Summer 2023

Intentional action can ease demographic pain

Long-term predictions are not set in stone, writes Simona Mocuta, chief economist, State Street Global Advisors.

Demographics and economic growth are inexorably linked. The production of nearly any good or service requires a combination of labour and capital, with varying relative weight for each of these two factors of production. Increasing the quantity or quality of either generally leads to higher output. The converse is rarely true, and certainly not for extended periods.

The dismal demographic outlook outlined in long-term United Nations population projections therefore implies deteriorating growth for the world economy. Within the next 15 years, the population growth rate of those aged 15-64 (considered standard working age) will halve from 0.8% to 0.4% annually. Fifteen years after that, it will halve again to 0.2%.

The world will either need to deploy more capital or make better use of its existing workers to compensate for the slowdown in available labour resources. The good news is that we can do – and have done – both.

While having a guaranteed inflow of ‘able bodies’ each year is a definite plus, there is more to the story than merely growing the pool of potential workers. They need to change status from ‘employable’ to ‘employed’ or, at least, ‘actively looking for work’. In economics, this is captured by the labour force participation rate. If a person is of eligible age but is neither employed nor looking for work, they are not counted as being part of the labour force. They may still perform valuable unpaid work like child or home care, but their contributions will not be counted in official gross domestic product statistics.

Two countries with similar populations could have very different growth outcomes if their labour force participation rates differ widely. Such divergences are most common in respect to women, as their perceived role in society can hinder an active engagement in the labour force. Figure 1 illustrates both persisting headwinds in this respect (Italy, India) and the potential for material improvement in relatively short period of time (Japan).

Figure 1. Number of women in labour force varies widely across countries

Female labour force participation, 15-64 years, %

Source: Macrobond, SSGA Economics, Organisation for Economic Co-operation and Development

Another opportunity lies in the distribution of employment across industries. Labour productivity is much higher in manufacturing than it is in agriculture as the shift from agriculture to industry is accompanied by a process of capital deepening. The same number of workers employed in manufacturing will produce more than if employed in agriculture.

All economies have benefitted from this at one point or another along their industrialisation journey. Most emerging markets still have considerable room to harvest such benefits. Not least among these are the two largest – India and China – where agriculture still accounts for 44% and over 24% of employment, respectively (Figure 2). By contrast, most developed economies have already exhausted this channel of growth – agriculture employment accounts for less than 2% in both Germany and the US.

Figure 2. Agriculture still accounts for significant employment in emerging markets

Agriculture employment, share of total, %

Source: Macrobond, SSGA Economics, World Bank

At a global level, making better use of existing labour resources or enhancing the productivity of those resources through capital deepening are the two main avenues to counter the headwinds associated with slowing (or even negative) population growth.

At a country level, another lever exists. Immigration has long been a key factor augmenting population growth in the US, while countries such as Canada, Australia and the UK (before leaving the European Union) also rely quite heavily on it. It is a marginal factor across the developed world but, even in societies long averse to immigration, the tide seems to be changing.

Japan is a fascinating example in this regard. Along with Italy, it has one of the worst demographic outlooks in the world. It is against this backdrop that the number of foreign workers in Japan has grown from under 500,000 in 2008 to over 1.8m in 2022 (Figure 3). It is not enough to fully offset poor domestic demographics, but migration can play a powerful mitigant role.

Figure 3. Immigration plays an important role in Japan’s labour force

Number of foreigners in labour force, millions

Source: Macrobond, SSGA Economics, MHLW

There are many other nuances to the demographics-growth connection. But, even as there is a lot of truth to the ‘demographics is destiny’ tagline, intentional action can alter that destiny at a national level. There is no need to throw in the towel already.

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