Demographics and Productivity

In a post I that I wrote last week I said (speaking of Edward Hugh’s post on a recent article in The Economist called Suddenly, the old world looks younger)…..

But while I agree with most of what Mr. Hugh says, his post fails to relieve me of the need to write my own post. This is partially because I think Mr. Hugh misses several important flaws in The Economist article that I think should be pointed out. But mostly it is because Mr. Hugh is just too kind to The Economist.

Now I think I have compensated for Mr. Hugh’s over-niceness in my last post. But I never really dealt with any issue in The Economist‘s article that Mr. Hugh had not already tackled in his own overly nice way. As time permits this week, I would like to raise the various issues in The Economist‘s article on demographics that Mr. Hugh did not address in his post. I am not doing this to continue to pile it onto The Economist (I like a good rant, but you can have too much of a good thing), but because I think there are some important points that often get overlooked and The Economist‘s article is a good springboard for talking about them.

Before I continue, I should admit that I exaggerated when I said in my previous post that Mr. Hugh misses several important flaws in The Economist‘s article. He got all of the important flaws. But since there were so many important flaws he probably felt that it would be overkill to deal with some of the more subtle problems that the article had. This is understandable.

But when I am not getting all excited and going off on a rampage, I actually find the subtler sorts of problems to be more interesting than dealing with obvious flaws. So now that I have calmed down a bit, those are the types of problems in The Economist‘s article that I would like to focus on.

For today I would like to focus on this passage in The Economist‘s article….

In the decades after the second world war, rich countries everywhere experienced broadly similar trends. The bonds of traditional family life began to slacken. More women got jobs. People sought enjoyment and satisfaction more and more through individual pursuits, rather than in families. This social transformation, which also occurred in America and East Asia, led to a demographic bonus (a bulge of people in work) and to what might be called the postponement of everything. People left school later, left home later, married later, had children later. They also died later.

Now let us think about this for a moment. Whenever someone tries to start up a discussion on the negative long term effects of a low birth rate, you are sure to have someone come along who will say “nobody can predict the future, so why do you think you can intelligibly talk about a country’s demographic future” or something to that effect. But as The Economist is admitting in the passage above, demographic change has already happened. The only thing is, the effect of the demographic change has so far been positive.

This raises the question, why has demographic change been beneficial so far? The obvious answer to that question is the one The Economist provides. When you have one generation that has a lot of kids and those kids have far fewer children (on a per person basis) than their parents did, then you will have fewer dependents per working person. Having fewer dependents per working person will mean that there is more economic output in society as a whole. Thus, the whole western world has experienced what The Economist calls a “demographic bonus.”

But I don’t think the obvious answer of fewer dependents per worker tells the whole story of the demographic bonus. I think there is also a productivity boost per worker as the average age of your work force increases. At least, up to a certain point.

After all, research has demonstrated that people are at their most productive in their 40’s. At this age, the degradation of their body has not been sufficient to negate the benefit of their experience. This number is not written in stone. It is quite possible that 50 will become the new 40 in the years to come. In any case, up until a certain point, ageing increases your productivity.

It stands to reason then, that as the average age of your work force goes up; your average productivity is going to go up (at least until a certain point). Therefore, it would seem logical to conclude that at least some of the productivity growth in the western world has been due to the ageing of the workforce, and not investment in capital or technological advancement.

If you have been following what I have been saying, you will understand that the “demographic bonus” is two fold. You have a smaller dependent-to-worker ratio and your workforce is more productive on average than it would be if you had not had a “bulge” in your demographic profile. Combine these two factors together and you have a powerful stimulus to national growth.

Or at least, in theory, these factors account for a powerful stimulus to national growth. I don’t think that this issue has been studied with the rigor that it deserves. But what studies that are out there tend to confirm the theory. For example, this study estimates that the effects of a demographic bulge account for one-third to one-half of the growth experienced in East Asia between 1965 and 1990. And this study is focused on the decrease in the worker to dependent ratio. They don’t even take into account productivity gains associated with an ageing work force.

But even with the lack of studies, almost everyone in the thinking world seems prepared to accept that having fewer children is a big part of the European and Asian success story. Yet very few people in the thinking world are prepared to accept that this bonus will reverse itself and turn into declining productivity growth and an increasing dependent-to-worker ratio. Why is it so hard to accept that the gravy train provided by the demographic bonus is going to stop?

Part of the problem is undoubtedly due to wishful thinking, but another part of this problem is due to insufficient research. We don’t really have a good handle on the economic effects of the demographic changes that have already occurred, much less how those demographics will play out into the future. This is particularly true of the issue of the aging of the workforce and productivity.

This is a particularly important issue. If I am right in suspecting that the increasing average age of the work forces has played a significant role in increasing average productivity, then there are no grounds for optimism in regards to the western world’s economic future.

That statement might seem a little extreme. But consider this: most people who are optimistic about the likely effects of a demographic shortfall are depending on productivity growth continuing at same rate that is has been increasing over the last 40 years. This dependency takes two forms.

First of all, even the most optimistic forecasters acknowledge that the dependency-to-worker ratio is going to go up in the near future. In order to maintain living standards at present levels, those workers are going to need to be far more productive than today’s workers. To reach this goal, productivity increases need to at least match the rate of increase over the last 40 years or so. But if a significant amount of the productivity increases over the last 40 years was related to the aging of the work force, this is not going to happen.

Second, the optimistic forecasters are depending on people to work for far longer than they do today to mitigate the otherwise sharp increase in dependent-to-worker ratios. But in order for this to provide any real relief, the older workers in their 60’s need stay at least as productive as they were in their 40’s. After all, even if increased participation by older workers holds the worker-to-dependent ratio steady (which not even the most optimistic forecasters believe), yet you have declining average productivity, then living standards are going to fall.

The above is not going to convince anyone of anything they don’t already believe. But my intention was not to convert anyone to the doom and gloom camp. Rather, I wanted to highlight the need for more research into the effects of the demographic changes that have already taken place. Particularly in the area of the ageing of the work force that has already happened and how that relates to past increases in productivity.

Only when we know what has already happened can we make reasonable predictions about the future.

One Response to “Demographics and Productivity”

  1. Edward Hugh says:

    Nice post.

    “Or at least, in theory, these factors account for a powerful stimulus to national growth. I don’t think that this issue has been studied with the rigor that it deserves.”

    Yep. I completely agree. At the end of the day maybe I should start to stop thinking about economics and demography, and start to investigate the phenomenon of deafness. Not the physiological kind, since I imagine that is already reasonably well understood. What can, and what can’t we hear at any given moment in time? And why do people feel much better going round using expressions like “over easy” and “sunny side up”. Maybe evolutionary psychology could give some insight.

Leave a Reply