Evan Soltas
Jan 23, 2012

Year of the Bear?

Demographic dividend, transition, and economics

I could very well retitle this post "Why I'm Suspicious about China" or maybe "China: Like Japan in '90, but Even Worse."

Let's get right to the charts. The UN maintains global population datasets, and one of the interesting measures, from an economic perspective, that their demographers produce is something called the "total dependency ratio." In short, it's the percentage of a nation's population which is working age. Due to laws of demography (#1: people get older, #2: fertility rates change slowly and predictably) they are able to forecast such numbers decades ahead, given certain assumptions about changes in fertility rate. (As a statistical note, I'm using the "medium variant" series, which is, as the name implies, neither an overly liberal nor overly conservative estimate.) The reason it's called "total" is because it's actually the sum of two related dependency measures: the child-dependency ratio and the elderly-dependency ratio. But for our purposes, the total dependency ratio best expresses very-long-term changes in the labor force.

In the first chart, I have graphed for your viewing pleasure the total dependency ratios of four nations--China, India, Japan, and the United States. In the second chart, I have graphed the annual change in the dependency ratio, calling it the "demographic dividend" for reasons which shall become clear soon enough.

We can see a whole lot just in the first chart: the post-war population boom in Japan followed by the well-publicized story of its aging population, beginning in the late 90s; the United States' "Baby Boom" entering the workforce in the early 70s and its echo boom; China's population boom, which continues up to the present as its workforce balloons.

In the second chart, we see the changes in dependency ratio, expressed as an annualized percentage (the UN's dataset uses a five-year interval). This is what we call the "demographic dividend," the contribution that, in the long-term, when we can assume full employment, growth in the labor force makes to economic growth. You should be able to see a few things here: first, Japan's rise was not fueled by labor force growth--it had to do with other factors, namely productivity--but its sharp reversal in economic fortunes had a whole lot to do with demography, which is costing it almost 3 percent in 2015. China, on the other hand, has netted a roughly 2 percent contribution to output growth from population alone. The U.S. has more or less broken even; India is gaining a stable percentage point or so.

Now let's look ahead. What do we see? In the U.S., the retirement of the "Baby Boomers" is going to produce an annualized cost to output growth of approximately 1.3 percent. In China, as the "One Child Policy" begins to bite in terms of the labor force, the costs are more severe, and more sudden, as the demographic dividend is sharply reversed in 2015. By 2035, the cost imposed by demography will be 3 percent.

I would produce a changes in demographic dividend chart, which I think is more important, but that would get confusing. The idea which I see coming out of this is that it is very hard to nations to adjust to long-term changes in output trend growth. Witness Japan. There is reason to think, too, that the economic dislocations are more severe with sharp changes in the annual demographic dividend, as governments often become accustomed to the "breathing room" that the dividend gives them, and they miscalculate. (If you're Japan, you get yourself stuck in the liquidity trap--I bet demography has played no small part in this event.) The culture of countries seems to evolve in tune with the dependency ratio, as countries with falling dependency ratios seem to develop pro-business political cultures to accomodate labor force growth, and political fragility and worries of déclinisme in periods of rising dependency ratios. The American political sphere is having a slow-motion panic about the future cost of entitlement programs--a symptom of its changing fortunes--but in comparison to China, these worries are small, which will end up building some form of social security, I imagine, to care for the aging.

I also worry about this because I bet that the demography has spillover effects, that is, it impacts the trajectory of economic growth beyond a simple addition/subtraction of the dividend. As an economy ages, it must retool rapidly to care for its elderly--but because of Baumol's cost disease, these industries (healthcare) have lower productivity growth rates and thus a lower long-run output growth rate.