Residents of a home for the elderly in Feixiang County, Hebei Province, share a laugh. China’s pension system faces pressing challenges as the number of working-age adults continues to fall.

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The problem of population aging in China is increasingly severe while the working-age population is declining drastically, causing the demographic dividend to wane, which will aggravate the economic slowdown to an extent.

However, qualitative and quantitative analysis suggest that middle-aged and older groups under the current definition have great labor potential. In this context, the government plans to increase the labor force participation rate by taking a gradual, step-by-step approach to raise retirement age, thus releasing a substantial amount of what scholars term the “sunset bonus.”

The current retirement age in China is 60 or 55 for men, 55 or 50 for women, according to Chinese regulations.

At the same time, a report released by the Economic Co-operation and Development in 2014 put the average of statutory retirement age in the 34 member countries at 65 for male workers and 63.5 for females.

 

Severe labor shortage
According to the sixth population census carried out by the National Bureau of Statistics, 13.3 percent of the population was older than 60 in 2010, a 2.9 percent rise from 2000, while the figure is likely to hit 19.3 percent by 2020 and 38.6 percent by 2050.

Population aging not only puts tremendous pressure on China’s pension system but also has significant negative effects on the labor force participation rate, restricting labor supply and diminishing economic prospects.

In fact, China’s working-age population began to drop in 2012, and it has fallen by an average of almost 3 million people a year since. As far as the population structure is concerned, the proportion of the elderly in China will continue to expand in the future while that of the working-age will continue to decrease, which will no doubt have a long-term adverse impact on labor supply. A number of studies hold a pessimistic view toward China’s economic outlook against this backdrop.

However, it is worth noting that though China’s working-age population has continued to decline in recent years, labor force participation rates have seen a small increase since 2010. In the meantime, China’s economically active population has not yet shrunk, and employment continues to go up. Given that, if we can strengthen labor supply—specifically by increasing the labor force participation rate and enhancing investment in human capital—demographic factors can still play a supporting role in employment and economic growth.

In the long run, China needs to improve the quality and efficiency of the workforce in order to capture the second “demographic dividend.” In the short term, the government can boost the labor force participation rate of middle-aged and older groups through a gradual retirement age policy to deal with the labor shortfall.

In reality, it takes a considerable amount of capital and time investment in human development before a second “demographic dividend” can be successfully translated into economic growth. A progressive retirement age postponement agrees with China’s situation, especially in the next five to 10 years when the labor supply pool holds the most potential.

 

Great potential   
The issue of population aging isn’t confined to China. The world is grappling with the growing number of elderly citizens, and many countries are looking into methods to maintain the sustainability of pension system and prospects for economic growth in an aging society. A widely accepted approach across the globe has been to gradually raise the statutory retirement age.

Taking the characteristics of the latest labor market into account, China has also been exploring a delayed retirement system. However, a consensus has yet to be reached given that there is no comparable benchmark to examine the effects of retirement on labor supply. Besides, most analyses and predictions regarding China’s economic outlook fail to consider the hedging effect that a delayed retirement has on the labor market.

One thing for sure is that middle-aged and older groups under the current definition are still vigorous. Compared with the existing retirement policy, China’s average life expectancy has extended dramatically. In particular, women’s average life expectancy of 78 years is much higher than the statutory retirement age.

In addition, analysis shows that the labor force participation rate of all age groups in China fell by more than 10 percent at the retirement age, whereas the urban labor force participation rate dropped by more than 20 percent. In contrast to the rural residents who rely on no formal retirement system, the labor force participation rate of retiring urban employees has plummeted sharply, creating a nearly 60 percent urban-rural labor force participation rate gap. This is inconsistent with the progressive changes of human labor and also contradicts the steady flow of the labor force participation rate in other age groups.

What’s more, this means that urban employees are withdrawing from the labor market too early because of the mandatory age of retirement, so a postponement will significantly increase our labor supply and offset the negative effects brought about by the decline in the working-age population.

Based on the sixth population census, this study maps out the labor participation rate in accordance to age and carries out a simulation analysis on the possible effects of two gradual delayed retirement programs on labor supply and economic growth. The results showed that the programs, especially during the first five phases, will add 2 million to 3 million working-age adults, generating half a percentage point in GDP growth and effectively easing the adverse effects of shrinking working-age population on China’s labor supply and economic growth. It will also create a valuable window for China to move from quantity-oriented “demographic dividend” to a quality-based second “demographic dividend.”

 
Problems to address
There is no doubt that delaying the retirement age can inject a positive stimulus to labor supply, the pension system and economic growth. Nonetheless, different groups will certainly react differently to the policies in the process, including both substitution and tightening effects as well as complementary and expansion effects. Such uncertainty needs to be addressed.

On the one hand, based on the hypothesis that senior and young employees can replace one another, delaying retirement can have a crowding-out effect on youth employment.

On the other hand, if we assume senior and young employees master complementary skills and the market size hypothesis stands, retirement postponement may have a crowding-in effect on youth employment. For example, delaying retirement will increase labor supply and improve social productivity, leading to a booming economy that will, in turn, give rise to a demand for labor.

Again, delaying retirement may prevent the elderly from taking care of grandchildren, which can cause two different types of market effect. One is a tightening effect because women of childbearing age are forced to leave the labor market, reducing the participation rate of the group. The other is an expansion effect because the demand for childcare will grow in the market.

To maximize the benefit of delayed retirement policies, the government must take into account the capacity of stakeholders for change to provide compensation and incentives to raise the level of acceptance and implementation, fundamentally improving the labor force participation rate of middle-aged and elderly groups.

A survey conducted among employees aged 40 to 60 in some cities in China suggests that income gap before and after retirement, health condition, economic status and work pressure are the main factors affecting their willingness to retire. Therefore, a flexible retirement system with compensation is conducive to effectively encouraging workers to delay retirement, boosting the sustainability of the pension system and improving social welfare.

That is to say, such a system should be in place where an employee who reaches the statutory retirement age can make his own decision whether to stay at work or to retire at the beginning of that year and so on. If one decides to stay at his or her post, the company should offer a certain amount of compensation every month.

   
Liu Xiaoguang is from the National Academy of Development and Strategy at Renmin University of China.