Friday, November 28, 2014

Lower Working Age Population and Secular Stagnation

The "working-age population" is often defined as those from age 15-64. For many high-income and emerging market economies, the growth in the size of the working-age population has been dropping. Indeed, in Japan the working-age population started contracting back in the mid-1990s; the size of the working age population in the European Union (excluding the UK) started contracting about 2010; and the working age population in China (after several decades of a one-child policy) is projected to start contracting in the next few years. For most high-income countries, the working-age share of the population is in decline.

A decline in the size or population share of the working-age population is a concern for several reasons. In the last few decades, the commonly expressed concern was that it was going to be difficult to finance retirement and health benefits for the growing elderly population. More recently, the concern has been that slower growth in the working age population might also slow down economic growth. This argument was central to the case put forward by Alvin Hansen in the 1938 speech where he raised questions of whether the U.S. economy had entered a phase of "secular stagnation"--that is, a permanent slowdown in economic growth.

For example, Hanson said: "[F]or our purpose we may say that the constituent elements of economic progress are (a) inventions, (b) the discovery and development of new territory and new resources, and (c) the growth of population. Each of these in turn, severally and in combination, has opened investment outlets and caused a rapid growth of capital formation." Hansen then noted that population growth had slowed down and that US territory was no longer expanding. Thus, he argued: "We are thus rapidly entering a world in which we must fall back upon a more rapid advance of technology than in the past if we are to find private investment opportunities adequate to maintain full employment. ... It is my growing conviction that the combined effect of the decline in population growth, together with the failure of any really important innovations of a magnitude sufficient to absorb large capital outlays, weighs very heavily as an explanation for the failure of the recent recovery to reach full employment."

For a sense of the slowdown in the growth rate of the working-age population since 1970 and in the next few decades, here's a figure from the "Free Exchange" column in the November 22 issue of the Economist. The U.S. economy, with a relatively high birthrate and relatively high levels off immigration, is projected to have slower growth of its working-age popoulation--but not an actual decline.

Here's a figure from a November 14 post by "the data team" at the Economist blog, showing the share of the population of working age. Notice that for Germany and Japan, the share of the population in the 15-64 age bracket peaked more than two decades ago. For the U.S., the peak in the working-age population is only a couple of years back. All of the high-income countries shown here are projected to have a sharp decline in the working-age share of the popoulation in the next few decades, although the share in the U.S.  is projected to remain the largest.

Why might a lower working-age population lead to a slower rate of economic growth? One reason is just mechanical: that is, Other things at least roughly equal, a 1% rise in the number of workers will add about 1% to the GDP.  But this factor only means that we should focus on the growth of per capita or per worker GDP, thus adjusting for the slower growth rate.

Two other concerns are potentially more serious. First, when the working-age population is growing, firms have an ongoing necessity to expand their investment spending, just to keep up with the number of workers. Conversely, slower growth of the working-age population reduces incentives to invest. Second, if the slower-growing or relatively smaller working age population finds that it must bear a substantially higher tax burden to support the growing proportion of elderly, the disincentives to work could become a factor in slowing growth.

What are the broad policy implications of a slow-growing or relatively smaller working age population? U.S. investment levels have indeed been lower than expected in recent years, given that the Great Recession officially ended back in mid-2009. Following in the lines of Alvin Hansen's 1938 discussion, one can imagine three possibilities for minimizing the risk of secular stagnation.

First, one might try to avoid the population decline. Government support for family-friendly policies hasn't had much substantial effect on falling birthrates across high-income countries. But there are other possibilities. The United States has relatively open border to legal immigration, not to mention illegal immigration, which increases the working-age population. Also, one can imagine expanding the definition of "working age" so that it considers workers in the 65-75 age range. A number of steps could be taken to encourage a larger share of these workers to remain in the workforce, at least part time.

Second, Hansen emphasized "the discovery and development of new territory and new resources." Substantial discoveries of new territory seem implausible, but the possibilities of expanding trade by active participation in the globalizing economy remain viable. Also, the U.S. economy has the capacity for a considerable expansion of its energy resources. As I have argued in an earlier post, I personally favor what I like to call "The Drill-Baby Carbon Tax: A Grand Compromise on Energy Policy." Such a policy would move ahead with all deliberate speed both on developing U.S. energy resources and also on finding ways to reduce carbon and other emissions.

Finally, Hansen mentioned the potential for new technology to create opportunities for investment in physical capital, so that that new technology can boost productivity and the surge in investment spending can also give a boost to macroeconomic demand. Potential policies here include encouraging a surge in public and private infrastructure, as well as aiming to double or triple the level of national research and development spending.

When the working-age population is growing, it stirs up the economy in a way that is often conducive to growth. With growth of the working-age population slowing, alternative ways of stirring up the economy and encouraging growth become even more important.