China, perhaps more than any other country, faces many important and difficult population challenges: reproductive health and reproductive rights, rural-urban migration and reform of the hukou system, and imbalances in the sex ratio at birth. And two deeply connected population issues, the rapid aging of the population, on the one hand, and the low birth rate and the family planning policy on the other, are of great significance to China's future development.

China's population is aging as rapidly as anywhere in the world and its low birth rate means it faces a significant population decline in the not too distant future. In part, China's population will age because people are living longer, an important dimension of China's great progress. But the country's low birth rate is the most important reason for population aging, leading to a very top-heavy age structure with many elderly, fewer workers, and even fewer children.

The low birth rate and population aging mean China faces two important economic challenges. The first is maintaining economic growth and poverty reduction, while the second is ensuring economic security for hundreds of millions of elderly.

Since the beginning of economic reform in 1978, changes in age structure have been very favorable in China. Because of the decline in the birth rate, only partly a consequence of the family planning policy, the number of children in China has decreased and the proportion of the population that is of working age increased. This led to a demographic dividend in China that provided an important boost to efforts to increase economic growth. Experts disagree about the size of the demographic dividend, but scholar Wang Feng and I believe that it added about 1.3 percentage points to economic growth between 1978 and 2000, smaller than some have argued, but still an enormous effect.

China's first demographic dividend is coming to an end as the size of working age population is peaking and will soon begin a rapid decline. Over the next 40 years, China's support ratio, the effective number of producers per effective consumer, will decline by about 0.4 percent per year. As compared with the dividend phase, this changing age structure of the population could lead to a downward swing in economic growth of 1.7 percentage points per year. That would be a very serious development and a great setback to China's efforts to join the ranks of high-income countries.

A second demographic dividend could be the answer to China's economic growth challenge, but it is far from automatic. First, as countries' birth rates decline they substitute child quality for child quantity. People around the world are having fewer children but they are spending more on each child. In particular, they are spending more on health and education for children. Countries end up with fewer workers, but workers who are healthier, more educated, and more productive. China's recent emphasis on improved human capital investment is an important step toward realizing this second demographic dividend.

Realizing the second dividend also requires an increase in wealth and investment. If the elderly are to be self-sufficient in old age, they will need to save more while they are working. By ensuring that China is well-endowed with both human capital and physical capital, a strong second demographic dividend is well within reach. But three additional steps are necessary if China is to meet its population challenges.

First, China needs to retool its approach to capital accumulation. High rates of saving and investment have been critical to fueling economic development, but wealth accumulated by State-owned enterprises and in sovereign wealth funds is not creating economic security for China's elderly. China needs to refocus its efforts on building strong and successful pension funds that can meet the dual goals of supporting both economic development and economic security for the elderly. China doesn't need to save more. If anything saving rates are too high. But China needs to save in a different way.

Second, China needs to make better use of its older work force. Labor income peaks at a very young age in China and drops sharply at a much younger age than in other countries in Asia, including South Korea, Japan, India, and Indonesia. Life expectancy is rising in China and older adults are much healthier than in the past. Extending the years spent in employment, lifelong learning, and better employment opportunities for older workers will contribute to stronger economic growth and better economic security for the elderly.

Third, China needs to reconsider its family planning policy. The low birth rate is leading to accelerated population aging making it more difficult to sustain economic growth and to meet major population challenges.

The author is a professor of economics at the University of Hawaii, senior fellow at the East-West Center, and co-author of Population Aging and the Generational Economy.

(China Daily 07/10/2012 page9)