. Moreover, this would then cause the output produced per worker to drop. The negative relation between positive population growth and the drop in capital per worker is labelled as capital dilution. A country with a high level of population growth needs to invest a high fraction of output in new capital to keep the level of capital per worker constant because of the capital dilution. The effect of depreciation, population growth, and investment on the accumulation of capital will be discussed theoretically in section Theoretical Analysis of the Solow Model This section will make use of a Cobb-Douglas production function with input factors capital (K) and labour (L), and including a parameter for the level of productivity (A): (1) The parameter α in the production function measures the share of capital in National Income. The analysis starts with rewriting the Cobb-Douglas production function in per-worker terms, dividing the equation (1) by L. (2) Due to the fact that the labour term in the per-worker production function does not change, output per worker can be written as a function of capital per-worker. Firstly, the focus will be on the basic capital accumulation process in per-worker terms without taking population growth into account. Assuming a constant fraction, δ, of the existing capital stock per worker to depreciate every period, the 20

21 assumption is also made that a constant fraction, γ, of output per worker is invested in capital every period. This leads to a function for the change of the amount of capital per worker in a period, influenced by both investment and depreciation: Secondly, this basic function of the accumulation of capital per worker can be extended by adding the negative effect of population growth on capital per worker to equation (3). This capital dilution works in the exact same way as depreciation. Labour force growth is assumed to be equal to the level of population growth and is measured by n: 5 Parameter n is affected both by fertility and mortality rates. Throughout the theoretical analysis in this thesis, however, the assumption is made that the mortality rates are constant, and that parameter n is, therefore, only affected by fertility rates. This assumption is justified when the analysis on the economic impact of a drop in population growth is done in the last two stages of the demographic transition where the mortality rates are already believed to be close to constant, as can be seen in Figure 2.1. The capital stock per-worker increases if the level of investment is larger than the combined negative effect of depreciation and capital dilution. On the other hand, the stock of capital per-worker will drop if the level of investment falls short by the combined effect of depreciation and population growth. A steady-state stock of capital per-worker will be reached if the capital stock does not change, in other words; if equation 5 The assumptions and dynamics of the Solow model analyzed here are discussed more thoroughly in the Economic Growth textbook by David Weil (2009). (3) (4) 21

22 (4) equals zero. This would imply that the investment in the capital stock has to be equal to the combined negative effect of depreciation and population growth on the capital stock per-worker: (5) Rewriting equation (5) leads to the steady-state stock of capital per-worker, : (6) Substituting this steady-state stock of capital per worker into equation (2) will yield the steady-state level of output per worker, : (7) Thirdly, the impact of population growth on income per worker in a country within the Solow model will be discussed. Population growth affects the steady-state level of income per capita negatively (see equation (7)). A lower population growth rate, measured by n, causes the (δ + n) term to decline and therefore causes the income per-worker in the steadystate,, to increase. The drop in the population growth rates, resulting from the drop in fertility rates, in the People s Republic of China should have had a positive effect on income per capita because of less capital dilution. The impact of population growth on the steady-state income per capita level in the Solow model can also be seen in figure 3.1 Determining the steady-state levels of capital and output perworker can also be done in a figure. In Figure 3.1, the steady-state capital stock per-worker is found at the point 22

23 where the investment curve and the line representing depreciation and population growth intersect: Figure 3.1: The Solow Model Incorporating a Decline in Population Growth Source: Created by author, based on Solow model. Figure 3.1 shows that the line representing the depreciation and capital dilution effect rotates outward if the level of n drops from, where. This causes the steady-state level of output per-worker to increase as a result of a higher steady-state capital stock per-worker. 3.3 Conclusion The theoretical analysis in this chapter provides an explanation why the People s Republic of China s government introduced its strict family planning policies. With the use of Solow model s theoretical framework it can be argued, that the permanent drop in fertility rates, while assuming mortality rates to be constant, has caused the capital stock per worker to increase and hence lead to higher levels of 23

24 income per capita during the last stages of the People s Republic of China s demographic transition. Chapter four will discuss the consequences of the rapid demographic transition with a special focus on the economics of population ageing. 24

25 Chapter 4: Consequences of Population Ageing in the People s Republic of China Will the People s Republic of China grow old before it grows rich? This is one of the questions often raised when discussing the periods of opening up, economic growth and population ageing experienced by the People s Republic of China since the 1970 s. The Demographic Transition phenomenon, discussed in chapters two and three, affects the process of population ageing in the Peoples Republic of China. A population is typically, by definition, ageing if it is experiencing an increase in the share of elderly people. As demonstrated in chapter three, the share of old-age people as part of the total population in the People s Republic of China is increasing. Therefore, the claim that the Chinese population is ageing can be justified, as is the case in nearly all countries according to Banister et al (2010). Factors with a significant influence on the ageing of a population are the decline in fertility rate levels, and the increase in life expectancy; these have been identified in chapter two. This chapter will indentify the consequences of the demographic transition on ageing and economic growth in the People s Republic of China, and discuss the concerns for labour shortage in the People s Republic of China. 4.1 Ratio of Working-Age Population to Non-Working-Age Population The non-working-age population consists of young and elderly people, who are presumed to be too young, or too old to support themselves through labour market activities. Therefore, these people are of dependent age and need to be supported by others. Trends in both fertility and the life expectancy have resulted in an increasing share of the elderly population of the 25

26 People s Republic of China s population as sketched in chapter two. The ratio of people in their working age to people in their non-working age has been increasing rapidly since the introduction of the Family Planning Policies in the 1970s to a peak level in 2010 (see Figure 8). Figure 4.1: Ratio of Working-Age-Population to Non-Working-Age Population in the People s Republic of China Source: Banister, Bloom, and Rosenberg. Population Aging and Economic Growth in China This ratio is of importance because it can indicate directly the number of dependents a person of working-age needs to support in the People s Republic of China, on average. Around the year 2010 it can be seen that for every non-working-age person there were 2.5 people in their working-age. Both RAND and the United Nations, however, have forecasted this ratio will decline after 2011 because of the significantly increasing rate of elderly people in the People s Republic of China as a consequence of the family planning policies. This would lead to increasing dependency ratios, equal to the inverse of the working-age / non-working-age ratio, as the fraction of dependent people in the total population 26

27 increases. A report by RAND 6 forecasts the number of dependent elderly to increase rapidly and significantly over the next twenty five years, surpassing the youth dependent ratio by Population ageing matters because of the mismatch over time of a person s productivity and a person s consumption profile. When people are still young they produce less than they consume, this period typically lasts until people finish their education. Then when people start working during their prime working years their production exceeds their consumption, and people are able to save part of their income. However, then again after people retire they consume, on average, more than they produce (see Figure 4.2). Figure 4.2: Average Pattern of Life-Cycle Income and Consumption Source: Bloom, Canning, and Finlay (2003): The Demographic Dividend. The drop in the growth rate of population has caused a decline in young dependency rates. Moreover, the combined effect of declining population growth and increased longevity has caused the number of dependent elderly to increase significantly. The 6 Wolf et al (2011), RAND Corporation. China and India, 2025: A Comparative Assessment. 27

28 total dependency ratio is forecasted to increase rapidly and significantly between 2012 and 2035 due to continuing increases in the number of elderly dependents while the number of young dependents remains relatively constant(see Figure 4.3). This continuing increase in the fraction of elderly people in the total population leads to a significant change in the People s Republic of China s age-structures over the period 2000 and 2035 (see Figure 4.4). Figure 4.3: Total Dependency Ratio and Number of Young and Elderly Dependents in the People s Republic of China, Source: Wolf et al (2011), RAND Corporation. China and India, 2025 Note: This Figure has been created by combining two graphs from the original paper. The scale for number of young and elderly dependents is on the right vertical axe, and the scale for the total dependency ratio is on the left vertical axe. 28

29 Figure 4.4: Age-Sex Structure of the Population of the People s Republic of China, Source: Wolf et al (2011), RAND Corporation. China and India, 2025 Note: Adjusted by author using figure 2.8 of the paper by Wolf et al. Although elderly, on average, need support from society after retirement they can still contribute in many ways, including economically, to a family and to the People s Republic of China s overall economy as opposed to young dependents. Many economists have expressed their concerns on the People s Republic of China s working-age population s future ability to support the increasing elderly dependent population according to Banister et al (2010). The impact of the demographic transition and population ageing on economic growth in the People s Republic of China will be discussed in section

30 4.2 How does Population Ageing, Resulting from the Lower Fertility Rates, Affect Economic Growth in the People s Republic of China? Global population ageing has been the cause of widespread concerns on the potential impact of population ageing on economic growth, and countries abilities to provide sufficient support for their elderly population. Peter Peterson s argument that global population ageing is a threat more grave and certain than those posed by chemical weapons, nuclear proliferation, or ethnic strife represents one of the most severe concerns for population ageing and might be slightly exaggerated. This section will analyze how the People s Republic of China s economic growth has been, and will be, affected by its demographic transition. The changes in population growth rates, influenced by the family planning policies, caused the People s Republic of China s age structure to change drastically (see figure 2.4). Shortly after the introduction of the family planning policies, the People s Republic of China could benefit from the relatively higher fraction of working-age people that emerged over time resulting in a large labour pool. These individuals in their working-age needed to spend less money on the care and nurturing of children as compared to earlier generations and could as a result save higher fractions of their income. Furthermore, because working-age individuals save, on average, more than individuals in other age groups, and because of the increasing need to save for retirement as longevity increased in the People s Republic of China. The economic boom experienced by the People s Republic of China with astonishing growth rates since the 1970s can be partly explained by the demographic transition which the country has experienced. The increasing share of working-age people in the People s Republic of China and reduced spending 30

31 on dependents resulting in accelerated capital accumulation provided the People s Republic of China with the opportunity to reap a demographic dividend. Bloom et al (2003) identify three mechanisms through which the demographic dividend can be achieved; labour supply, human capital, and savings. Each of these channels will be discussed in brief Labour Supply The demographic transition has a twofold impact on the labour supply in the People s Republic of China. Firstly, as mentioned before, the increasing ratio of working-age people can lead to higher levels of per capita production, and the ratio of working-age people to non-working-age people increases at the same time (see Figure 4.1). Secondly, because of the decrease in family sizes, women are more likely to be educated and participate in the labour market. This leads to a stronger, more productive workforce of labour. The extent to which the Chinese economy benefits, depends on the ability of its labour market to absorb this increased supply of labour. The opening up of the Chinese economy has caused demand for productive labour to increase rapidly Savings Savings are affected by the demographic transition because the increased share of working-age people saves more, as discussed before. Moreover, incentives to save for retirement, to maintain a constant level of consumption after retiring, have gained importance because of the reduced family size and improved health standards. 31

32 4.2.3 Human Capital Investments in human capital, lastly, are significantly affected by the demographic transition. Bloom et al (2003) argue that the longer life expectancy resulting from the demographic transition causes people to change their way of life fundamentally. People s attitudes towards education, the role of women, retirement, and work all tend to change. The decreasing number of children and increasing life expectancy induces parents to invest more in their children s education and devote more time to each child. This causes the labour force as a whole to become more productive, which will lead to a promotion of higher wages and an improved standard of living. In conclusion, the demographic transition with an increasing share of working-age people can lead to a opportunity to reap a demographic dividend as a result of higher savings and people investing heavily in their children s and their own education and health, providing great economic benefits. According to Bloom et al (2009), the increase in the proportion of working-age people together with the increase in productivity did contribute significantly to the People s Republic of China s economic growth between 1980 and An important question to address, however, is: whether the People s Republic of China should be worried for its economic growth in the future, as the period of demographic dividend is over and population ageing is expected to rise significantly? An economy s performance depends on the availability and productive functioning of labour and capital, among other factors that are not central in the discussion of ageing and economic growth according to Banister et al (2010). Figure 4.1 showed that the future working-age to non-working-age people is forecasted to drop sharply over the next decades as a 32

33 result of the low fertility rates and increased longevity. Savings rates are likely to follow the decreasing trend, because people tend to be saving especially during their working-age period of life (see Figure 4.2); this would have an adverse impact on economic growth as there are lower savings available for investment in the future constraining capital accumulation Population Ageing in the People s Republic of China: Curse or Blessing? The question whether the People s Republic China should fear population ageing can be answered in multiple ways. Firstly, OECD reports argue that population ageing might lead to a decrease in the labour force and, because the number of dependents rises, causes fiscal problems for governments. Secondly, the Wolf et al (2011)RAND report argues that a correct anticipation of population ageing might foster incentives to increase human capital and savings which would lead to a second dividend. Thirdly, Bloom et al (2010) conduct empirical research on the impact of the share of elderly people in a population on economic growth and find negative short run effects but no significant long run effects, either negative or positive, of population ageing on economic growth. The paper by Bloom et al (2010) distinguishes between young dependents and elderly dependents and argues that an increase in the share of elderly dependent people has less adverse effects than an increase in the number of youth dependents would have had, because elderly tend to remain beneficial in families and to society. There are, nonetheless, concerns for a shortage of labour in parts of the People s Republic of China resulting from the 33

34 population ageing caused by the drop in fertility rates. Cai and Wang (2006), who identify the People s Republic of China s demographic transition as the world s largest and unique because of the impact of its family planning policies, argue that labour shortage will be an inevitable result of its demographic transition. They reason that structural labour shortages are likely to occur from time to time and that these labour shortages will deteriorate the People s Republic of China s comparative advantage in labour-intensive industries because a rise in wages is needed to eliminate these labour shortages. Labour shortages have been identified as early as 2003 in the Pearl River Delta, and expanded to the Yangtze River Delta and central provinces such as Anhui, Jiangxi and Henan. These concerns for a scenario in which the People s Republic of China would face labour shortage resulting from population ageing are opposed by Banister et al (2010). They come up with numerous reasons why the People s Republic of China s economic growth might not be adversely affected by labour shortages, namely: the People s Republic of China has a reserve army of unemployed, Chinese labour force participation rates may actually raise, and immigration in the People s Republic of China might increase. This reserve army of unemployed consists of individuals who are not counted as being part of the labour force but would accept a job if acceptable job opportunities would arise, according to Banister et al (2010). The effectiveness of these factors, that could potentially offset the labour shortage problem, is hard to attain at this moment. 4.3 Conclusion All in all, it seems justified to conclude that the views of economists on the impact of population ageing, resulting from the demographic transition, on economic growth in the People s 34

35 Republic of China are contradictory. And, therefore, further research on the economic impact of population ageing might be helpful to solve these disputes. Chapter five will discuss how the People s Republic of China can respond to the demographic transition and introduce policy options that could alleviate the problem of population ageing caused by the low fertility rates, under the assumption that population ageing does have an adverse impact on economic growth and thus ignoring the arguments by Banister et al that there are no effects. This assumption is made because in the absence of this assumption it would not be relevant to discuss the issue on how the People s Republic of China can respond. 35

36 Chapter 5: How Can China Respond to the Consequences of its Lower Fertility Rates? The People s Republic of China s demographic transition has certainly been unique both because of its size and rapidness; where in most developed countries the transition takes a century to complete, the People s Republic of China s demographic transition has been completed in around forty years. The expansion of China s labour force resulting from the demographic transition has been an important source of economic growth during the era of the People s Republic of China s opening up as discussed in chapter four. In the absence of any policy changes, the People s Republic of China will experience rapid population ageing which will have possible adverse effects on economic growth. This final chapter will discuss the issue on how the People s Republic of China can respond to this emerging population ageing problem resulting from its rapid demographic transition. This chapter will identify three different channels through which the Chinese government can limit the economic consequences of population ageing, include: implementing policies which will cause the current working-age population to increase; implementing policies which will have an impact on fertility; and investing in a more productive workforce of labour. Finally, in section 5.4, the People s Republic of China s current Five Year Plan will be discussed in order to investigate whether the policies listed in section are among the priorities set by the Chinese government. 5.1 Increase Current Working-Age Population An increase in the working-age population will limit the growth rate of the number of people retiring relative to the number of people still actively working. It is listed by an 36

37 OECD report 7 as one of the keys to avoid the potentially negative economic effect of population ageing. This increase can be realized through reforms in migration, labour mobility and retirement Migration and Free Labour Mobility The promotion of international migration is another instrument the Chinese government could use in order to increase the working-age population, theoretically. The question, however, arises whether this migration of economically active people is sustainable in the long run. Moreover, the government should encourage people to move towards regions with demand for their labour in order to stimulate the matching process between jobs and workers. At the moment, there are policies, such as the hukou policy 8, in place that cause disincentives for workers to move between regions and thus restrict labour mobility. An increase in the mobility of labour can be helpful in reducing the incidence of labour shortages as were introduced in chapter four Retirement Reforms Changes in the legal retirement age and creating incentives for elderly to continue working can also be helpful in achieving a larger labour force population by means of an increase in labour force participation rates among elderly. This would then decrease the speed at which the ageing of population will influence dependency rates because it will limit the growing number of retirees relative to the number of active workers. It can be argued that the increase in retirement age is justified by the fact that life expectancy in China has been increasing significantly during the last 7 Organization for Economic Co-operation and Development. (1998), Work Force Ageing: Consequences and Policy Responses. Ageing Working Paper The Hukou system is a household registration system which protects urban residents against competition of migrants according to Heckman (2005) 37

38 fifty years (see Figure 2.4). It should be noted that, although, there have been many reforms in the Chinese pension system; participation rates among urban elderly are still below fifty percent whereas rural elderly remain largely outside of the current system according to Salditt et al (2008). Therefore, a lot of elderly people without a pension will remain dependent on their family unless a countrywide pension system is implemented. Moreover, better health care and training are also needed to ensure the elderly s capability to work and stay productive until a later retirement age. These reforms in the pension system and health care should be introduced before 2015 according to Salditt et al (2008) in order to provide a financial and institutional basis that can discount the adverse effects of population ageing. 5.2 Affect the Fertility Rates An increase in the level of fertility rates in China will eventually result in higher growth levels of the working-age people relative to non-working-age people and therefore reduce the process of population ageing. A RAND 9 reported on the different channels through which a country can achieve this objective of slowing the decrease in fertility and concluded that a bundle of policies is the most effective way for a government to affect fertility rates. The abolishment of the family planning policies would provide China with a good opportunity to reverse the trend of decreasing total fertility rates Alleviating the Family Planning Policies The family planning policies, most notably the one-child policy, were introduced to limit the growth of the Chinese 9 Grant, J, Hoorens, S, Sivadasan, S, van het Loo, M, DaVanzo, J, Hale, L, Gibson, S, Butz, W. (2004), Low Fertility and Population Ageing: Causes, Consequences, and Policy Options. RAND Corporation Working Paper 38

39 population in order for the Chinese economy to experience periods of rapid economic growth and higher levels of income per capita. In the upcoming decades, this low rate of population growth, however, will contribute to an increase in the dependency ratios because the working-age share of population will decrease. Increasing the level of population growth towards total fertility rate levels above the natural replacement rate would be an apparent mechanism through which the scale of population ageing could be limited. This increase, in the level of total fertility rates, could be accomplished by an alleviation of the rules of the family planning policies. A welcoming side effect of this relaxation of China s family planning policies would probably be a reduction in the imbalances of sex-ratios in the People s Republic of China, where boys are significantly overrepresented in the ages between zero and four according to Salditt et al (2008). Better balanced sex-ratios can in the long run also contribute to higher population growth, for intuitive reasons, and can, therefore, reduce the burden of population ageing. 5.3 Increase the Productivity of Labour A higher level of labour productivity can also offset some of the drawbacks of a relative smaller working-age labour force resulting from lower population growth. This more productive labour force can be obtained through increased investments in human capital, which is very much desirable according to Heckman (2005), Fleisher et al (2010), and the World Bank s China 2030 report. Heckman argues that the relevance of human capital benefits is especially significant today because the Chinese economy, along with its labour and capital markets, is changing. 39

40 5.3.1 Increased investments in human capital An increase in the investments in human capital has a positive impact on economic growth through both direct and indirect effects. Higher levels of human capital per worker have a direct effect on the productivity per worker. The People s Republic of China can achieve higher levels of economic output for a given level of factors of production with a more productive workforce. Besides this direct effect, more productive labour is also beneficial to society as a whole and economic output through the indirect spillover effect according to Fleisher et al (2010). Heckman s analysis suggests that the social returns to education are significantly higher than the private returns because of these indirect effects. Therefore, the government should provide incentives for workers to build up human capital. Investments in human capital are also efficient when compared to other options of investment available to the government, such as infrastructure and physical capital, across the People s Republic of China according to Heckman (2005), Fleisher et al (2010), and Banister et al (2010). Galor (2010) has also identified the relevance of high skilled workers in the context of the People s Republic of China s demographic transition. The hypothesis that high skilled and high educated workers adapt better relative to low skilled workers to changes in the Chinese economy has been demonstrated in numerous empirical studies according to Heckman. 5.4 The Twelfth Five Year Plan The People s Republic of China s economic development was planned carefully by its leaders. Every five year a new Five Year Plan is introduced by its government in which the goals 40

41 and objectives related to economic, social and industrial issues are outlined. The current twelfth Five Year Plan promotes the People s Republic of China s government focus on inclusive growth meant to ensure that the benefits of its economic growth are spread equally across its citizens. This focus creates a fruitful situation in which investments in human capital across the People s Republic of China can be equalized to resulting in a significant increase in the level of human capital per worker in the People s Republic of China, while lowering inequality at the same time (Heckman (2005)). The government also aims to increase disposable income levels of households, through higher wages and increased social safety nets, in order to stimulate consumption as savings levels are rather high at the moment. This would lower the economy s dependence on investments in physical capital and exports, and at the same time reduce income disparity. An increase in savings to even higher levels in order to create a second dividend as suggested by Wolf et al (2011), therefore, seems unlikely. This aim for higher wages can lower the economic burden of population ageing as it is likely to draw more people into the labour force. 5.5 Conclusion There is a wide scope of policy options available through which the People s Republic of China s government can limit the adverse economic consequences of population ageing in the future. 41