Ageing demographics to crunch global growth

Over the past few years, I have written a series of articles arguing that the ageing of populations across the globe would have major adverse implications for consumption spending, asset values, and government revenues and taxation.

I have also argued that the impacts from ageing would likely be most acute in Western Nations, although some developing countries, most notably China, would also be negatively affected.

The problem stems primarily from the coming end of the demographic ‘sweet spot’. That is, where there is a high proportion of working age people supporting only a small pool of dependents. Such an advantageous age structure has effected almost all of the world’s major economies and produced a population structure optimal to economic growth – that is, where the largest segments of the population were neither young nor old, but in the middle (i.e. working age).

These demographic sweet spots can be seen in the below charts, which show the dependency ratios of each major economy – i.e. the ratio of the non-working population, both children (< 20 years old) and the elderly (> 65 years old), to the working aged population.

In the Anglosphere, of which Australia is a part, the dependency ratios fell steadily in the decades to 2010. However, in the decades ahead, their dependency ratios are projected by the United Nations to rise steadily as the baby boomers retire and their populations age:

In some major European countries, as well as Japan, their populations aged earlier and their dependency ratios bottomed in the 1990s, which might help to explain some of the economic malaise currently being experienced across those regions:

Earlier this month, Index Universe published an interesting report estimating the impact of population ageing on a wide range of economies. And the results aren’t pretty:

…until recently 3–4% growth in real GDP was considered “normal.” So it should come as no surprise that the economic performance of the past few decades has strongly influenced expectations about economic growth. However, when optimistic expectations get detached from reality we risk creating a significant expectations gap—a disconnect between what we take for granted given our recent experiences and what we should anticipate given simple arithmetic.

…favorable trends in the size and composition of populations have helped to fuel the rapid economic growth experienced in the developed world over the past 60 years, and their reversal plays a crucial part in the current rapid deceleration in developed world growth…

We forecast growth in Real Per Capita GDP (holding everything else constant) for every five-year interval between 1950 and 2050, based on the demographic linkages observed in the 1950–2010 data spanning 22 countries. These are not “normal” GDP growth rates, they are abnormal GDP growth rates, reflecting the impact of a demographic tailwind or headwind…

All 12 countries will confront varying speeds of demographic headwinds in the coming decades, first in the developed economies, then in the older emerging economies (China and Russia), and finally in the younger emerging economies (Brazil and India). These headwinds get stronger over time and appear to stabilize in the developed world and the older emerging economies only after about 2040. For the younger emerging economies, the demographic headwinds do not become acute for perhaps another 20–30 years.

All 12 countries enjoyed demographic tailwinds during the past 60 years, so these headwinds will feel more obstructive than they are. It is human nature to consider our personal experience to have been “normal,” so we evaluate subsequent events in comparison with this self-referential “norm.” If the people of Japan consider the former tailwind of 2–3% to be “normal,” then a future 2% headwind will feel like a ponderous 4–5% drag, relative to expectations. On average, the countries in this analysis enjoyed benign demographic profiles that boosted GDP growth by around 1% per year during much of the past six decades…

Our main goal in presenting these results is to correct the common misconception that developed countries went through a “normal” period of high growth, as if we are all entitled to fast-growing prosperity. In reality, the developed world is entering a new phase in which the low fertility rates of past decades lead to slow growth (in many countries, no growth) in the young adult population; young adults are the dominant engine for GDP growth. Mature adults, many of whom are at or near their peak productivity, are poised to retire, creating an impressive surge in the rolls of senior citizens. These newly minted senior citizens, transitioning from near-peak productivity to retirement in a single step, will be drawing on the economy while no longer producing goods and services. The unequivocal good news of a steady rise in life expectancy means that these retirees will create a very substantial drag on GDP growth, as these seniors move from peak productivity to negligible productivity in just a few years.

The danger is not in the slower growth. Slow growth is not a bad thing. It’s still growth. The danger is in an expectations gap, in which we consider slower growth unacceptable. If we expect our policy elite to deliver implausible growth, in an environment in which a demographic tailwind has become a demographic headwind, they will deliver temporary outsized “growth” with debt-financed consumption (deficit spending). If we resist the necessary policy changes that can moderate these headwinds, we risk magnifying their impact.

As argued above, the high growth rates experienced in the decades leading-up to the global financial crisis were an anomaly and growth is likely to be far more sedate going forward as the population ages and dependency ratios worsen. And although Australia won’t be hit as hard as some other nations, it too will feel the pinch.

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