Labour market & demographics

Is the impact of demographic transition inevitable?

Content available in

In developed countries population growth has been gradually diminishing throughout the last half century. This phenomenon corresponds to the end of a stage of demographic transition in which a society that has already considerably reduced its death rate also reduces its birth rate to a similar (or even lower) level, bringing about stagnation (or a drop) in the size of the population. At the same time, there is also an increase in life expectancy which results in significant ageing. This month's Dossier analyses the extent of this demographic transition, its effect on the macroeconomy, the changes that might occur in population terms and which factors might lessen the impact.

The United Nation's report entitled «World Population Prospects 2015» describes the slowdown in population growth and even suggests this will become negative in some geographical areas. This drop in the level of population, which had already begun a decade ago in countries such as Germany, will continue over the next ten years in other countries such as Spain and Italy and will reach the euro area as a whole by 2030 and, although immigration flows are currently positive, they will not be enough to offset this trend. Apart from the decrease in size there is also a change in the population pyramid with a higher proportion of older people. The share of individuals aged over 65 has gone from 15% of the euro area population in 1990 to 21% in 2015 and is expected to reach 24% by 2025 and 32% by 2050. In countries such as Germany, Italy and Spain, more than one third of the population will be 65 or older by that date. The (relative) exception is France which, thanks to its higher birth rate, will be able to expand its population and delay ageing, although 26% of its citizens will be over 65 by 2050. Evidently this ageing process will also occur in the future in developing countries although their population pyramids show that it has yet to come about in most of them. Such countries therefore have the potential to at least partially delay the phenomenon of an ageing population in developed countries via immigration.

This considerable demographic transformation could have a direct effect on economic growth. A smaller population might result in less labour supply, less aggregate consumption and less need for investment, which would reduce the size of the economy as a whole. An ageing population would also alter the characteristics of its economy as different age groups have different needs and production capacities. The life cycle theory claims that individuals try to maintain a stable level of consumption throughout their lives. Therefore they save while working and start to spend their savings once they retire. Assuming there are no changes in the behaviour of the different age groups or in the total population level, an ageing population could reduce the labour supply at the same time as the level of aggregate savings. However, longer life expectancy might encourage individuals to work longer, invest more in education to increase their human capital or save more before retirement in order to fund a longer period of inactivity, which could counteract the aforementioned effects. To a large extent the aggregate effect on the labour supply will be determined by the impact of ageing on GDP per capita. Empirical evidence shows that, to date, this impact has been limited but negative.1 The impact of ageing on aggregate savings also seems to be negative (for more details, see «Demographic trends and the price of financial assets: the tail winds are dying down» in this Dossier). Demographic change could also affect prices by adding deflationary pressures to the economy if aggregate demand falls (because the population is smaller, for example) as well as affecting the sustainability of the welfare state as the proportion of the dependent population increases (see «How a greying population affects public spending», also in this Dossier).

Several factors could modify the impact predicted of demographic transition on the economy. Firstly, although in this Dossier we focus on demographic aspects, we must not forget that increased productivity in an economy (through technology, for example) could significantly counteract the effects of ageing as higher productivity would increase the potential growth rate throughout the period (see the second graph). Secondly, we must also bear in mind that demographic forecasts have been calculated using specific hypotheses (such as the fertility, death or immigration rate) that are difficult to predict accurately, particularly over the long term, and there is therefore some doubt as to whether they will actually come about. Lastly, demographic forecasts assume that the behaviour of each generation remains constant but, as we have already mentioned, the population's behaviour may alter in response to demographic changes.2 For example, growth in GDP could be higher if the retirement age is raised in line with life expectancy.

Let us look more closely at the changes in a population's behaviour that could offset the impact of this demographic transition: the birth rate, immigration and labour supply. A higher birth rate could lessen the ageing of the population. However, a birth rate is endogenous to a country's development and, as it develops, its birth rate falls until reaching a level of well-being where social preferences tend to change and the state is able to finance significant policies to support the birth rate. In any case altering a society's birth rate pattern is complex and expensive and therefore unlikely to counteract the effect of ageing by itself.

Another way to offset demographic change in developed countries is by boosting immigration. It is predicted that net annual immigration between 2020 and 2050 will be equivalent to 0.22% of the population of the euro area and that this will be greater in Spain (0.27%), Germany (0.25%) and Italy (0.24%) than in France (0.15%). We must remember, however, that it is difficult to predict migratory flows as they depend on the economic and social conditions in both the original country and also the host and can also change quickly, as we have seen in the mass arrival of refugees in Europe over the last few months. Nevertheless, migratory flows can have a considerable impact, particularly for those countries whose populations are ageing the most, such as Germany, but suitable immigration policies must be put in place to ensure such immigrants are successfully integrated.

Lastly, the impact of these demographic changes can also be reduced by increasing the labour supply, either by means of a longer working life or greater participation in the workforce. A longer life expectancy, especially more healthy years, is going to allow people to work much longer, a relevant factor which is nonetheless not always taken sufficiently into account. Another way to increase labour supply is by encouraging the participation of women and other under-represented groups in the workforce such as immigrants, as well as increasing the number of hours worked.

In summary, changes in the behaviour of the population can offset a considerable part of the demographic transition that is very likely to occur. But for this to happen it is vital to use all available resources, including taking political decisions in the design of institutions (reforms of pension and tax systems, immigration policies, etc.). If not, it will be almost impossible for individuals to have the necessary incentives and resources to adjust their behaviour and take the right decisions.

Josep Mestres Domènech

Macroeconomics Unit, Strategic Planning and Research Department, CaixaBank

1. See IMF (2014), «Impact of Demographic Changes on Inflation and the Macroeconomy», IMF Working Paper 14/210.

2. See Bloom et al. (2011), «Implications of Population Aging for Economic Growth», NBER Working Paper 16705.

Tags:
Demographics
documents-10180-1811604-i1510IM_D1_01_ING_Edade_fmt.png
documents-10180-1811604-i1510IM_D1_02_ING_AnosI_fmt.png