China’s population is shrinking, and the demographic shift will ultimately hurt its economy, shrink the labor force and put pressure on fiscal policy.

“The working age population [in China] will fall so rapidly over the next decade, that the Chinese economy will need to deal with 1% drag in GDP growth per year for next 10 years,” Darren Tay, head of Asia country risk at BMI Country Risk & Industry Analysis, told “Squawk Box Asia” in June, referring to estimates gathered by evaluating world population data released by the United Nations.

“The fiscal strain as a result of ageing is immediate and concerning,” the Economist Intelligence Unit has warned.

“Economic growth hinges on productivity, capital accumulation and labour inputs. The negative effect of an adverse demographic landscape will manifest primarily through a shrinking workforce,” according to the report published in January.

Raising the retirement age is “one of the few viable options” to maintain long-term fiscal balance, the EIU said.

“Our calculations suggest that if the retirement age is raised to 65 by 2035, the pension budget shortfall could be reduced by 20% and received net pension can be increased by 30%, suggesting relief of both government and household burden,” according to the report.

Birth rates are falling around the world as women choose to have children later, or not at all.

Fertility rates have halved across OECD countries — some of the world’s richest nations — falling from about 3.3 children per woman in 1960 to about 1.5 children per woman in 2022, according to the OECD, or Organisation for Economic Co-operation and Development.

“This is significantly below the ‘replacement level’ of 2.1 children per woman needed to keep population constant in the absence of migration,” according to the June report.

China’s shrinking population

China’s population fell for a second consecutive year in 2023 to 1.409 billion people — dropping by 2.08 million from the previous year, according to data from the National Bureau of Statistics of China.

That’s more than the population decline of about 850,000 in 2022 — the first year deaths outnumbered births in the country since the early 1960s during the Great Famine.

“This is a consequence of the one-child policy [set] in place [in] the 1980s,” Erica Tay, director of macro research at Maybank, told CNBC.

China’s population is expected to shrink to 1.317 billion by 2050, and drop by nearly half — to 732 million — by 2100.

Fertility rate in the country is dropping more quickly than its regional peers like South Korea and Japan, Tianchen Xu, a senior economist at The Economist Intelligence Unit (EIU), told CNBC.

He said the three countries are disproportionately impacted by a rapidly aging population, largely due to improved standards of living, which have a “very strong inverse relationship with fertility rates.”

China, in particular, has been “growing at a very high rate for nearly three decades.” and its economic expansion has been “rapid and extended,” he added.

The country’s welfare system has also “lagged” and fiscal support for childbearing is “quite low by international comparison,” according to Xu.

Surging home prices are not helping.

“The government has largely been incapable of managing the significant rising housing costs,” according to Xu, who pointed out that as housing becomes increasingly costly, people may find it difficult to purchase homes and delay starting a family.

Falling birth rates

The rapid economic expansion seen in recent decades in developed nations has brought about rising income levels and the broadening of educational and career opportunities for women.

These improved conditions have led to a greater opportunity cost for having children, Xu said.

“In more developed societies, the tendency is that parents face a much higher cost of raising children, and that tends to be a deterrent to having [them],” said BMI’s Tay.

“The more developed an economy is, the more skills the actors in the economy have to have, and thus, the required investment in each [child] rises by that amount,” he said.

The work culture in Asia can also play a part.

“Among the Asian countries, there’s the entrenched mindset of working long hours,” said Xu, which is “particularly an issue in China, South Korea… [and] other parts of East and Southeast Asia.”

“These countries are where the aggregate working hours are the longest in the world,” and as a result, workers have less time to build a family, Xu told CNBC.

Shrinking workforce

A decline in fertility rate puts pressure on the economy and the society at large as the working population shrinks.

“A country’s birth rates will translate into its working age population growth, some two decades down the road,” said Tay from Maybank..

Additionally, falling fertility rates can impact the ratio of elderly folks who need support from younger generations, which can put “excessive burdens on a country’s health care and pension systems,” Maybank’s Tay told CNBC.

Ultimately, the burden on younger generations will grow as they need to care not only for their own children, but for their elderly parents as well.

This demographic shift in parts of Asia is a structural issue that will require “determined and holistic government effort,” on both fiscal and monetary policy, she said.

China’s policy shifts

In China, policymakers have been putting a big emphasis on “productivity growth,” Xu told CNBC.

“They have [seen] that there’s a very big decline in the labor contribution to GDP, [which] cannot be mitigated via any sort of policy intervention in the short term,” he said. “That’s why they have been focusing on their productivity growth.”

The country has invested heavily into shifting to digital solutions and developing technologies such automation and advanced chips, said Xu, with the goal of making traditional industries more efficient, and overall, improving productivity.

Looking ahead, Chinese policymakers are encouraged to do more about the labor environment. “That probably entails tighter enforcement of the labor law and promoting work-life balance,” said Xu.

Economists also agree that Chinese policymakers should also work to raise the retirement age in the country, create more aggressive tax rebates for costs associated with child-rearing, and step-up its efforts in constructing affordable housing in the country.

Despite the slowdown in growth expected in China due to its demographics issue, the country’s GDP has grown an average of 9% per year since 1978, according to the World Bank.

Ultimately, “the fact remains that growth of even around 3% would not be, by any stretch of the imagination, a disaster for the Chinese economy,” Tay from BMI told CNBC.

“If they would continue to grow at that pace, which probably would be more sustainable, the average Chinese citizen would be in real terms, better off in income by 13% by 2033,” he added. “So living standards would still continue to rise.”