January 18, 2020
Folks who have followed economic policy debates for the last few decades can never be surprised by the poor quality of reporting, but it still can get annoying. In a world where we are already doing irreparable damage to the environment through global warming, the idea that we will have fewer people in the future should be seen as a good thing.
Nonetheless, our leading news outlets are warning us that China, the world’s most heavily populated country may be seeing its population decline in the decades ahead. The story is that fewer babies will mean fewer workers twenty years out. We are warned that this would lead to a labor shortage and make it more difficult to support retirement pensions. The Post article warns that in Japan (it also talks about countries other than China), it could make it difficult to sustain economic growth.
Let’s deal with these one by one. What does a labor shortage mean? Presumably it will be hard to get people to do the least productive, lowest paying jobs. The obvious response is, so what? This is called “capitalism.” If a particular job holds little value then it won’t get done. This is the reason half of our workforce is not still in agriculture. They are doing more productive tasks elsewhere.
Going forward, if we do see serious labor shortages we will probably see fewer people serving tables in restaurants, working as housekeepers in hotels or providing valet parking. And, the people who still work at these jobs will get much higher pay. Sounds like a terrible crisis!
The second point is that with fewer workers per retiree, it will be harder to support retirement programs. The problem with the story is that the benefits from higher productivity growth swamp any possible increase in costs associated with changes in demographics. Here is what I wrote a few years back in reference to China.
“Suppose that China starts out with five workers per retiree, each with a wage before payments for retirees of 100. Let’s assume that the living standard of retirees requires that them to have 80 percent of the income of an average worker. In this story, we would need a tax rate of 13.8 percentage points on wages to maintain this living standard for retirees. This makes the wage net of payments to support the retired population equal to 86.2.
“Now suppose that over two decades the population ages so that the ratio of workers to retirees is just two to one. However, suppose over this two decade period productivity growth (output per worker hour) averages 5.0 percent annually. If we first calculate the tax rate needed to maintain a living standard for retirees, it is now 28.6 percent, leaving our worker with 71.4 percent of their pre-tax wage.
“But as a result of 5.0 percent annual productivity growth, the before tax wage will 265.3 percent of its level from twenty years earlier. This means that the pay net of the tax to support retirees would be 189.3 percent of the average before tax wage from twenty years earlier. If we compare after-tax wages for the two periods, the after-tax wage in the second period would be 219.6 percent of the after-tax wage in the first period. The living standards of retirees would also be correspondingly higher. So what’s the problem?
“This example is obviously highly stylized, but the assumptions used are almost certainly more negative than the reality. The demographic transition is taken place over 3–4 decades, not the two decades I have assumed here. Also, productivity growth has averaged 7–8 percent, not the 5.0 percent I assumed in these calculations. In short, China should have no problem supporting its retirees at a far higher standard of living than they enjoyed during most of their working lifetimes even as workers also see rising standards of living.”
While a 5 percent annual rate of productivity growth is plausible for China, it is certainly too high for the U.S., Europe and Japan. A more reasonable rate would be 1.0-1.5 percent. (Sorry, there is no evidence in these data that the robots are coming.) But even taking a 1.0 percent rate of productivity growth, the before tax wage (assuming wages keep pace with productivity growth) will be 22 percent higher in two decades. That is far more than enough to offset any tax increases needed to support plausible increases in the ratio of retirees to workers.
Many point out that wages for most workers have not kept pace with productivity growth. That is indeed a very serious problem, but the problem is wages not keeping pace with productivity growth, not the increasing numbers of retirees. There are many groups with lots of money that would like us to focus on the latter, but that doesn’t change the fact that the problem is intra-generational inequality, not inter-generational inequality.
Finally, we have the story that in a country like Japan, a declining population might mean that it cannot sustain economic growth. The proper response here is, who cares? Insofar as we are interested in growth at all, we care about per capita growth. If Japan’s population declines 1.0 percent a year and its economy shrinks modestly (say 0.2-0.3 percent annually), this is still consistent with a rise in per capita GDP of 0.7-0.8 percent annually. That’s not super-fast, but still decent for a wealthy country. And, if Japan chooses to take the benefits of higher productivity in the form of shorter work weeks and work years, as it has done over the last three decades, why is this is a problem?
In short, the concern about shrinking populations is complete nonsense. It is unfortunate that serious news outlets would waste time trying to scare people with this non-problem.