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May 11th 2016 print

Chris Berg & Jason Potts

The Economics of ZPG

Some 50 years ago, US biologist Paul Ehrlich's warnings of a teeming planet sparked a panic that has yet to abate. There is indeed reason to be fearful, but not of too many humans. The very real and looming problems have everything to do with declining birth rates

ten on a bikeIn the dystopian 2013 film Elysium, written and directed by Neill Blomkamp, the earth is badly overpopulated. The society that results is deeply unequal. The haves flee to a luxurious space station orbiting the earth. The have-nots remain on an increasingly polluted and decaying planet, subject to the robotic oppression of the haves in space above them.

The dangers of runaway population growth, and the dangerous society that such growth would create, have been an enduring Hollywood obsession for half a century. Elysium nostalgically recalls a spate of films in the 1970s that predicted overpopulation—and increasingly totalitarian measures of controlling population—from the famous, Soylent Green and Logan’s Run, to the forgettable, ZPG and The Last Child.

Yet in the early twenty-first century it is increasingly clear that if humanity faces a population crisis, it is a crisis not of overpopulation, but underpopulation. Neill Blomkamp derived a sort of crude Marxist vision of capitalism from the overpopulation crisis, depicting workers toiling under oppression to feed the demands of the comfortable and distant rich.

While the economic analysis shown in Hollywood films might be questionable, the idea that dramatic changes in population will have significant economic consequences is not. Today, fertility rates are below replacement level in developed countries like Australia. They are heading in the same direction in the developing world. Nearly fifty years after the American biologist Paul Ehrlich published his book The Population Bomb, sparking off the modern overpopulation panic, it seems more urgent to consider the costs of population stagnation than population explosion.

A society’s demography is shaped by three factors: fertility, ageing and migration. Australian fertility rates were as high as 3.5 in 1961, giving us the baby boom generation. But they sharply declined from those heights, so that by 1980, the fertility rate was 1.9. It has remained there ever since, and the Commonwealth Treasury assumes the fertility rate will remain at 1.9 for some time to come. But this is below replacement rate: that is, the couples of Australia are not reproducing enough to replace themselves.

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The second factor is ageing. The Commonwealth government’s Intergenerational Report suggests that life expectancy at birth will increase from its 2015 state of 91.5 years for men and 93.6 years for women, to 95.1 and 96.6 years respectively by 2055. When Joe Hockey said that it was possible that a child born today might live to 150 it was widely seen as a political gaffe but, with the rapid changes in molecular biology, living to 150 is not at all absurd. The sequencing of the human genome, completed in 2003, has been described as the biological equivalent of the development of the table of elements in the nineteenth century, a breakthrough which led to a revolution in chemistry. Placing genetics at the centre of medical practice is almost certain to dramatically change our expectations about longevity and health. Whether Hockey is right or not, the consequence of these trends skews the age distribution so that the Australian population is older.

The countervailing demographic pressure against increased longevity and fertility decline is migration. Simply put, what we no longer produce ourselves we can import. However, our migration intake selects against the highest-fertility population. Policy favours skilled migrants over unskilled migrants, and highly educated migrants over migrants with less education. These are the same populations that are going to be both older and less fertile. The obvious exception to that approach is our refugee intake, but refugee numbers are a tiny subset of the immigration total. Migration expands the population, because while Australia’s fertility is under the replacement rate, the global fertility rate is 2.4. Global fertility was around 5 in 1960. But where Australian fertility has plateaued, global fertility is still on its trajectory of long-term decline. And migrant populations quickly adopt the fertility rates of their new homes.

However, while the mathematics of population decline are fairly straightforward, history shows that untangling the economic consequences of population stagnation or decline is not. Between 1347 and 1351 the Black Death killed between a quarter and a half of Europe’s population, even more in some major centres. Three quarters of the population in Florence may have died in 1348. The plague sparked a century-long population decline across the continent. Where England had a population of 2.8 million people in the 1370s, it had only around 2.3 million in the 1520s.

The plague and the subsequent demographic decline cut short a relative economic boom in the high Middle Ages, which had seen the buds of capitalist exchange, expanding markets, technological development and population expansion. The first economic consequence of the Black Death that historians have long pointed to was its role in rewriting the structure of the labour market. The sudden scarcity of labour pushed the price of wages up dramatically, to the extent that the English parliament attempted to place a maximum ceiling on wages.

This smaller number of workers changed the economic and political leverage of the survivors. Contemporary elites complained about the newly demanding workers, who would refuse to work—or would work poorly—if they were not rewarded the market wage. “So the world goes from bad to worse,” wrote John Gower, a poet and friend of Geoffrey Chaucer, “when they who guard the sheep or the herdsmen in their places, demand to be rewarded more for their labour than the master-bailiff used to be.” Labour scarcity broke the traditional peasant–lord relationship, as workers went on the road looking for the best wages and short-term contracts. “Servants are now masters and masters are servants,” complained Gower. Economic power tends to become political power. A sense of the political consequences of this population shift is offered by the Peasants’ Revolt in 1381, when rural workers reacted to the introduction of a series of poll taxes by forming an army and ransacking government buildings in London. This was a proletarian parallel to the rebellion of the elites that had given England Magna Carta a century and a half earlier, but one which ended unhappily for the rebels.

The long-term consequences of the Black Death were more subtle. Demographic change allowed for rapid institutional innovation as the bonds that maintained the old order were weakened. It has been too common for popular historians to strip the medieval world of agency of its own and imply that only an outside shock—in the form of the bacillus Yersinia pestis—could alter fixed political and economic dynamics. The humans of the medieval world adapted to their new demographic environment in complex ways. The fact that the plague was less severe in some parts of Europe has allowed economic historians to show that even where the population continued to rise, as it did in Holland, wage rates increased in this period. The supply-and-demand relationship between population decline and labour costs does not necessarily mean that in all regions affected by the plague wages increased at a higher rate than in those which avoided the plague. And while Holland fared well in the long run from its relative avoidance of the Black Death, other places which also avoided the plague—such as Prague or Bohemia—did not experience the same sort of economic prosperity as the Low Countries.

This non-linear relationship between demographic change and economic change is not surprising. How societies responded to the consequences of the Black Death depended on their institutional environment: the legal and regulatory framework, the capacity of classes enfranchised and disenfranchised by change to prevent or exploit those changes through the political system, the capital structure of the economy, resource endowments, the depth of market exchange for goods and labour and so on. The Black Death wrought institutional changes that gave us the modern world—institutional changes that were unpredictable to those who lived through the crisis and which historians are still trying to trace. Higher wages moved economic activity towards capital-intensive agriculture and proto-industrialisation, sparking changes in urbanisation and the organisation of guilds and communities. Rather than the short-term effects on the supply and demand for labour, it will be in institutions that we see the long-run significance of modern population change.

This captures one of the essential errors in much of the popular debate about the consequences of population change. A strictly mathematical approach to population analysis—fertility plus migration equals population—transposed onto the current political order does not capture the institutional evolution that would result from the trends. In the January 1977 edition of Quadrant, the Liberal gadfly W.C. Wentworth derived the consequences of population change from such an accounting of fertility rates, concluding, “There may be serious doubts as to how many can really live well on the limited surface of the globe.” Decades on, in the wake of the digital and agricultural revolution, it is clear that such negativity was unjustified.

The direct economic consequences of a declining population could be a slow increase in the price of labour, as occurred suddenly in the years after the Black Death. As the scarcity will be concentrated in the younger population, these price increases will be particularly for work which has traditionally been performed by the young, including service jobs and unskilled manual labour. Technology allows for some substitution, and higher labour costs encourage development in further innovation. Existing tendencies towards automation of labour—encouraged by the demands of consumption and the prohibitive strictures of industrial relations laws—will be accelerated. Every Australian suburb now has a vision of the future in the McDonald’s automated ordering system, and it is easy to imagine further automation of service industries that were once believed to be immune.

More diffuse economic consequences of population stagnation will be delivered through the political system. All else being equal, an older population means that the interests of older citizens will be better reflected in public policy. We are already seeing some of the direct political economy consequences of an ageing population. Much current public policy tends to favour older rather than younger people. One of the most harmful is the restrictions on land use that benefit established home-owners over possible new entrants to the housing market. Both controls on urban development and limits on land release raise the price of housing by creating artificial scarcity. This works out very well for home-owners but terribly for those who want to enter the housing market for the first time. These sorts of policy-induced housing shortages ultimately divert capital away from more productive investments—Australians end up using more of their wealth for what could otherwise be much cheaper—with long-term consequences for living standards.

Other political economy consequences could be less harmful—even beneficial. High rates of population growth distort the political system towards the interest of its younger members. For instance, while the overwhelming benefit of education accrues to the person who is being educated, governments have long paid the bulk of education expenses out of taxpayer funds. This over-subsidisation of education may be reduced as the population skews older. Wasteful or unnecessary family payments are less likely to be tolerated by an older population that does not feel it receives direct benefits from these funds. On the flip side, that older population will be much more protective of generous pension schemes and health subsidies. A rebalancing between older and younger generations is likely to lead to more social spending rather than less. Pensions are a far larger drain on the Commonwealth budget than family payments, and the cause of market-oriented reform in healthcare provision is much less advanced than in education. While the shape of social spending will change, population stagnation is more likely to increase that spending rather than decrease it.

We have already hinted at some of the causes for optimism. One approach might be to use policy to reverse negative trends. In the overpopulation dystopias of the 1970s, Big Brother governments took it upon themselves to limit breeding or eliminate the elderly. Governments have long been aware of the declining fertility rate and, particularly under the Howard government, sought to align policy incentives to encourage people to have more children through baby bonuses and tax benefits. However, the downsides of using the political and legal system to influence the demographic profile of the population are substantial. Obviously those dystopias imposed huge costs of the rights of the citizenry, and the one-child policy in China has had enormous human costs. The modest family payments designed to boost fertility in Australia are subject to the same inefficiencies, churn, opportunities for rent-seeking and politically motivated subsidisation as any other part of the welfare system.

We see more reasons for optimism in the development of healthcare technologies that might both lower the cost of providing healthcare services to an ageing population, and also allow an ageing population to work more productively. The net effect is that an ageing population becomes less of an economic burden on the rest of society, requiring fewer resource transfers.

There are multiple sources of such technologies. At the biomedical level, enormous improvements in new biotechnologies such as personalised genomics may significantly improve the effectiveness of targeted medicines. The breakthrough gene-editing technology CRISPR may dramatically reduce the incidence of chronic genetic diseases and improve our ability to repair diseases of senescence. Very large falls in the cost of wearable personal monitoring technology and the internet-of-things may greatly improve access to healthcare and increase the incidence of low-cost early interventions. Personal robotics may facilitate greater ability for the ageing to continue to live independently, both as providing services that range from robot vacuum cleaners and quadcopter drones for delivery, which already affordably exist, to robotic assistants (imagine the Artificial Intelligence platform Siri on Apple’s iPhone coupled with industrial robots), to driverless cars (which already exist), to personal exoskeletons, which are in use in the US military. This list can go on and on, and while there are certainly high development costs, the economics of mass adoption and market competition will drive these costs down.

Such benefits do not depend on a special class of technologies for the ageing and elderly, but are adaptations of general-purpose technologies (for instance gene-editing techniques, big-data, industrial robotics, and so forth) that are subsequently applied to particular and growing market segments. We can rely on the market mechanism and profit-seeking entrepreneurs to figure out how to adapt new general-purpose technologies to create value by improving the lives of an ageing population. Many such benefits can be expected to maintain health, well-being and independent functionality to enable continuing participation in society and contribution to the economy.

Of course, a longer working life is not just a joy for the federal Treasurer; it is also a very good thing for each individual person because it means a higher level of income and freedom, which in turn means greater independence and ability to consume. Working longer is a good thing not because work is a good thing—although there are surely benefits from increased social and community engagement that come from gainful employment. Working longer is good because more production means more consumption. These higher levels of income and consumption may be spent on travel and experiences, higher quality of living, on family, or on greater levels of healthcare or even enhancement.

These causes for optimism are dependent on current trends in innovation holding true. It is equally obvious to observe that an ageing society will experience second-order effects that can reasonably be expected to dampen the rate of innovation and technological change. These are effects that go directly to the underlying incentives to develop the new general-purpose technologies mentioned above, rather than the specific adaptations of these innovations to the needs of the elderly.

The first is that an ageing population has a different overall risk-reward profile than a younger population, particularly among males. The young of all species (and not just humans) have a higher risk-taking propensity because they are engaged in mate competition. We’re wired this way. This increased risk-taking propensity can be destructive when it is channelled into fighting, raiding and warfare. But a great benefit of a free-market society, as economists from Adam Smith to Joseph Schumpeter to Deirdre McCloskey have pointed out, is that there are substantial pay-offs to society when this competitive instinct is harnessed towards entrepreneurial action to create and develop new ideas—whether great artworks, new technologies or new products.

Entrepreneurship and innovation are risky. But when they succeed they furnish substantial benefits for many, and possibly a great many. The US economist William Nordhaus estimated that entrepreneurs only capture (as Schumpeterian profits) about 2 per cent of the social value of their innovations. That means that 98 per cent spills over to society as consumer surplus. But other economists such as Edmond Phelps have pointed out that the net private return to innovation is actually pretty close to zero. This should not be surprising. Most entrepreneurial endeavours to develop new technologies, companies and innovations fail. The few that succeed in effect balance the many that fail, such that there is a Pareto distribution of returns. But because most of the value of an innovation spills over as consumer surplus, the social returns to innovation are everywhere substantially higher than the private returns. (Another way of saying this is that innovation has public good qualities, or can be subject to market failure.) One of the great benefits a society with a young population experiences is its high natural propensity toward risk-taking entrepreneurship, and the associated social benefits that brings. Equivalently, one of the great although often hidden costs of an ageing population is the loss of entrepreneurial dynamism. Along with this comes an increased tendency to seek political solutions rather than market solutions to social problems, which further drives an economy towards rent-seeking.

A second and related point that further constrains innovation in an ageing society is that the basic economics of investment returns to innovation are different. Specifically, in respect of the costs of adopting new technologies the discount rate for a younger population is lower than an ageing population. This is for the simple demographic expedient that an older population has less time to amortise the costs of developing and adopting a new technology and also less time to receive and accumulate the benefits. In short, because the costs to innovation are upfront while the benefits accrue through time, innovation is simply more expensive when you have less expected life in front of you. Now the elderly might actually care not just about themselves, but also about the future welfare of their children and grandchildren and so on, creating what economists call an infinite overlapping generation model. But without such an assumption, or some attempt to engineer it through the tax system, an ageing population will rationally invest less in innovation.

A third observation follows from these two and connects the types of economic institutions that a democratic society will choose when the population is relatively younger and growing or older and stable or shrinking. One of us has written recently about why the mass leisure society that John Maynard Keynes famously envisaged in his 1930 essay “Economic Possibilities for Our Grandchildren” has never come to pass, by emphasising that the sorts of economic institutions of a wealthy prosperous society are those that encourage entrepreneurship and innovation and not just consumption. But this same argument also runs the other way. As we have noted above, the sorts of economic institutions that a zero population growth society chooses are likely to be geared towards political redistribution of economic resources. These institutions require higher taxes, which penalise entrepreneurial action and therefore blunt the rewards to innovation.

An ageing society tending towards zero population growth also risks tending towards zero economic growth because of the harmful consequences on the supply of entrepreneurship and innovation, because of its effect on risk preferences and on investment, and also on the way such a demographic transition will likely distort economic institutions away from a liberal market ideal. In the long run, it is hard to say whether these headwinds on general-purpose entrepreneurship, innovation and new technology are likely to dominate the more optimistic tailwind scenarios on the specific application to the problems and opportunities of an ageing population.

 

An obvious class of solution is to recognise that an ageing zero-growth population will create increased pressure on political solutions to economic problems, and therefore to seek to constitutionally head that off by constraining and limiting the powers of politicians to offer political solutions. Privatising more of the healthcare system would be a start. Our institutions need to be capable of adapting to the consequences of ageing and population stagnation—consequences which are now unpredictable. Allowing for greater market control of social services will provide such adaptability. The fragility of medieval society to the Black Death and its demographic aftermath was not only technological and medical: medieval markets were shallow, meaning that resources could only slowly reallocate to new uses, if at all.

Another class of solution follows from the diagnosis of the intergenerational nature of the innovation problem. Innovation requires both an entrepreneurial risk appetite and liquid resources. A young population has much of the former, and an older population has more of the latter. If pension funds were able to function more effectively as venture capital funds, that would be a step in the right direction. For instance, financial regulations designed to protect investors by constraining pension fund investments to say ASX30 listed companies stand in the way of such reform.

But the most important factor is the importance of maintaining an open economy with free and easy movement of people, resources, capital and ideas. If risk preference and investment in creating new ideas and innovations will decline in a zero population growth economy, then it becomes critical to be able to import new ideas from elsewhere. This will also be true of gaining access not just to technologies but also to services offered in other countries. Perhaps certain types of regenerative therapies or surgeries will be developed in Singapore or the Philippines. It may not matter much if they are not invented, produced or delivered in Australia, provided Australians have access to them, through having produced things of value that we can exchange for them. This is where the importance of continued participation in the labour force matters.

A zero population growth economy will impose substantial challenges on Australia in the future. It is not the ecological utopia that some imagine, but nor is it likely to be a Marxist dystopia. It will make us all poorer. And it will do so in significant part because of its effect on entrepreneurship and innovation. But these consequences can be mitigated by sensible and far-sighted commitment not to allow the harms to happen. Maintaining an open economy, constraining government growth with commitment to free-market institutions, will go a long way towards allowing us to live well as population growth slows.

Chris Berg is a Senior Fellow at the Institute of Public Affairs. Jason Potts is Professor of Economics at RMIT University in Melbourne.