Productivity Trumps Demographics
By Michael Mandel
In his 1798 book, An Essay on the Principle of Population, Reverend Thomas Malthus argued that rapid population growth would inevitably exhaust the food supply and lead to permanent immiseration. "Population has [the] constant tendency to increase beyond the means of subsistence," intoned the good Reverend wisely. Demography was destiny.
Malthus was wrong, of course. His gloomy scenario never came to pass, in large part because productivity gains from the Industrial Revolution far outstripped any population growth. Indeed, even as he was writing, Britain was about to enter into a century of increasing population and sharply rising living standards.
OFF THE MARK.
Today, plenty of economists still want to argue that demography is destiny. But instead of overpopulation, the bugaboo is a future with not enough people -- or more specifically, not enough working people. In the U.S. the common assumption is that the aging of the baby-boom generation will create an economic crisis, where fewer and fewer workers will labor to pay the Social Security and health-care bills of more and more retirees.
As for the rest of the world, we're told that countries with low birth rates, such as Germany, Italy, and Japan, are going to be hit by the same problems courtesy of their aging populations, only faster and more dramatically than in the U.S.
But history shows that the importance of demography is way overblown. Malthus' false assumption is the rule rather than the exception. Time after time, economic predictions based on population shifts, while seemingly common sense, have been off the mark. It's shifts in technology and growth trends that rule well being -- and they'll continue to rule in the future.
HOUSE OF CARDS.
Let's look at a few recent examples of economic soothsaying based on demographic reasoning. In the 1980s and early 1990s, many economists predicted that the savings rate would rise as the baby boomers got closer to retirement age. It seemed completely obvious that people would want to sock away more money for their old age. In fact, the flow of new savings from worried baby boomers was supposed to boost the stock market. (This argument was often trotted out by Wall Street strategists as a reason why share prices would go up.)
Similarly, in 1988, Harvard economist N. Gregory Mankiw, now head of the White House Council of Economic Advisors, argued that the aging of the baby boomers was going to undermine the housing market. "Housing demand will grow more slowly in the 1990s than in any time in the past 40 years," wrote Mankiw and his co-author, David Weil. As a result, they said, "real housing prices will fall substantially over the next two decades."
Both the savings and housing forecasts were wrong -- for the same reason. The dominant factors of the 1990s were sharp increases in growth, productivity, and incomes, not demographics. With higher incomes and low interest rates, the demand for home ownership soared, in direct opposition to what Mankiw predicted. It didn't matter what population growth was. What mattered was that more people had enough money to buy their own homes.
And instead of rising, the savings rate actually plummeted, from 4.8% in 1994 to a stunningly low 0.6% in July, 2004. Interestingly, even with this fall, the net worth of households has almost doubled over the past 10 years. It has increased by $21 trillion, according to figures from the Federal Reserve. The reason is simple: Existing home prices are up by 75% since 1994, and stock prices are up by almost 150%, the direct result of the acceleration of productivity, not an increase in savings by investors.
What about the big demographic crisis of the future, the aging of the baby boomers? The "dependency ratio" -- the ratio of Americans 65 and older to those 20 to 64 -- is expected to more than double from 2005 to 2080. That is undoubtedly a big change, with tremendous cultural ramifications. But the demographic shift will happen over so many years that its economic impact can be neutralized, if productivity continues to grow at current rates.
Here's the math: Productivity growth for the whole economy has run at a rate of 2.3% or so annually since the mid-1990s (based on calculations by the Social Security Administration). Suppose the U.S. can maintain this rate for the next 75 years. The result would be an almost sixfold increase in output per worker. With each worker in 2080 producing six times more than a worker today, plenty would still be left over even if each worker had to support twice as many older Americans.
Of course, the demographic shifts loom larger if there's a slowdown in productivity growth. But that's precisely the point: The biggest danger is a slowdown in technological advance, not the aging of the population. In the end, growth trumps demographics.
Mandel is chief economist for BusinessWeek
Edited by Patricia O'Connell