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

 

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

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

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

Claims by those such as that by Financial Times writer David Pilling that "the song of China's miracle has a three-word refrain: Just add people" are therefore absolute nonsense. Only 4 percent of China's growth came from "adding people" and 96 percent came from factors other than "adding people!"

This does not mean no economic problems are created by China's aging population. But these come from a completely different route than shortage of labor. The real economic difficulty China faces with regard to population is that people in work can save, while those not working, because they are too young or too old, generally do not save. The decline of the percentage of China's population in work therefore tends to lower China's household savings rate. As investment necessarily has to be financed by savings, this puts downward pressure on China's investment rate, and as investment is the main source of economic growth not only in China but in most economies this could lower China's economic growth. While the decline in China's working age population does not pose a risk of significant economic slowdown due to lack of labor, it could cause a problem due to fall in savings.

But fortunately households are only one of three sources of savings. Of the other two, government savings are small in almost all countries, and usually negative. But company profits are the biggest source of saving in China. If savings via company profits were to increase, this can compensate for any decline in household savings due to the fall in the percentage of the population which is working.

Maintaining high growth in China therefore depends more on maintaining company profitability than it does on population. A decline in company profitability is a much more serious threat to China's growth than any demographic factor. A rise in company profitability, through its effect in raising company savings, would be a far more powerful factor in maintaining China's economic growth than relaxing the one child policy.

In summary, the claim that China faces a significant slowing of its economy due to population factors, and therefore China will "grow old before it grows rich," is a typical example of myths created by engaging in woolly rhetoric without using numbers. Increases in labor supply play such a small role in China's economic growth that the end of the rise in the working age population will have only a very small effect in reducing China's growth rate. It is what happens to China's productivity, and above all its investment, that overwhelmingly will determine its economic growth and therefore its prosperity. Provided the correct policies are pursued, China will certainly become rich before it becomes old.

The author is a columnist with China.org.cn. For more information please visit:

http://www.h5a3.com/opinion/johnross.htm

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