Scary Population Tales

Fear ever stalks the land. Thomas Malthus (left) warned of the ravages of fertility, pre-empting Paul Ehrlich’s “population bomb” by 150 years or so. Ehrlich can take a crumb of comfort that his bomb, which he brought to prominence in 1968 and which he predicted would have exploded well before now, is still ticking in West Africa. Throughout the developed world it has been thoroughly defused. However, fear is resilient and transferable. So, if a rapidly growing population doesn’t get you, a sluggishly growing one will. My intention is to show that any such fear is overblown when pitted against the remarkable adaptability of capitalism.

Rodney Stark makes a persuasive case in The Victory of Reason (2005) that Western economic success sprang from Christianity by way of its support for reason and freedom which, in turn, allowed capitalism to flourish. Whether or not you buy Stark’s thesis in its entirety, it is clear that capitalism is the only path to prosperity. Societies which have not embraced capitalism, for whatever reason, have remained poor.

Beyond embracing capitalism, numbers of factors come into play to explain why one nation is more prosperous than another. Education is undoubtedly important. The wisdom of rulers in the way they go about taxing, spending and regulating is important. The availability of natural resources might play a part as, less tangibly, might the degree to which societal norms create an environment which encourages individuals and businesses to be adventurous and innovative. How does population—its size and growth—fit in?

As I will show, by a quick look at the evidence, population size itself hardly matters at all. The economic effects of falling population growth are more difficult to assess. They fall broadly under a heading of the direct and indirect consequences of an ageing population. Those consequences most prominently discussed are increased welfare spending, a fall in the rate of saving, a deficiency of aggregate demand, and a loss of adventure and innovation. I will consider each in turn, but first to population size.

Take a population of ten million nomads and another of one million settlers. The second will almost certainly become more innovative and prosperous than the first. Population size is not relevant in explaining the disparate economic fortunes of the two population groups. Except in very limited circumstances population size is immaterial. It would only matter in the case of an isolated community with insufficient numbers to allow specialisation and exchange to flourish.

According to World Bank data, Denmark with a population of 5.7 million people in 2015 had a per capita income (measured by GDP in current US dollars) of $52,000. The UK with a population of 65 million people had a corresponding income of $44,000. Enough said, in a way, because numbers of such examples can be found. But I decided to undertake a simple statistical exercise on developed countries with per capita incomes of over $25,000 and populations above several millions. To avoid biasing the results, I excluded some oil-rich Arab states. There were twenty-three qualifying countries, from the richest, Switzerland, to the poorest, Spain—which just made the cut. The correlation between population size and per capita income was a slight negative; not significantly different from zero. Heavily populated countries can be rich or poor, as can sparsely populated countries. There is no connection between population size and prosperity. I will come back to this World Bank data later.

In Europe in 1960 all but one or two countries had fertility rates well over the replacement rate of 2.1 children per woman. By 2014 these rates had all fallen below the replacement rate; some well below. In Italy, for example, the fertility rate fell from 2.37 to 1.43. The implications of such low rates of fertility persisting are existential and go beyond economics. My focus is on the economic effects of populations growing more slowly, down to, say, replacement rate plus or minus, rather than on populations falling precipitously or on the brink of doing so.

Aside from historical episodes of wars, diseases and famines, falling population growth results from declining fertility which, in turn, is a product of prosperity. Richard Easterlin has noted:

Over the long term, growth in real per capita income has everywhere been accompanied by a decline in child bearing from levels sometimes averaging as high as six or more births per woman to around two or less.

Declining fertility always accompanies growing prosperity. It is one of those few socio-economic relationships that can be relied upon.

The Western world is rich. Consequently women have fewer children. The usual explanation is that as family income grows the opportunity cost of having each additional child becomes prohibitive. Perhaps too, as income grows, there is a tendency for families to invest heavily in the upbringing and education of one child or two, at the sacrifice of having three or more. However it is explained, there is no good reason to believe that we can become both rich and resist having an older population. Providing (very) generous financial support to working mothers might help to increase fertility rates and, in my evolved view, should be prioritised by all Western societies no matter what their fiscal positions. This might have an economic payoff but its main rationale is the preservation of Western civilisation. But, whatever is done, the fertility rates of our poorer past will not reappear in our richer future.

Increasing rates of fertility produce a progressively younger population. To some extent prolongation of life through medical science can rebalance the age scales, but fertility is a powerful geometric force which overwhelms all others. It works in the other direction too. Declining fertility produces a progressively older population. Practically speaking, net inward migration of “younger” people can only stem the tide. Eventually the geometric force of declining fertility holds sway and brings with it a rise in the dependency rate—the proportion of the population, specifically in this case older people, dependent on others for their income.

It appears self-evident. The more dependants there are, the poorer a society will be. As I will explain, this is the case in a never-changing economy; it is not necessarily the case in a dynamic economy. Certainly public pension and health costs will be higher. This is a problem these days because most governments have grossly overspent and put themselves in unaffordable hock. But let’s not think naively that a dollar saved on pension payments would perforce be used wisely to pay down debt. The likelihood is that it too would be wastefully spent. It is also a profound mistake to conflate the current penurious positions of governments with the capacity of free-market economies to generate enough wealth to care for the aged. Western nations generate more than enough wealth to provide generously for those in retirement. Perspective is needed.

Take Australia, Denmark and the UK as examples. Those sixty-five years and older as a percentage of the population have risen from 9, 11 and 12 per cent respectively in 1960 to 15, 19 and 18 per cent in 2015. In the same period, the standard of living, measured by real GDP per capita, has well more than doubled in each country. This performance is worth stressing. Despite the significant additional burden of providing for increasing old-age dependency, real per capita income has risen. On the whole, everybody—young or old—is much richer. Quite simply, the fear of what an ageing population means for economic well­being is a triumph of pessimism over experience.

There is considerable hype these days about ageing populations and the burdens they will bring. “Pensions under stress” is the editorial heading of the OECD publication Pensions at a Glance (2013). We are constantly reminded that we, inhabitants of rich Western nations, face unaffordable increases in public pension costs unless something is done. This is nonsense. And it is the kind of nonsense which has had a rich nation like Australia seriously intending to erode the relative living standards of aged pensioners. While the Abbott government’s 2014 budget measure to pare back the indexation of pensions was not put into law, it showed how unconscionable decisions can be made on the basis of a confected economic narrative. It also sowed the seeds of Tony Abbott’s demise as prime minister, but that’s another story.

In the last Intergenerational Report (2015), the Treasury projected that Australia’s labour productivity growth in the next forty years would approximate the 1.5 per cent per year recorded in the 2000s rather than the 2.2 per cent of the 1990s. But note, even this fairly modest yearly productivity growth of 1.5 per cent results in production per worker doubling after forty-seven years. In the same report it was projected, as though it were alarming, that if no changes were made to aged-pension arrangements, their current budgetary impost of 2.9 per cent of GDP would rise in forty years’ time to 3.6 per cent of GDP. In fact, such a rise barely puts a dent in society’s expected enrichment over the period.

Public pension payments become a problem in fiscally-straitened, ageing and stagnating economies. In such cases, the principal solution is to facilitate productivity growth by reining in government and unshackling business development. To be clear, I am not saying that rising pension payments don’t exacerbate the current fiscal messes that governments have got into. Nor am I saying that pension arrangements should be immune from review; for example, in respect of asset tests and retirement ages. My point is that the need for so-called “fiscal consolidation” has ensnared pension payments which, in themselves, are easily affordable provided the productivity improvements of the past are any guide to the future.

A more substantive concern about ageing is the potential effect it can have on national saving. As a population ages, the ranks of the middle aged eventually decline relative to those in retirement. Those in their middle years tend to save; those in retirement tend to run down their savings. Saving is important. As pointed out astutely by John Stuart Mill, economic growth is dependent on (physical) capital accumulation and capital accumulation depends wholly on savings. Without savings we would very soon be mired in poverty as the capital stock ran down. As an aside, that is one good reason why we need rich people. They save.

The question arises: Can anything be done to offset the dampening effect on saving of an ageing population? A number of things can be done. Saving can be rewarded and each dollar of saving made to work harder. A first thing to understand is that publicly provided safety nets discourage private saving. The more generous the safety net, the less people feel the need to save. Publicly provided safety nets, including pensions, are largely paid for on a pay-as-you-go arrangement between people and their government. So far as possible these arrangements should be privatised.

Most safety nets related to health, injury, unemployment and pensions could be privatised with appropriate taxpayer-provided incentives and subsidies. The superannuation arrangements in Australia provide a good-practice example. People are encouraged to save because their benefits are geared to their contributions and their savings largely go to the business sector which uses them far more productively than would government.

In the less complex world of the nineteenth and early twentieth century, occupied for a time by Mill among other notable classical economists, saving was regarded as being positively and fairly strongly related to the rate of interest. I am not sure how influential an increase in the rate of interest now is in boosting saving, but the evidence still points to it having some positive effect. Accordingly, the extremely low rates of interest being orchestrated by central banks in Europe, North America and Australia are unlikely to be helpful in encouraging saving—a point made, for example, by the ex-governor of the Bank of England, Mervyn King, in his recent book The End of Alchemy.

Other things can be done or undone. Death duties, for example, discourage saving and its productive use. First they provide an encouragement to spend to rob the taxman, and second the proceeds go to government where they are largely wasted on unproductive spending. It is unnecessary to be exhaustive to make the case that while an ageing population might tend to save less, there are off-setting measures that can be put in place.

If ageing reduces saving, you would not think, at the same time, that a deficiency of aggregate demand would be in the frame. Nonetheless it is. The rationale is that an ageing population results in a reduced demand for certain goods, for example, children’s clothes at one end and housing at the other, and that this may have a knock-on effect on the demand for goods and services more generally.

Keynesians put demand at centre stage. This misdirects attention away from lessening obstacles to increased investment and production—cutting business taxes, reducing labour market restrictions and cutting red and green tape—towards focusing, forlornly, on finessing demand. However, in this instance, it is right to focus on demand; though not as an aggregate in the way Keynesians do, but as an array of different demands in the way Mill did.

Equilibrium in an economy means that there is a close match between the pattern of production and the pattern of demand. Disrupt the pattern of demand and adjustments will need to be made on the production side. Such adjustments can result in unemployment in particular industries and this, in turn, can have deleterious flow-on effects in others.

Industries and businesses gear their operations to the demographic characteristics of the market. With a more slowly growing and ageing population, a range of individual industries and businesses will need to adapt their operations to changing patterns of demand. Transitory adaptation costs will be incurred. Such costs are part and parcel of dynamic capitalism. They can’t be avoided.

While transitory costs can’t be avoided, adapting to a more slowly growing and ageing population does not, in the end result, mean less for all. A free-market economy is akin to a living system which resists falling into disorder and which, under the guidance of relative price movements, adapts to changing circumstances and usually, in so doing, grows the pie. As J.G. Miller showed in his book Living Systems (1978), living systems are open systems which self-organise and interact with their environment. Even back in the late Middle Ages, after the bubonic plague, the power of price movements, in particular the price of labour, was evident. As Rodney Stark points out, a shortage of labour in England led to rising wages and subsequently to serfs becoming free tenants, thereby increasing the productivity of agricultural land.

Let’s bring this Middle Ages story up to date. Its applicability remains intact. In fact, modern-day capitalism multiplies its relevance. Fewer young workers as a result of falling birth-rates will put upward pressure on wages. This will stymie business expansion only if the future is a continual rerun of the present. Capitalism does not work that way. Experience tells us that fewer workers and higher wages result in the development and introduction of new technology to boost labour productivity. It is useful to go back to the concept of “open systems” and to their relevance in understanding capitalism. (I covered this more fully in a previous article, “Growth in a Finite World”, in the December 2014 issue of Quadrant.)

Open systems have the capacity to adapt and survive. Their inputs are higher in complexity than their outputs, which gives them the capacity to forestall decay and undertake repairs. Additionally, according to Miller, each open system has what he calls a “decider” which guides the interaction of the component parts. Among economic systems, capitalism uniquely meets the requirement of an open system.

The finished goods which we see and buy are the products of a highly complex coming together of many resources: raw materials, physical and financial capital, labour and skills, engineering, ingenuity, invention, entrepreneurship and innovation. Crucially, to complete the picture, capitalism has a highly effective “decider” in the form of market prices. By rationing demand and optimising the allocation of resources, market prices guide the economy through changing circumstances.

The guiding role of market prices will ensure that we grow richer, even under the burden of an ageing population; always provided, that is, that capitalism continues to throw up a continual flow of entrepreneurship and innovation. This brings me to a recent article in Quadrant: “The Economics of Zero Population Growth” by Chris Berg and Jason Potts (April 2016). Berg and Potts stress the role of a growing and therefore more youthful population in spurring entrepreneurial and innovative activity. They sum up their position this way in their final paragraph:

A zero population growth economy will impose substantial challenges on Australia in the future … It will make us all poorer. And it will do so in significant part because of its [dampening] effect on entrepreneurship and innovation.

Berg and Potts are surely right in associating relative youth with an appetite for risk-taking. Whether this translates into more value-adding entrepreneurial and innovative activity, I am not nearly so sure. The view that a more youthful society is readier to innovate is particularly associated with the French demographer Alfred Sauvy who wrote about this in the 1980s. The problem is that this supposed effect is intangible and therefore by no means easy to measure.

Short of compelling evidence, it is not at all clear that the age profile of a society is the determining factor in explaining the extent of its productive innovation. Other factors, including government policy settings, could be equally or more important; though it is difficult to be definite. It is instructive to go back to some World Bank data.

The populations of Denmark and the UK have aged considerably since 1960. In 1960, 11 per cent of the population of Denmark was 65 years and older, as was 12 per cent of the population of the UK. By 2015 these numbers had increased to 19 and 18 per cent respectively. There is no material difference in their ageing, if anything Denmark has aged a little more. Yet, from a more or less equal start in 1960, prosperity in Denmark (measured by per capita income) has grown materially faster than it has in the UK. Now clearly this and other examples I could give are rough and ready and say nothing directly about innovation per se. But it is evident among numbers of countries in my list of twenty-three, and beyond that list, that something other than their age profiles appears to be at work in producing disparate economic performances.

I am far from concluding that Berg and Potts are wrong in emphasising the effect of ageing on innovation and, as a by-product, on future prosperity. What I do say is that some evidence is needed of its materiality, particularly in view of the policy responses that it might trigger. Among these, Berg and Potts suggest that the most important is “maintaining an open economy with free and easy movement of people, resources, capital and ideas”. Free and easy movement of resources, capital and ideas is one thing; free and easy movement of people is quite another.

An ageing population presents economic challenges. There is no doubt of that. But at question is to what extent these challenges have to be simply ridden through; or else ameliorated in ways other than by continuously importing young workers, which can do no more than postpone the inevitable population-ageing effect of declining fertility. Transitory economic fixes which impose significant social costs of absorbing large numbers of migrants, year after year, from diverse and sometimes clashing cultural backgrounds, might be best avoided. Equally, in case there is any doubt, it should not be a guiding principle of policy to provide an open door for those on the outside wanting to improve their economic circumstances. Economic policy should primarily be directed towards improving the living standards of a country’s own citizens.

Using immigration judiciously to plug skill gaps may well contribute materially to increasing real per capita income. It is not nearly so clear that bringing in large numbers of people in order to decrease the dependency rate would do the same. The dependency rate is only one factor among many in determining living standards. And, counter-intuitive though it may seem, increasing rates of dependency and fewer workers might result in more than off-setting increases in productivity. If it happened after the bubonic plague, it can certainly happen in our advanced, highly adaptable, free-market economies.

An older population is a consequence of capitalism making Western societies richer beyond anything thought conceivable when our (us older people’s) grandparents were young. This is a cause for celebration. It is not an economic threat. We are now wealthy enough to care generously for an increasing proportion of retirees. Unless the past is a very poor guide to the future we will be better able still in future years. Government profligacy has created a fiscal fog which hides that truth. Governments could help by containing their spending, by reducing regulatory obstacles to economic development and by refraining from raising energy costs in pursuit of the chimera of cooling the planet. But, make no mistake, capitalism, albeit with hiccups and an occasional convulsion, will go on making us richer, and better able to care for an ageing population.