Demographic Transition and Economic Growth in China

Transcription

1 Demographic Transition and Economic Growth in China Cai Fang and Wang Dewen Institute of Population and Labour Economics Chinese Academy of Social Sciences, Beijing , China Abstract Changes in population age structure have allowed China to harvest its demographic dividend since the mid 1960s. The decline of dependency ratio has created a productive population age structure with an affluent supply of labour force. Empirical results illustrate that the Chinese demographic transition has contributed to percent of economic growth and 5-21 percent of savings rate in the reform era. With the acceleration of population aging, demographic dividend will be depleted at the end of Moreover, the reduction of working age population will cause the rise in wages. At present, it is very important for China to take measures such as achieving full employment and smoothing rural-urban migration, speeding up the accumulation of human capital, and setting up a sound pension system consistent with China s basic situation, so as to offset the shocks of population aging and maintain its sustainability. Key Words: Demographic Dividend, Demographic Debt, Savings Rate, Economic Growth, and China JEL Codes: J11, J13, O47, E21

2 Demographic Transition and Economic Growth in China 1 China has witnessed rapid demographic transition since the middle 20 th century. Following fertility decline and prolonged life expectancy, population reproduction in China has transformed itself from a phase with high fertility, high mortality and low natural growth to a phase with low fertility, low mortality and low natural growth, i.e., the so-called modern pattern of population growth. In developed countries, this process was smooth and spontaneous when they experienced industrialization and urbanization. It generally takes one century or one and half centuries to enter a post-transitional society from a demographic transitional society, but the span in China is very short. Within less than 40 years China finished its demographic transition and has now entered an aging society. The pace of demographic transition in China is the fastest in the world. Table 1 International Comparison of Total Fertility Rate Year World Developed Countries Less Developed Countries Underdevelop ed Countries Asia China 1950~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ Source: Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat. World Population Prospects: The 2004 Revision and World Urbanization Prospects: The 2003 Revision. Changes in total fertility rate (TFR) capture the adjustment of population reproduction. This rate aggregates the weighted women s fertility probabilities at a specific time point to approximately represent the number of children that one woman gives birth in her lifetime. 1 Paper prepared for the presentation at the International conference on the Dragon and the Elephant: China and India s Economic Reform, July 1st-July 2nd, 2006, Shanghai, China. 2

3 According to the UN prediction, the drop of the worldwide TFR takes about one century from 5.02 children per woman to a replacement level (about 2.1 children per woman). Table 1 illustrates an international comparison of total fertility rates. From 1950 to 2005, total fertility rate has been declining in all countries, but their paces vary. In 1950s, Chinese total fertility rate was higher than the worldwide level, but it has been decreasing quickly since the mid 1970s. The fifth population census in 2000 revealed that total fertility rate in China was about 1.6 children per woman. A number of arguments have been made that it is not the real fertility level. Some demographers believe that the current Chinese fertility level remains at a level not far below the replace level, at about 1.8 per woman, but results from two recent studies both suggest that the real Chinese fertility level should be around 1.6 per woman (Zhang and Yuan, 2004; Retherford et al. 2004). As Griffith and Yuan (1994) pointed out that the rapid decline of the Chinese fertility is astonishing with important implications, because China is the most populous country in the world, its demographic transition has produced profound impacts on both itself and the world population growth. The decline of mortality is another determinant of demographic transition. With the improvement of health and medical conditions, life expectancy is significantly prolonged in China, which results in the issue of aging population. The ratio of aging population was 7.69 percent in 2005 and will be accelerated in the next 30 years. Jackson and Howe (2004) warned that China would lose its opportunity to become wealthy if the sound social security system is not set up to cope with its rapid population aging. Changes in population age structure will continuously shrink the supply of labour force population. In 2003, the shortage of rural migrant workers first emerged in coastal south China. This phenomenon has spread to other coastal areas and even inland areas since then. The shortage of rural migrant workers has driven the increase of wage cost and exerted negative impacts of Chinese labour-intensive products export and international competitiveness. If we take the various impacts of demographic transition into consideration, there are several critical questions to be answered concerning the sustainability of Chin s economic growth. First, when will China face the depletion of its demographic dividend? Second, how can China maximize the potential before the depletion of its demographic dividend? Third, how can China sustain its economic growth through relevant policy adjustments? This paper attempts to answer these questions by identifying the turning point where the demographic dividend becomes the demographic debt, analyzing the mechanisms by which the demographic transition affects economic growth and estimating the contribution of the demographic factor to economic growth. Population and Economic Growth in China As shown in Figure 1, population growth in China was faster in the era of planning economy. Its annual growth was more than 2 percent in most years except for the period of three-year disasters between 1958 and 1961, and late 1970s. The average growth of 3

4 population was 2.0 percent from 1953 to 1977, and dropped to 1.1 percent from 1978 to In a sharp contrast to population growth, economic growth is faster in the reform era. The average of growth has maintained at an annual rate of 9.5 percent since 1978, while it was only 6.5 percent in the whole period of planning economy. The negative relationship between population growth and economic growth seems to support the Malthusian viewpoints of population on economic growth, but it will be wrong if we do not consider changes in demographic structure and institutional environments. Figure 1. Population and Economic Growth in China: Growth Dependancy Ratio Dependancy Ratio (%) Pop. Growth( ) GDP Growth(%) 0 Source: NBS, China Population Statistic Yearbook, various issues; NBS, China Statistic Yearbook, various issues. In fact, different models are developed to examine the relationship between population growth and economic growth. Blanchet (1991) synthesized those models and classified them into the following four paradigms: Table 2. A classification of Demographic-Economic Paradigms Technological Change Exogenous Endogenous Population Growth Exogenous Orthodoxy Revisionism Endogenous Transition Theory General Model Source: Blanchet,

5 The traditional Malthusian theory had ever taken the dominance in demographic-economic models. It assumes both population growth and technological change are exogenous, and attributes the backwardness in developing countries to the large size of population and its fast growth. This theory has produced a profound influence on the formation of population policies in developing country, asserting the control of population growth is one of initial conditions to get rid of the backwardness through active population intervention policies. Obviously, the introduction of one child policy in China was affected by the suggestion of the Malthusian theory and has sped up the demographic transition since the 1970s. In 1980, the CCP central committee sent out an open letter and called for the implementation of family planning program. In this letter, the family planning program was designed as a long-term policy to control the Chinese population growth. If the assumption of exogenous technological change in the Malthusian theory is relaxed for the positive response of technological change to population growth, economic growth will not be constrained by population growth. In the meantime, if population growth is endogenous, demographic transition induced by economic growth and technological change will affect the long-run economic growth. The endogenous assumption of both population growth and technological change generalizes the relationship between population and growth, and can provide a good explanation to various realities during different development stages and in different institutional contexts. Compared with the short-run disturbance factors, demographic transition is relatively a long-run variable that determines economic growth. When population characteristics cannot match the requirements of economic growth, it will hinder the potential of economic growth. For example, in the extremely bad resources environment, fast population growth will cause economic growth locked in the Malthusian trap (Nelson, 1956); the regional market network can be a bottleneck of the economy of scale due to a low-density population (Johnson, 1994); the shortage of human capital can be one of constraints that severely prevent the recovery of economy from disequilibrium status when an economy is just free from war or natural disasters (Barro et al., 1995); in a labour intensive economy, the shortage of working-age population or higher ratio of ageing population can be barriers to economic growth (Bloom et al., 2002). This paper aims to investigate the impacts of demographic transition on the Chinese economic growth, so we can divide the contributions of demographic factors into demographic dividend and demographic debt. The former are some factors that are favorable to economic growth; the latter are other factors that are unfavorable to economic growth. Both demographic dividend and demographic debt co-exists in different demographic and economic development stages. Their relative magnitudes are determined by the conjunction of economic development stages with demographic phases, and relevant policy interventions. During the current Chinese development stage, higher ratio of working-age population can be utilized as a favorable factor to promote fast economic growth and obtain the demographic 5

6 dividend when the suitable economic development strategy and policies are adopted. According to the demographic transition theory, the process of demographic transition has three phases with specific characteristics of population age structure that come from the time lag between the declines of fertility and mortality. They are characterized sequentially with high children dependency ratio, high working-age population ratio, and high old-age dependency ratio (Williamson, 1997). If we treat population as producer and consumer, different age groups have different consumption patterns, savings behaviour and labour participation rates, and they then have specific effects on economic growth. A high proportion of the aged population and/or children increases the burden for society to assume a greater responsibility for dependents and reduces the productive capabilities of the economy, therefore having a negative effect on economic growth. Similarly, a higher proportion of working-age population is a more productive population structure, increasing the labour supply, savings rate and consequently stimulating economic growth. The demographic dividend is created in these circumstances (Bloom et al., 2002). A developing economy or region with a productive population age structure can take full advantage of the potential demographic dividend and create the miracle of economic growth. The Asian Miracle demonstrates that developing economies can move swiftly to bridge the income gap with industrial economies. Demographic transitions in East Asian economies began in the 1940s and 1950s. Prior to 1970, economic growth potential was limited, income per capita was low and accompanied by high children dependency ratios. With demographic transition, the proportion of working population to total population increased, while total population dependency ratios declined. These trends favoured the labour supply and savings rate and provided an additional source of economic growth. According to Williamson (1997), between 1970 and 1995, East Asian economies grew at average annual rate of 6.1 per cent, 4.1 percentage points above the steady state rate. Demographic transition contributed 1.5 to 2.0 percentage points to the steady state rate, accounting for one-quarter to one-third of the actual growth rate and one-third to one-half of the steady state growth rate during the period. Krugman (1994) criticized the so-called Asian miracle mainly comes from the accumulation of factors of production and will not be sustaining due to the lack of total factor productivity improvement. After carefully examining Krugman s standpoints, Bhagwati (1996) argued that the Asian miracle did really happen. Economic growth and investment ratio in South Korea, Sigapore, Hong Kong and Taiwan are high and last for 20 to 30 years, which have never happened in the history. If taking 10 years as a period to do comparison, technological changes in those economies are increasing over time. He further pointed out that the choice of export-oriented development strategy is one of important factors for those economies to realize economic takeoff and gain demographic dividend through participating in international competition. Economic performance in China has also been criticized for its high input of factors of production. No matter how correct this criticism is, two facts are widely accepted: one is that 6

7 economic reform and opening up has gradually replaced the traditional priority strategy of heavy industry development with the principle of comparative advantage, and created a good institutional environment for economic growth; the other is that the Chinese demographic transition is just at the stage with the most productive population age structure, which provide an opportunity for China to develop labour-intensive industries and sectors so as to take part in the international competition and harvest demographic dividend. In Figure 1, the dependency ratio peaked in 1964, kept a downward trend afterwards, and dropped to 38.9 percent in Abundant Labour Supply and the First Demographic Dividend The divergence between production and consumption during demographic transition generate two demographic dividends (Mason and Lee 2004). The first demographic dividend comes from changes in population age structure that raises the share of population concentrated at the productive ages. Given the potential economic advantages from the age structure of a population, high labour force participation and employment allow the productive use of human resources engendered by the population structure. Therefore, we can also view the first demographic dividend as the effect of labour supply on economic growth. Figure 2. Economically active population, employment, and labour force participation EAP Employment LFPR Population (million) LFPR (%) Note: Labour force participation rate is the ratio of economically active population to working-age population; working-age population is calculated based on NBS, China Population Statistic Yearbook, various issues. Source: NBS, China Population Statistic Yearbook, various issues; NBS, China Statistic Yearbook, various issues. 7

8 In the period from 1978 to 2004 the size of the economically active population steadily increased and the labour force participation rate reached 71.2 to 81.9 per cent, higher than most economies around the world. Despite changes in sectors of the economy and ownership structure of employment, economic growth has drove the growth of employment in urban and rural areas. The economically active population, employment and level of labour force participation increased during the period (Figure 2). With favourable labour endowments and increasingly expanded opportunities for employment, economic growth in China has been supported by ample and low-cost labour supply enabling the transformation of an advantageous population structure into a comparative advantage in labour-intensive industries. Fast growth of labour supply is one of sources of economic growth. During demographic transition, the growth of the working population may not keep pace with the growth of the total population, indicating population age structure changes over time. While the working population grows more slowly relative to total population, the population should assume a greater economic burden for dependents. In contrast, faster growth of working population relative to total population is accompanied by a declining economic burden on the population. According to the neo-classic growth theory, changes in the labour supply would have little effect on long-run growth. However, the division of labour can generate economies of scale and a decreasing labour supply will weaken the effects of the division of labour and reduce total output and income per capita. Kelley (1988) summarized that one sector, two sectors or multisector models have been chosen to illustrate the relationship between population and growth, but there has been no a consensus even based results from one sector models. Observation reveals a conflict between the facts and theoretical assertions (Hodgson 1988). One shortcoming in conventional economic theories of growth is that theories consider population change as a steady process, that is, they only focus on the magnitude and growth of population, while neglecting changes in the age structure during the demographic transition (Williamson 1997). In fact, population should be acknowledged as a factor affecting the conditions of economic growth. According to the lately development, two approaches of growth accounting and growth regression are developed to assess the impacts of population change. In the neo-classic growth model, the steady-state growth of income per labour is theoretically determined by a series of variables that include physical and human capital, technological advances, natural resources endowment, policies and institutions. This is illustrated as y * = Xβ. Where, y * is the steady-state growth of income per worker; X is a vector consisting of initial conditional and structural variables, β represents the marginal effects of those variables. In this standardized model, we assume the growth of population 8

9 equals the growth of labour, the factor of changes in population age structure is excluded. However, We can illustrate the impacts of population change on economic growth by the following mathematic manipulations (Bloom and Williamson, 1997; Mason and Lee, 2004; Cai and Wang, 2005). Define the effective number of consumer ( N ) and the effective number of producers ( L ) as: Nt () = α( apatda ) (,) (1) Lt () = γ ( apatda ) (,) Where Pat (, ) is the population. Output per effective consumer, y, is given by the product of the support ratio ( L N ) and output per worker ( Y ) as follows: L y t Yt () Lt () Yt () Lt () * = = * = * y t (2) Nt () Nt () Lt () Nt () Taking logarithm at both sides in equation (2), we obtain the growth of output per effective consumer ( g y ) is the sum of the demographic dividend, the difference between the growth of the effective labour force ( g L ) and the growth of the number of effective g N g y * consumers ( ), and the growth of output per worker ( ). gy = gl gn + g (3) y * If we define the dependency ratio as ( D ), the ratio of the number of children and the elderly to the number of working-age population, then we can re-write equation (2) as follows: () * () * 1 yt = Lt * yt = Lt * y * t = * y t (4) Nt () Lt () + Lt ()* D 1+ D Applying logarithm manipulation to both sides in the above equation, the growth of output per consumer equals the growth of output per worker minus the logarithmic value of the dependency ratio plus one. gy = g ln(1 + D) (5) y * 9

10 Figure 3. The Time Period of the First Demographic Dividend in China Ratio (%) Demographic Dividend Demographic Debt Dependecy Ratio (%) Support Ratio (%) Source: NBS, China Population Statistic Yearbook, various issues; NBS, China Statistic Yearbook, various issues; Author s calculation based on data provided by China Center for Population and Development Studies. In equation (3), demographic transition will generate demographic dividend if the growth of effective number of producers is greater than that of consumers; otherwise it will generate demographic debt if the growth of effective number of producers is less than that of consumers. The sign of marginal change in the support ratio indicates the time period to capture the first demographic dividend. When the marginal change in the support ratio turns into a positive sign from a negative sign, it illustrates the beginning of demographic dividend; otherwise, it demonstrates the ending of demographic dividend and the beginning of demographic debt. In equation (5), the decline of dependency ratio will generate demographic dividend and the increase of dependency ratio will generate demographic debt. Virtually, equation (3) and equation (5) are identical and can be shown in Figure 3. China has entered the time period of the first demographic dividend since 1964 and will be ended in Although China had the conditions to capture demographic dividend in the planning economy, the implementation of the priority of heavy industry development distorted the market 10

11 structure and input ratio of factors of production, and could not fully utilize labour sources and improve labour productivity. In contrast, the market-oriented reform has gradually corrected the distortion of products and factors market and provided incentives to improve the allocative efficiency of factors of production. Table 3. Average Annual Rate of Growth in the Support Ratio in China and Other Selected Economies, China Taiwan Japan United States France Source: Wang and Mason, Mason and L ee, Manson and Lee (2004), and Wang and Manson (2005) decomposed the contribution of demographic dividend by using the growth accounting approach in selected economies. In Table 3, the average annual growth rate of the support ratio between 1960 and 2000 was 0.48 percent in China; the growth of per capita GDP was 5.8 percent; the contribution of demographic dividend to the growth of per capita GDP is equivalent to 8.3 percent. From 1982 to 2000, the support ratio increased by 28 percent with an average annual rate of 1.3 percent, which was especially favorable to economic growth. In the same time period, real GDP per capita grew at an annual rate of 8.4 percent, thus the first demographic dividend accounted for 15 percent of China s economic growth between 1982 and The support ratio will peak in 2013, and will begin a sustained gradual decline. From 2014 to 2050, growth in output per capita will be decreased by 0.45 percent per year as the first demographic dividend unwinds. Therefore, there are only seven years left for China to rape the first demographic dividend. Cai and Wang (2005) estimated the impacts of demographic dividend by using growth regression approach and obtained a larger contribution of demographic dividend. They used the demographic data from the population census in 1982, 1990 and 2000 and regressed the growth of per capita GDP versus the initial per capita GDP, life expectancy, investment ratio, openness, government expenditures and dependency ratio. They calculated the average annual growth rates of per capita GDP between 1982 and 1990, between 1990 and 2000, and treated them as the long-run economic growth rate. After pooling the two period provincial data, they got 55 observations excluding Tibet, Hainan, Chongqing and Ningxia in The empirical results are as follows: 11

12 g = ln GDP ln Life Invest Open 0.067Gov 0.115D y ** * ** (0.54) (5.64) (1.84) (2.63) (4.03) (0.85) (2. Where, GDP78 represents the initial per capita GDP, Life82 represents the initial life expectancy, Invest represents investment rate, Open represents the share of trade in GDP, Gov represents the share of government consumption in GDP, D represents total dependency ratio. The good fit (R 2 ) of the above equation can explain about 57 per cent of the variation in the economic growth rate. The coefficients for variables of the initial per capita GDP, investment ratio, openness, and total dependency ratio are all significant at the 5.0 percent or 1.0 percent level. The coefficient for the variable of life expectancy is close to the 10 per cent significant level, but the share of government consumption is insignificant. The coefficients for all variables have the signs theoretically expected. According to the results, the marginal effect of total dependency ratio is , where a decrease in the total dependency ratio by 1.0 percentage point will cause the increase of economic growth by percentage points. From 1982 to 2000, China s total dependency ratio dropped by 20.1 percentage points, contributing the equivalent of 2.3 percentage points to the growth rate. The average growth rate during the same period was 8.6 per cent. That is, about one-quarter of the growth rate in per capita GDP can be attributed to the decline in total dependency ratio during the period. Obviously the contribution of demographic dividend estimated from the growth regression approach is larger than that from the growth accounting approach. The difference from the two approaches could be that the estimation in the growth accounting approach measures the direct effect of population change while the estimation in the growth regression possibly captures both direct and indirect effects, i.e., the effects of labour supply and lifecycle savings. 87) ** Lifecycle Savings and the Second Demographic Dividend Changes in the population age structure have reduced population dependency and enhanced the productiveness of the population. The increasing levels of economically active population and employment have produced an economic surplus and helped China approach a high savings rate. High savings rate is helpful for capital formation and driving economic growth, so this kind of demographic transition impact can be referred to the second demographic dividend, or the effect of savings. Measured by the ratio of capital formation in GDP, the savings rate has remained more than 30 per cent and peaked at 45.9 per cent in 2004 (Figure 4). In addition to the rapid economic growth and increasing employment levels, the favourable savings rate in transitional China can mostly be attributed to the decline in total dependency of population under the development of markets for production factors, lessening 12

13 social burdens of dependents, enhancing the productiveness of population and capitalising on the demographic dividend. Figure 4. Changes in the Population Dependency and Savings Rate Children Dep Old Dep Savings Rate Percent (%) Source: Data on dependency ratio are from NBS, China Population Statistic Yearbook, various issues. For some years, data are not available, the figures on dependency ratio are estimated; Data on savings rate are from NBS, China Statistic Yearbook, various issues. If we use age profile to estimate labour income and mean consumption, the results illustrate a typical lifecycle income generation pattern with smoothly mean consumption. Figure 5 shows that earnings heavily concentrated in the working ages of 26-55, and consumption spread relatively evenly across age groups. The saving and dissaving in life cycle will cause relative changes in the shares of national income (Kelly, 1973). Over an individual s lifespan, savings will increase upon entering the workforce and decrease in retirement. The higher the proportion of the working population implies the national savings rate will rise and increase overall national capital formation. As the population ages, public investment expenditure increases with the provision of pensions and medical care. As the proportion of non-productive expenses from the total income increases, the proportion of public investment in productive investment declines. Decline in the levels of private savings and public investment reduce the growth of total output and income per capita. 13

14 Figure 5. Labour Income and Mean Consumption in Urban China Source: NBS, 2003 Household Survey Data. Changes in dependency ratios and savings rates have presented a similar pattern in Asian economies. Savings rates tend to rise during economic takeoff, but fall with the rise of dependency ratio afterwards as economies become wealthy. In Table 4, savings rates in East Asian economies were significantly higher than both the world average and developed economies. For example, the savings rate in Japan was more than 36.4 percent in the 1960s, while savings rates in Hong Kong, Korea, Thailand and Malaysia were 20 to 30 per cent in the 1970s and continued to increase during the subsequent two decades. As the Japanese economy and population matured, the savings rate dropped gradually during the 1980s and economic growth slowed in the 1990s. The savings rate in China has continued to rise since the 1960s. A high savings rate has been viewed as a key factor contributing to rapid economic growth since the reforms. While most debates about the savings rate focus on government efforts to mobilise savings, capital market development and precautious savings incentives, whether household savings and consumption behaviour has an impact on national savings and the extent of the impact has not been extensively discussed in the existing literature. As the Chinese economy continues to undertake market liberalization and the structure of the population changes, the effects of the demographic transition on individual saving behaviour has important implications for policymakers. 14

15 Table 4. Dependency Ratios and Savings Rates in China and Selected Asian Economies Dependency Ratio (%) China Hong Kong Japan South Korea Malaysia Singapore Thailand Savings Ra te (%) China Hong Kong Japan South Korea Malaysia Singapore Thailand Note: Savings rates in the first column are the average values betwe en 1965 and Source: World Bank, Wor ld Bank Online D atabase. Changes in population age structure over time will deplete the first demographic dividend (Manson and Lee, 2004) and cause the ending of the second demographic dividend through the decline of savings rate. Running a cross-section regression of 74 countries in 1964, Leff (1969, 1971) found variables such as per capita income, economic growth rate, children dependency ratio, old-age dependency ratio and total dependency ratio have significant effects on the national savings rate. According to the results in his study, rise in children dependency ratio, old-age dependency ratio and overall dependency ratio will significantly decrease savings rate. Leff s study generated much criticism, and subsequent studies revealed a great disparity in the magnitude and significance of the effect. Hammer (1986) suggested that a better approach would be to use individual country time-series data to control the country-specific variables that determine savings because many variables in the development process are highly correlated. Based on three individual countries of Argentina ( ), Australia ( ) and Canada ( ), Taylor and Williamson (1994) found supporting evidences that dependency ratio significantly depress domestic savings rate and pull in foreign investment from the Old World. 15

16 Table 5 Savings Function Estimates for Selected Asian Economies China Japan South Korea Singapore g (0.15) (1.08) (2.38)* (0.81) D (4.02)** (2.81)** (8.30)** (5.38)** D * g (0.45) (1.05) (3.22)** (0.86) Constant (8.81)** (4.41)** (14.50)** (10.65)** Observations R-squared ρ Durbin-Watson Partial Derivative: s D Elasticity: ( D )( s ) s D Note: (1) Absolute values of t statistics are in parentheses (2) * represents significant at 5%;** represe nts significant at 1%. The empirical regression equation in Taylor and Williamson s study takes a linear regression of the savings rate on the growth rate of per capita GDP, dependency ratio, the interaction item between economic growth rate and dependency ratio. This paper selects four Asian countries including China, Japan, Korea and Singapore and runs a similar regression equation as Taylor and Williamson did by using the 1965 to 2004 data from the World Bank. In Table 5, s represents the savings rate; g is the growth rate of per capita GDP; D represents the dependency ratio; D* g is the interaction term between the economic growth rate and the dependency rati o. The results in Table 5 are similar to the findings in Taylor and Williamson s paper. In their paper, the coefficients of economic growth rate and interaction item are insignificant ex cept the dependency ratio. In our regression results, the coefficients of the dependency ratio in four countries equations are all significant, and the coefficients of economic growth rate and interaction item in South Korea regression equation are significant. Therefore, the results from our individual country regression confirm that changes in population age structure do depress the domestic savings. 16

17 Table 6 Regression results of the demographic transition on savings rate in China Variables OLS Method FGLS Method (1) (2) ln(per capita GDP) (1.05) (3.52)** ln(average growth rate of GDP in the previous five years) (2.23)* (2.53)* ln(total dependency ratio) (2.99)** (2.97)** C entral region dummy (6.64)** (10.73)** Western region dummy (0.28) (0.33) Intercept (13.24)** (15.70)** R Observations Note: (1) Variables of year dummy are deleted for simplicity; (2) Absolute values of t statistics in parentheses in equations (1); Absolute values of z st atistics in parentheses in equations (2); * represents significant at 5 per cent; ** represents significant at 1 p ercent. Cai and Wang (2005) followed Leff s (1969) model to examine the impacts of Chinese demographic transition on the savings rate using a provincial panel data set. The data come from China s population censuses in 1982, 1990 and 2000, population sampling data over 13 years (1987, 1989, , 2001 and 2002), and China Statistical Yearbooks (various issues). The variables are defined and generated as follows: the savings rate is the share of gross capital formation in GDP; per capita income equates to per capita GDP at 1952 constant prices; the economic growth rate is a five-year arithmetic average to eliminate the influence of annual economic fluctuations; the total dependency ratio is the summation of children dependency ratio and old-age dependency ratio. In regression, all variables took the logarithm form except dummy variables. They first ran an ordinary least-square regression and then ran a feasible generalized least-square to overcome the heteroscedastic issue. The regression results are reported in Table 6. Apart from the regional dummy variables, the coefficients for other variables in Table 6 are values for the elasticity of savings rate. Although the coefficients for all variables in Table 6 are significant and the signs consistent with theoretical expectations, the absolute values for coefficients are less than those in Leff s study. Based on cross-country data, Leff (1969) reported the values of the elasticities of savings rate, economic growth rates and total dependency ratio were 0.160, 0.025, and 17

18 respectively. The greater variability in the cross-country dataset is the main reason for the difference in the absolute values between the two studies. However, using a provincial panel analysis has an advantage by effectively eliminating the unobserved effects of policies and institutions across countries. The introduction of a year dummy variable into regression equations could be another reason, because the coefficients of year dummy are significant with a range from 0.13 to 0.39, which may absorb some effects of other variables. The elasticity of dependency ratio from individual country regression for China is almost 3 to 4 times that in Table 6. From 1982 to 2002, the total dependency ratio dropped by 33.3 percent, so the contribution of total dependency ratio to savings rate is approximately 5.0 to 20.9 percent based on the above two regression results. With the ending of demographic dividend, population aging will produce a long-lasting effect on Chinese economic growth. Peterson (1999) summarized six negative effects of an ageing population for society. A simulation demonstrates that shocks from the labour supply and public finances for social security will negatively affect economic growth rates in the European Union and Japan by 0.5 percentage points and the United States by 0.25 percentage points (Pench 2000). Feldstein (1995) found an increase in social security expenses crowd out 60 per cent of private savings. Therefore, how China adopt a sound social security system will have an important implication for its sustainability. As China has entered an aging society, how to efficiently allocate resources from the surplus ages to deficit ages challenges the sustainability of Chinese economic growth. In a market economy, there are three alternatives to reallocation resources through capital deepening, income (wealth) transfer or credit market to cope with the challenges of population aging (Manson and Lee, 2004; Wang and Manson, 2005). The immature credit market in China cannot be chosen as an ideal policy tool. The current age structure of Chinese population is relatively is young, income transfer can be chosen as one of policy measures to allocate resources from the surplus ages to deficit ages. In the long run, the development of capital stock through capital deepening should be the major policy tool to capture the second demographic dividend. Under the steady-state golden rule, a capital-output ratio of 2.6 for demographic conditions in 1982 should rise to that of 7.1 for demographic conditions in 2050 to maintain the welfare of consumers and the elderly. If the capital-output ratio could be increased to that magnitude output per worker would grow at 1.4 percent per year as a results capital deepening in the 50 years (Wang and Mason, 2005). Concluding Remarks China has had the potential to take advantage of the demographic dividend since the mid 1960s, but reforms were necessary to maximize the potential sources for economic growth. Since reforms, the decline of total dependency rate has contributed to percent of economic growth and 5-21 percent of savings rate. Recent predictions suggest total 18

19 dependency rate in China will further decline from 42.6 per cent in 2000 to 38.8 per cent in 2013, and a 2.6 percentage point drop. Therefore, the demographic dividend will continue to make a contribution to China s economic growth before the turning point is reached in 2013, when the demographic dividend becomes a demographic debt. Most industrial countries have benefited from the demographic dividend, but this extra source of growth eventually ceases as the demographic transition is completed. The experiences of industrial economies suggest the use of a favourable population structure as an extra source of growth can be replaced by other factors, such as full employment, improved education and health levels and more efficient institutional environments for economic activities. As for China, full utilisation of economic potentials from the advantageous population structure will be able to not only sustain economic growth, but also prepare for a rapidly ageing society. Since the late 1990s, radical reforms of state-owned enterprises have caused massive unemployment and a fall in labour force participation in China. Increasingly, levels of employment and the economically active population have lagged behind increases in the size of the working population, indicating a demographic dividend still exists. The more effectively labour resources are utilised, the longer the demographic dividend is maintained and the advantageous development conditions, from low labour costs and high savings rates, can be maintained. These conditions will require further reforms in a variety of areas, including the elimination of institutional barriers that deter labour mobility and the market-based determination of wages. In the long run, increase in human capital investment through public and private financing will be the major source of China s economic growth. The ageing population will continue to increase in the coming decades. China will need to establish a sustainable pension system to safeguard society in the era of an ageing population and make some critical policy adjustments. The government needs to undertake a variety of policy adjustments such as the transition from the pay-as-you-go system to a fully funded pension system and public education programs to make society better informed and prepared for an ageing population. Improving labour market efficiency is a critical condition for transformation of the pension system. Creating more work opportunities in the labour market and raising the retirement age will reduce the dependency of older people on social pensions, by prolonging the number of years in the workforce. Including rural-to-urban migrant workers in the pension system will also enhance the total premium and financially support the transformation of the pension system. Moreover, the adjustment of population policies is also needed to prevent the Chinese population from ageing too rapidly. 19

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