A New ‘New Normal’ In Demography And Economic Growth

August 27, 2013

Suppose we compare these hypothetical steady-state distributions with actual distributions from countries that currently have very similar life expectancies. The best examples are Canada, France, Germany and the United Kingdom, whose life expectancies in 2005-2010 are within one year of 80. Figure 4 shows that the current fraction of individuals in age group 20-64 is roughly 58 percent, well above the expected value of 53.8 percent for a life expectancy of 80 years. The other two age groups, 0-19 and 65-plus, are currently below their expected values of 24.6 and 21.7 percent, respectively. Note that current demographic profiles have relatively lower support ratios than steady-states ones. The steady-state involves higher support ratios than today's demographic profiles. Before we reach a new steady state, as we have shown above, during Phase III we will experience strong head winds that are worse than the eventual steady state.

We hope that this summary of past and future demographic phases clearly suggests that demography is driving many of the drastic changes in the economic profile of developed and emerging countries, and that these changes are poised to accelerate in the coming years. We now turn our attention to the impact that demography may be expected to have on economic growth.

Implications For The Economy
Our previous discussion about the four phases of demographic development invites a few important questions:

  1. How much of a tail wind did we enjoy during Phase II?
  2. How much of a head wind can we expect during Phase III?
  3. Assuming that a (Phase IV) steady state will eventually be reached, what can we expect in terms of economic growth?

In answering these three questions, we end up magnifying one troubling attribute of our earlier work: With the sharp increase in the roster of senior citizens in steady state, the implied real GDP growth derived from the relationships in AC/2012 is actually negative if life expectancy rises beyond current levels. This is not plausible: Steady state, even with no technological innovations that boost future productivity would, of necessity, be a world of zero real GDP growth, not negative growth.

This result is less disturbing than it seems, however, when we realize that our previous work was built on a foundation of data drawn from 1950-2010, a period of remarkably benign demography. Moreover, steady state is quite radically out-of-sample, so we are no longer interpolating within past data; instead, we are extrapolating to estimate the results in profoundly different circumstances. Tacitly, we are also assuming that a series of socioeconomic circumstances remain the same, even with fast-rising longevity: The retirement age doesn't change, employment policies and resulting productivity don't change, entitlement programs don't change, and so forth. So, the final question we try to answer is the following one:

  1. Given that these data implausibly point to negative real per capita GDP growth with any steady-state population, if there's any increase in life expectancy at all, what do we make of these findings?

 

 

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