The challenge of a graying China

The Chinese People's Political Consultative Conference and the National People's Congress are holding their annual sessions against the backdrop of a once-in-a-decade leadership transition. The new leaders face high expectations. Addressing the country's glaring income disparities tops the wishlist of many Chinese. The recent release of the guidelines to reform income distribution is a welcome measure. The international community, again, is looking to the new leadership for comprehensive economic reforms that will ensure sustainable growth and help stabilize the global economy.

The open style adopted by the new leaders signals their willingness to reform. They have indicated their intention to focus on the quality, efficiency and sustainability of growth. This will help rebalance the economy and reduce the gap between the rich and the poor. The leaders have also identified reform priorities. Interest rate liberalization, fiscal reform and greater private sector participation are high on the agenda.

So far the leadership has focused on economic restructuring. Several further challenges need to be addressed. Chief among them is the socio-economic impact of a rapidly aging population.

The fiscal constraints related to aging are well known, caused mainly by spiraling healthcare and pension costs. However, the repercussions are much wider. In an aging society, labor markets, saving patterns and migration flows will change. Most worryingly, labor shortages, declining labor market flexibility and slowing productivity pose a serious threat to growth.

In the past three decades, a dramatic increase in life expectancy underpinned by the strict family planning policy prompted the greatest demographic transition in the world. During three decades of economic expansion, China's growing workforce added a "demographic dividend" of about 2 percent a year to GDP.

With rapid aging, the situation has now reversed. The demographic dividend is vanishing, while the dependency ratio of children and elderly on the working age population is increasing. The labor force shrank for the first time in 2012. By 2050, about 30 percent of the population will be above 60, against a world average of 22 percent.

Aging in China is particularly complex because it is happening at a low-income level. Social safety nets are weak, with most of the elderly depending on family support. Declining family size and the erosion of traditional values magnify the challenge and place a heavy burden on small households.

High-income countries have offset the losses caused by a declining workforce by adopting innovation-driven growth models. China could achieve the same by decisively rebalancing the economy, shifting to consumption-led growth and developing the services sector.

Aging also requires specific policy measures. The new leadership needs to focus on three issues.