Tuesday, May 1, 2012

The Economic Advantages of a Declining Population

Hardly a week goes by when there does not appear a new article decrying falling fertility rates and aging societies. The theme is usually centered on the catastrophic effects of a decline in the fraction of the population of working adults. Nicholas Eberstadt has provided the latest entry in The Wilson Quarterly: Japan Shrinks. Eberstadt’s piece is different from most because he actually allows that there may be a viable economic solution that is consistent with a declining population. This is an issue we have approached in the past in Population Management: Aging Societies, Total Dependencies, and Fertilities, and in Demographics and Child Dependency: What It Costs To Raise a Child. Eberstadt’s article prompts us to continue the discussion in an economic context and provides Japan as an appropriate example.

Eberstadt begins by reminding us of some well-known facts about Japan and its population.

"By Tokyo’s projections, Japan’s population will decline from about 127 million today—the 10th largest in the world—to about 106 million in 2040. The working-age population (ages 15–64) will plunge 30 percent, from 81 million to 57 million. In 2040, by these projections, the total population will be declining by about one percent annually (roughly one million people per year), and the working-age population by almost two percent annually."

"Despite salutary trends in "healthy aging," Japan’s extraordinary demographics can only mean that a rapidly growing share of the country’s population will be frail in the years ahead—and that public pension allowances, health and medical services, and long-term care will be ever more pressing priorities for Japanese society."

There we have the standard concerns of economists: too many old people and too few workers. But then Eberstadt allows this comment to escape.

"....from a purely arithmetic standpoint, a country with a shrinking population—and even a shrinking GDP—could theoretically enjoy steady improvements in personal income and living standards."

Let us pursue this revolutionary suggestion and see how it might make sense.

The United Nations provides a fascinating array of data on past populations and future projections. It projects a world population in 2100 with this distribution of age and gender (males on the left, females on the right):



The UN seems to be making the bold assumption that humanity will come to terms with the earth and establish a stable population. What they have assumed here is a steady state population—input equals output.

The UN 2100 distribution above can be approximated as being uniform to age 65 and then declining linearly until age 100. One usually talks about demographic burden issues in terms of dependencies—the number of non-workers compared to the number of workers. Remember that there is a cost to society to support children as well as seniors. Traditionally, a child dependency is defined as the number aged 0-20 divided by the number between 20 and 65 and then multiplied by 100. Similarly, the dependency for the aged would consider the population over age 65. The sum of these two ratios would be the total dependency.

The table below provides the UN’s dependency ratios for several countries as well as those expected for the equilibrium population.


From this perspective, Japan’s population should not be described as "aged" because of the number of senior citizens; it should be described as having attained the equilibrium value.   It is the total dependency that matters and Japan’s burden is about the same as that of the US.

If a society with a declining population is to maintain a successful economy it must be able to provide at least a constant GDP per capita, it must be able to provide work for all its people of working age, and it must be able to provide social support to those who might need it.

Are seniors a burden on society that necessitates financial aid from a younger cohort in order to survive? Only if the seniors are poor. In Japan, for example, seniors control much of the wealth of the country. The wealth of senior citizens is determined to a great extent by the choices society makes in distributing its wealth. Much of what seniors in the US receive under social security comes from funds that they contributed with their payroll taxes. That component cannot be considered a burden on society.

Seniors need not be a financial burden on a society with a healthy economy. What about children? Data on the costs of raising children in the US can be found here. The numbers are large and growing. The costs are born privately by parents and publicly through education, and social support services.

At one time it was easy to raise a child: you fed it and clothed it and forced it to go to school and at age 16-18 it was capable of leaving home and entering the economy. At one time a person could make a good living with a high school diploma. Then a college degree was required to separate an individual out as an "achiever." Now the best positions seem to be reserved for those who have post-graduate education or experience such as an advanced or professional degree. For those seeking the best jobs, the age of "maturity" is rising towards 25 years. And those latter years can be very expensive indeed with costs shared by parents, society, and the children themselves in the form of student debt.

Not every child born can be expected to compete for the most intellectually demanding positions. Society must provide jobs for people with a range of capabilities. While children who might drift into a lower wage service occupation will not require as much schooling, they are still not cheap. Most expensive of all are those who remain unemployed. If an economy maintains unemployment rates in the 5-10% range, that is equivalent to being required to support 5-10% of children born for their entire lives.

It is the total dependency from the table above that must be dealt with. The argument is being made here that children are a bigger burden on society than the aged. If true, then a falling birth rate can balance whatever burden a burgeoning senior population might be. Society merely needs to decide to adjust to the changing demographics.

Evidence is accumulating that indicates a modern capitalist economy provides a small percentage of highly paid positions, a diminishing number of mid-level positions, and a great number of poorly paid, semi-skilled positions in the service sector. One of the reasons service sector positions tend to be poorly paid is that so many people compete for them.

A falling birth rate provides several advantages. Fewer children to educate would allow a greater level of public support for providing appropriate levels of education and training without exhausting the number of potential candidates for the ever smaller number of positions. Fewer applicants for necessary service functions would force employers to create higher quality and more responsible positions in order to compensate for the higher wages that would have to be paid. This can be a satisfying upgrade in situation for both the employer and the employee. Individuals who choose to remain childless will have more money to spend on savings, consumption, investments and taxes.

Is there any evidence that economies can succeed and provide prosperity in the face of declining populations? Consider Japan’s performance as an example.





When GDP per person is considered, Japan exceeds the US in creating wealth for its citizens. And it maintains an unemployment rate about half that of the US. Japan seems to be doing just fine with its falling population

The country in the above table that most nearly resembles Japan is Germany. Its population has also been declining for several years. Germany is the one country generally singled out as having the most successful economy among the developed countries. It also maintains an unemployment rate much lower than the US. Germany also seems to be doing just fine with its falling population.

Economists spend too much time trying to understand the past. When they look backwards all they see are growing populations. It does not have to be that way.

And we have not yet arrived at the ultimate arguments related to diminishing global resources and the impacts of global warming. We have more people than we need so let’s stop making so many!

9 comments:

  1. Rich, I commend your insightful critical thinking on the topic. It's a shame most people are not interested in comprehending the long term nature of demographic challenges.

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  2. Well done Rich! I've shared your article on the stable population party's facebook page https://www.facebook.com/populationparty?fref=ts

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  3. Finally, I found a piece that makes this case. No offense, but I wish a mainstream economist would take on this perspective in a popular publication--emphasizing how the shift in labor supply/demand can be a good thing for everybody. I'm so tired of the short-sighted predictions of economic disaster due to population decline by journalists jumping on the bandwagon.

    Nor does the conventional wisdom take into account the constant advances in productivity that technology is bringing and how that will help create enough wealth for all while finding the right balance for the planet

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  4. "Much of what seniors in the US receive under social security comes from funds that they contributed with their payroll taxes. That component cannot be considered a burden on society."

    This is not at all how the Social Security system works.

    "Social Security funds are not invested on behalf of beneficiaries. Instead, current receipts are used to pay current benefits (the system known as 'pay-as-you-go')"

    http://en.wikipedia.org/wiki/Social_Security_debate_in_the_United_States

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  5. Social security funds are invested in Treasury Bills. Since the government continually has a need to borrow, the funds are actually used to offset some of the borrowing needs. This is functionally equivalent to having a "Trust Fund" that has purchased securities and is earning interest on them, although the bookkeeping can be confusing. Social Security taxes offset government debt therefore the participants are contributing and are owed the results of their contribution. It is incorrect to refer to this as "pay as you go."

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  6. False.

    Compare the expenditures to the "net increase" here: http://www.ssa.gov/history/tftable.html

    "Social security funds are invested in Treasury Bills."

    No, only the SURPLUS can be invested. As you can see from the table, SS accumulated funds early in its life in the 30s and 40s... and then was entirely pay-as-you-go until about 1987, when surpluses increased due to the Greenspan reforms. Even then, at no point has the amount invested been enough to cover expenditures. This makes the system almost entirely pay-as-you-go.

    Furthermore, since 2010 there has no longer been any surplus. So your argument is no longer applicable at all.

    I would suggest reading Kotlikoff's work in this area, specifically this one: http://www.amazon.com/Clash-Generations-Saving-Ourselves-Economy/dp/0262016729/

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  7. There really no reason not to slowly increase the retirement age to 70. When "retirement" and SS was first implemented in the 1930s for age 65 that was also pretty close to the average life span. Not many people were expected to live long enough to collect. Now that life spans are closer to 80 it does not make sense for retirement to be age 65.

    You can also look at it in terms of years of work, as Rich mentions peopel now start their work life close to 25 than 15 (when my father started working having completed grade 8 in the early 1940s). That generation worked 50 years (and we should admit that those were a lot more difficult working conditions than any of us face today) before retirement.

    I think most studies of old age benefits show the 'underfunding' problem goes away with just a few extra years of work before retirement. Keeping these workers in the workforce a few extra years also alleviates out a lot of the 'running out of workers' fears.

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  8. Actually, the life expectancy at age 65 has increased over the years, but mainly for the more wealthy. The less wealthy, those who depend most on Social Security, have seen little improvement in life expectancy.

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