Demography Is Rewriting Our Economic Destiny
The idea that the world economy is undergoing a demographic transition is now so familiar that it barely even registers. The point is noted; the conversation moves on. This is a mistake. It's important to recognize just how powerful a force this shift is going to be.
A remarkable boom in the world's working-age population is ending, and a new boom in the population of retired people has begun. People are living longer; more importantly, when it comes to reshaping the global age structure, they're having fewer children. Today, there are roughly four people of working age for every person aged 60 or over. By 2050, it's estimated there'll be just two. The steep fall in this ratio is unprecedented.
What will it mean? For one thing, of course, systems for paying incomes in retirement will come under serious pressure. But the implications go far wider than that.
In a couple of recent notes for VoxEU, the portal of the European Center for Economic Policy Research, Charles Goodhart and Philip Erfurth explain the connections between global demographics on the one hand, and economic growth, real interest rates and inequality on the other. Seemingly entrenched patterns, they argue, are likely to be disrupted over the next two or three decades.
The starting-point is that countries with older populations tend to save less, because people save while they're working and then run down their savings in retirement. As patterns of saving change, so will flows of capital. Through this channel, demographic forces were implicated in the global financial imbalances that helped cause the Great Recession. Looking ahead, they'll shift the pattern of financial imbalances, and all that follows from them, again.
For years China and Germany have had persistent current-account surpluses (reflecting an excess of saving over investment), while the U.S. has been persistently in deficit. But China and Germany are now aging faster than the U.S. Their so-called support ratios -- the number of workers per consumer -- are falling faster. So their external surpluses are likely to decline.
Japan, at the leading edge of the aging curve, shows the way. By the same token, the U.S. deficit is likely to narrow. In the future, Africa, Latin America and South Asia will have relatively high support ratios -- which implies high saving, which implies external surpluses. The global economy will look very different.
Another supposedly entrenched pattern, also about to be disrupted, is the long-term decline in real interest rates. As the recent literature on secular stagnation makes plain, persistently low interest rates are a big problem for economic policy. They make it harder to provide monetary stimulus when needed, and they can create the conditions that lock in sub-par growth.
The heavy hand of demographics will strike here too. The global balance of saving and investment drives the long-term real interest rate. An aging global population implies less saving. The question is whether it also implies less investment. If not, or if investment demand falls by less than saving falls, the net effect will be to raise the real interest rate. That's what Goodhart and Erfurth expect to happen.
The reasoning is as follows. At first sight, lower population growth suggests less demand for investment in housing, but rising incomes lead people to want bigger houses or (in the case of young adults and the elderly) a house of their own rather than space in somebody else's. Residential investment may not fall very much.
Business investment has been lower than usual in recent years, but that may be a consequence of the "demographic premium" that's about to go into reverse. In recent decades, high support ratios plus rapid globalization created a huge increase in the effective worldwide supply of labor. You'd expect a glut of cheap labor to suppress investment. This is now about to flip. Because of the age transition, the global supply of labor will grow more slowly. This should support the demand for investment.
In the aggregate, Goodhart and Erfurth argue, investment demand is unlikely to fall as much as saving.
The obvious, indeed almost inevitable, conclusion is that real rates of interest will reverse from their present decline, and go back up. The current negative real rate of interest is not the new normal; it is an extreme artefact of a series of trends, several of which are coming to an end. Where might real interest rates reach? By 2025 they should have returned to the historical equilibrium value of around 2.5–3.0 percent, with nominal rates therefore at 4.5–5.0 percent, perhaps somewhat higher by 2050.
This casts doubt on one form of the secular-stagnation thesis. But don't mistake it for good news -- except for central bankers, whose job would be easier if the equilibrium interest rate went back up to 3 percent. Slowing growth in the number of workers and abrupt declines in support ratios mean less saving and less economic growth.
Labor will be more scarce, so pre-tax wages may rise, and the recent decline in the labor share of national income may reverse. Inequality, measured that way, may moderate. Taxes, though, will have to go up to support incomes in retirement. And in any event, output per person -- living standards measured across the whole population -- will grow more slowly. That's just arithmetic.
It's hard to believe that the past couple of decades have been as good as it gets. Yet, in one crucial sense, that's the case. You can be more or less optimistic about technological prospects and the outlook for growth in productivity -- I'm at the cheerful end of that spectrum. But there's no denying that, demographically speaking, a golden age is coming to a close. We've barely even begun to think this prospect through.
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