In the 1960s and 1970s, the take-off of Japan’s post-war growth was associated with the entry of the post-war baby boom generation into the Japanese workforce. The average age of persons employed in the Japan External Trade Organization (JETRO) was just 26 when I first went to Japan in the early 1960s. That was typical of many fast-growing Japanese firms and organisations at the time. Now the average age would likely be closer to 50. Then, the rapid growth of the young working-age population propelled the acquisition of skills and lifted productivity around the introduction of new technologies, boosting the trajectory of growth first in Japan, later in Korea, then other Northeast Asian countries and the early developers in Southeast Asia. Between the mid-1960s and the early 1990s, the working-age population in East Asia grew almost four times as fast as the population as a whole, so what is called the ‘dependency ratio’ (the ratio of children and old people outside the working age population to total population) fell. This meant, of course, that output per head rose even more quickly.

With low fertility rates and an ageing society, Japan now faces the demographic burden of a rising dependency ratio and the need to lift the productivity of the working age population even more rapidly in order to achieve positive per capita income growth. In the past decade, average Japanese growth has only been 0.9 per cent, although labour productivity has grown by 1.8 per cent — among the highest in the developed world. An increasingly productive workforce is supporting a population with a higher proportion of retirees and other dependents.

Other countries (for example in Latin America) have enjoyed favourable demographics in the form of a young and growing population without capturing the demographic dividend in high growth. The difference in performance across countries depends on what else is done in the way of investment in physical and human capital, introducing new technologies and know how, and opening the economy up to international markets and competition to promote high growth.

China’s recent remarkable growth too has benefited from capturing the demographic dividend as well as getting development strategies right. A growing, young workforce has contributed to strong output growth per capita. Yet China’s demographic dividend, it has always been clear, was bound to be truncated by its famous one-child policy which sought to avoid the social, environmental and political problems associated with expansion of its already huge population base. Demographics are reasonably predictable, at least in the medium term. But just how soon China’s demographic crunch would come was not entirely predictable, because fertility rates and other social factors affect population and workforce growth independently of policy controls.

This week’s lead essay from Cai Fang, China’s leading demographic and labour force expert, drops the bombshell that China’s workforce has already begun to shrink — a message delivered with impact at this year’s China Update in Canberra recently. This has happened well before per capita incomes have reached advanced country levels, as they did in Japan towards the end of the 1980s.

The fertility rate in China has apparently plummeted to 1.4 (births per woman in a lifetime), a ratio that is low by industrial country standards. The age structure of China’s population has changed dramatically. The latest census data reveals that the absolute number of people between the ages of 15 and 59 (the core working age population) began to fall in 2010. Over the decade through to 2020, this age group will shrink by 29.3 million. This represents a substantial fall in labour supply.

At the same time, Cai points out, ‘Chinese economic growth continues to generate strong demand for labour. In the period 2001 to 2011, for instance, total urban employment (urban resident employees plus migrant workers) increased by 115 million’. Even if this number is cut in half in the next decade, it will greatly exceed the diminishing supply of entrants to the workforce.

This circumstance will require an elevated focus on reallocation of labour across the country. Rural-to-urban migrants — not new local entrants to the labour force — will be increasingly critical to meeting the demand for labour if relatively high economic growth is to be maintained.

This turning point in the labour market, putting upward pressure on wages and requiring a raft of structural reform, will cut in earlier in China than it has in other emerging economies because of truncation of the demographic dividend. It is one reason why the growth rate will decline over the coming decade. The potential annual GDP growth rate has fallen from 9.8 per cent in 1995 to 2009, to 7.2 per cent in 2011 to 15 (under the Twelfth Five-Year Plan), and is expected to be 6.1 per cent in 2016 to 20 (under the Thirteenth Five-Year Plan).

But, Cai concludes, ‘there are reasons to be optimistic about China’s future growth’. The potential rate of growth can be lifted, for example, through hukou reform aimed at accepting migrant workers as urban residents with full access to public services, expanding and stabilising labour supply; through investment in education, increasing the contribution of human capital to economic growth; or if barriers that prevent labour and capital from moving across regions are removed, encouraging the reallocation of resources to higher value-added uses.

These are unusual challenges that will require, as Cai says, Chinese policymakers to ‘resist the temptation to employ policy measures that distort prices and waste resources to stimulate short term growth’, and to make efforts to raise the potential rate of growth in the long term instead.

Peter Drysdale is Editor of the East Asia Forum.