Arnott: Demographics And The New Normal

September 10, 2013

  • The fourth phase merits less attention, because it is not imminent and is very speculative. For convenience, we model it as a new steady state with births matching deaths, and with long life spans, perhaps considerably longer than today's. We include it for comparison purposes; because Phases II and III are assuredly temporary, it must differ from them. This phase will be characterized by support ratios that are simultaneously higher than the demographic tail wind of recent decades and lower than what we'll see in Phase III over the coming decades. Although it may take any of several forms, we can reasonably hope that it will be an era of prosperity (a consequence of past and future technological innovations), renewable energy (and an end to global warming), general peace attributable to a global recognition of the merits of an established rule of law, and the perils of global conflict, with weapons of mass destruction.

In the second half of the paper, we try to answer the second question by using the links between economic growth and different age groups estimated in Arnott and Chaves (hereafter, AC/2012) to study the implications of the different demographic phases in terms of economic growth.

First, we confirm the strength of the demographic tail wind received during the second phase by comparing forecasted growth rates using (a) actual demographic profiles of the past, and (b) demographic profiles obtained from hypothetical steady-state populations with the same life expectancy. For instance, by comparing the 1960 U.S. demographic profile—which had a life expectancy very close to 70 years—with the steady-state demographic profile corresponding to a life expectancy of 70 years, we can actually derive how much of the growth during these boom times might be a direct consequence of the benign demographic profiles across the developed world in recent decades.

In other words, we're comparing the actual experience of the last third of the 20th century with an "alternative reality," in which life expectancy is the same as it was at that time, the population is roughly the same, but births match deaths. In our alternative reality, we have steady state: The population is stable and we have considerably higher support ratios relating to children and senior citizens, with both groups considerably more populous than the actual experience in the late 20th century.

We find that the third phase is worrisome: more seniors and proportionally fewer children or young adults than the world has ever seen. For countries with extremely low fertility rates—that would include most of the developed world and a growing fraction of the emerging world—the support ratios can become severe. The good news, on the other hand, is that this period is also temporary and does not represent a long-term "new normal." It's a new abnormal.

With this demographic head wind in the coming decades, we need to adjust our expectations to a lower level of economic growth. It is dangerous to expect our political leaders to deliver the same pace of growth—from a work force that is both slower-growing (even shrinking) and aging—that we enjoyed in the past. Our policy elite can create an illusion of prosperity in the same way that a family spends beyond its means, by borrowing from future generations and using the proceeds to fund current consumption.

 

 

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