How Demographics Drive the Economy

How Do Demographics Drive the Economy?

There is a straightforward relationship when identifying the sources of economic growth:

Where:

• GDP per capita = GDP divided by population

The Cobb-Douglas relationship provides another way of looking at the same idea: change in economic output is related to the change in capital stock, change in labor stock, and change in the state of technology. What is important about both these models of economic growth is that demographics play a key role.

The demographic problem that lies on the horizon is an increasing number of retirees who, while no longer in the workforce, are nonetheless expected to live longer lives. Unfortunately, the number of new births seems to be too low to replace those retirees in the workforce.

Understanding How Demographics Drive the Economy

Economic growth depends on productivity gains and changes in the number of people in the workforce. Service industries have dominated the U.S. economy over the past decades, but through increased competition and technological advances, productivity gains are diminishing in the service sector. At the same time, baby boomers are in retirement, changing the labor demographics.

Globally, working-age populations are beginning to fall, at times dramatically, such as in Japan. The increasing cost of maintaining the elderly population will fall onto those still in the labor force and put strains on government-sponsored efforts like Social Security and Medicare. 

While the life expectancy of retirees is increasing, birth rates have fallen by nearly 50% since the 1950s. A key factor to economic prosperity in the developed world from the end of World War II through the 1980s was an ever-increasing working-age population. The U.S. and European working-age population peaked in the past decade, and it is set to drop by nearly a full percent through the year 2040. 

Population, Productivity, and Prosperity

Furthermore, the labor force participation rate has fallen to the lowest level since the 1970s. This metric tells us what percentage of people in a country are employed or actively looking for work. Those people who are unemployed but no longer actively searching for work are not included in this number. The current low level of labor force participation points to a larger portion of people without jobs who are not looking for jobs. 

Together, these factors suggest a potential decline in global economic growth due to a decreasing workforce population.

One reason why the global economy has continued to grow despite this ominous forecast is due to advances in technology, which have given a boost to labor productivity. In other words, even with fewer people working, each worker has become more productive. Since the 2008 financial crisis, however, year-on-year productivity growth has slowed. Still, even though the rate of productivity growth has slowed, the absolute output per worker is now the highest it has ever been in real economic terms.

Technological Advances

It is clear that to sustain economic growth, either the birth rate needs to increase by a large amount, or productivity needs to keep increasing. To grow productivity, workers need to work harder, or technology must advance, allowing each worker to contribute more economic output without sacrificing the quality of life.

Technological progress, therefore, lies at the heart of the economy of the future and the types of jobs that will employ the labor force; being able to effectively interface with technology, while important now, will become paramount. Those individuals who do not have proficiency in software programming, computer hardware, networking, or other facets of the IT sector will become less important in the new economy.

Already, we have witnessed technology replace entire middle-class job categories such as bank tellers, travel agents, stockbrokers, librarians, translators, and tax accountants. These are jobs that likely will not come back.

Take as an example TurboTax, the software and website dedicated to preparing tax returns. Millions of people now use this or its competitors, each taxpayer handing over a fee to use the program and e-file their taxes.

The economic impact is that while many people can more easily and affordably complete their taxes, only a small number of developers and programmers built the product. This made only a very few rich, including turning some into billionaires. At the same time, many tens of thousands of full-time accountants found their livelihoods threatened.

E-Commerce

E-commerce has taken a huge amount of market share away from traditional brick-and-mortar businesses. The sharing economy and P2P platforms have removed the need for items like hotels, movie theaters, and taxi drivers by creating alternative marketplaces for those services or activities.

The future will only accelerate this pattern. Google and universities around the world have developed driverless cars, which will one day eliminate the need for any sort of driver or chauffeur. 3-D printing and improvements in robotics promise to revolutionize the way products are manufactured and make companies rethink the need for warehousing and managing excess inventories. This can only accelerate the existing trend of job losses in manufacturing.

While many people will lose their jobs to technology, people who have trained themselves in the relevant skills will be at an advantage. It will be those workers who are not only comfortable with using technology but who can code and understand how the technology works inside out.

The Bottom Line

Demographics do not determine the fate of economic growth, but they are certainly a key determinant for an economy’s growth potential. An aging population coupled with a declining birth rate in the developed world points to a decline in future economic growth.

Increases in productivity can lessen the impact of such population shifts, and technological advances are the ideal source of productivity boosts. This, however, is a double-edged sword. On one hand, technological progress increases productivity, but at the same time, it can eliminate jobs outright, increasing unemployment.

It will be those workers who have computer and technology skills that will excel in the future economy. As the age make-up of the workforce changes in the future, so will the make-up of the kinds of jobs the economy employs.