Most countries that ascended to middle-income status, including China, did so with the aid of the demographic dividend, which refers to the extra boost to productivity and GDP that can occur when a country's working-age population expands faster than its dependent population. The demographic dividend arises in the second of a three-stage process called the "demographic transition".
The first stage accompanies the emergence from subsistence-level agriculture and is characterised by falling mortality, especially among younger children. Because fertility remains high in this stage, population growth is high and the demographic support ratio, the number of working-age adults for every child and senior, is low. A proportionately large dependent population limits the accumulation of savings and constrains productivity-enhancing capital formation.
Accordingly, economic growth per capita tends to be low in the first stage. Falling fertility triggers the second stage; the demographic dividend. Population growth remains fairly high in this stage, but reduced fertility means working-age adults become the fastest growing age group. As the ratio of savers – working-age adults – to spenders – children and seniors – increases, the national savings rate rises. This, in turn, bolsters a country's ability to invest. Economic growth per capita tends to be high due to labor supply growth and productivity-enhancing capital accumulation
Eventually, in stage three, persistently low fertility reduces population growth. Meanwhile, the large cohort of working-age adults that drove outsize economic growth in the second stage retires and the support ratio falls. As the workforce shrinks and the savings rate declines, economic growth slows.
Birth Laws Triggered an Early Demographic Dividend
China's family planning laws, beginning with the "Triple L" policy in the 1970s, accelerated the country's demographic transition by triggering a premature drop in fertility. From 1970 to 1980, China's total fertility rate plunged from 5.7 to 2.6 births per woman, an unprecedented decline for what was still a poor and largely agrarian country.
While that led to an immediate slowdown in population growth, the working-age population continued to expand, from 582 million in 1980 to nearly 1.0 billion by 2010. Over that time, China's support ratio surged from 1.5 to 2.9. As theory would predict, China's household savings rate surged, facilitating especially rapid, and, for a long time, productivity-enhancing, capital accumulation.
Premature Demographic Change
China is entering the third stage of its demographic transition. The working-age population has already begun to contract. The demographic support ratio, while still high, has begun to slip, and so too has the household savings rate. Over the next 10 years, China's support ratio will fall further, from 2.7 to 2.3. For every 10 dependents, China will have four fewer working-age adults than it does today.
The household savings rate is likely to fall further, draining the pool of funds available for investment. Without major structural reforms, borrowing by local governments and state-owned enterprises would increasingly crowd out private enterprises, economywide returns on investment would continue to deteriorate, and productivity would falter further.
