Fri, Dec 22, 2006 page8

• China wakes up to find an aging population

  • By Friedrich Wu
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  ThE CHINESE government finally appears to be acknowledging the urgent challenges presented by the country's aging population.

  On Dec. 12, it released a Cabinet-level white paper on the problem -- the first of its kind -- in an effort to grapple with the prospect of rising social security and healthcare costs, a tightening labor market and other potential obstacles to continued rapid economic growth.

  Looking back, it is ironic that the Chinese government's draconian "one-child" policy, imposed in 1979, was implemented at the same time as the "open door" policy aimed at capturing labor-intensive foreign manufacturing investment.

  While both policies must be regarded as successes, over the years the family planning program has contributed to an aging population that may diminish China's attractiveness as a low-cost, labor-intensive manufacturing hub.

  During the nearly three decades since the "one-child" policy was introduced, live births have dropped from 22.5 million per year in the early 1980s to around 16 million to 17 million by the middle of this decade. Moreover, with the number of elderly growing as a result of rising life expectancy, this low birth rate has pushed the share of those aged 65 and above from 4.9 percent of the total population to 7.7 percent.

  The UN Population Division's (UNPD) "medium-variant" projections indicate that, without reform of the "one-child" policy, the share of China's population aged 15 and below would decline from 24.8 percent in 2000 to 15.7 percent in 2050, while the share of those aged 65 and above would soar from 6.8 percent to 23.6 percent.

  With fewer children to replenish the work force, the working age population would shrink from 68.4 percent to 60.7 percent.

  The elderly would thus account for a far greater share of China's population than in other large emerging economies, such as Brazil, India, Indonesia and Mexico.

  China's demographic trends hold several adverse implications for its economy. With a rapidly aging population and a shrinking work force, tax revenue will contract, while expenditure on pensions and health care will expand, undermining the fiscal position. Various estimates by private-sector economists and World Bank officials suggest that the government's accumulated "net implicit pension debt" could balloon to 75 percent to 110 percent of GDP.

  Furthermore, the decline in the working-age cohort would squeeze labor supply, fueling wage growth and eroding the country's economic competitiveness. Already, in the Yangtze and Pearl River deltas, where manufacturing activity is the densest, labor shortages have appeared.

  In 2004, for example, Guangdong Province had to raise the mandatory minimum wage by as much as 20 percent to attract workers from other regions. To hire and retain skilled workers, many foreign-invested enterprises routinely pay above the minimum wage.

  But some foreign manufacturers, seeking to cap rising labor costs, are shifting production from China to cheaper destinations such as Vietnam, where average monthly wages for factory workers is US$60 -- half that of China. Foreign direct investment (FDI) in Vietnam grew 40 percent last year, led by investors from Japan, South Korea and Taiwan.

  China's inward FDI fell 1.2 percent in the first seven months of this year, after a 0.5 percent decline last year.

  Meanwhile, combined investment from Japan, South Korea and Taiwan plummeted 31 percent in the first half of this year, compared with a 6.5 percent decline last year.

  These figures are only the early warnings of an emerging trend. In the long run, as labor shortages become acute, China will need to relinquish some low-end, labor-intensive manufacturing activities, which will translate into decelerating export performance and lower economic growth.

  Aside from abandoning the "one-child" policy, China could avoid this outcome by climbing the value chain in manufacturing and services, as Hong Kong, Singapore, South Korea and Taiwan have done. However, for China to succeed, higher investment in research and development (R&D), together with a fundamental overhaul of the educational system, is essential.

  According to OECD estimates, China's expenditure on R&D amounts to only 1.3 percent of GDP, compared with 3.2 percent in Japan and an average of 2.5 to 2.6 percent in South Korea, Taiwan and the US. Although the government recently announced that it intends to increase R&D spending to 2 percent of GDP by 2010, this remains below the OECD average of 2.2 percent.

  As for China's backward educational system, the large number of university graduates is offset by their overall sub-standard quality. According to a recent survey by McKinsey, of the more than 3 million graduates churned out by China's universities and colleges every year, less than 10 percent are suitable for employment with international companies, owing to their deficiencies in practical training and poor English.

  In view of these systemic weaknesses, China's ability to overcome its labor deficit by shifting to an economy driven by innovation and productivity remains dubious.

  Friedrich Wu is a senior research associate at the National University of Singapore's East Asian Institute.

  Copyright: Project Syndicate
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