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Economics of Population Decline

I read Phillip Longman's The Empty Cradle: How Falling Birthrates Threaten World Prosperity and What to Do About It a while back and was quite intrigued. What the book doesn't do, though, is attempt to offer a serious model of the macroeconomic implications of population decline. Under such a scenario it seems that things would be quite different from what we're used to.

Currently, if real aggregate demand grows just a little in a given year, the result is considered to be poor economic performance because it leads to a bad labor market and eroding wages. Depending on how quickly the population was dropping under a decline scenario, very small -- or even slightly negative -- increases in real output could be consistent with rising wages. What's more, we live in a world where housing prices -- and especially the price of land -- are almost always increasing. Under a decline scenario it seems that that would change, which presumably would have some kind of noteworthy consequences. I tried Googling around to see if there was any available work on the subject that took a serious theoretical approach. Besides this article wondering, like me, why no one is researching this, you can find an article or two specifically about the impact on public sector pensions, but that's not what I was looking for. It also seems to me that it's very much the wrong question to be asking. The only viable alternative to public sector pensions is private ownership of assets of various kinds, but it seems that a decline scenario would render the standard assets pretty poor options as well.

Owning a home, for reasons noted above, would no longer be a very good way to save your money. And as we recall from Dean Baker's No Economist Left Behind Challenge, even a slowdown in population growth leads to lower levels of stock market growth. An actual decline could turn stocks into terrible investments. And if stocks cease to be good investments, then how are companies going to raise capital? The point isn't that public sector pensions won't be in bad shape, but the badness of their shape is going to come in the context of a generally weird and possibly catastrophic situation. Or maybe the overall situation has hidden benefits I'm not seeing. The more I think about it, the more I think it's beyond my capacity to really think this issue through properly. But surely someone's up to the challenge. There are a lot of economists here in the blogosphere.

March 13, 2005 | Permalink

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Comments

Isn't it the increase in productivity, not the increase in population, that affects prosperity? I don't see why a decine in population would have bad effects -- at least in the short run, it would increase the amount of capital per person, which should increase prosperity. And it certainly would increase the quality of life to have fewer people -- less congestion, less pollution, and so on. And why would a decline in population turn stocks into poor investments, if productivity continued to increase? You have lost me on this one, Matt.

Posted by: Greg Arnold | Mar 13, 2005 1:28:04 AM

Raising capital via bonds or loans. Then your problem is whether your business can maintain the net income necessary to pay the bond/loan. There is a significant number of privately held companies.

Investing in bonds vs. stocks (though similar problems may happen). Or dividend paying stocks (where stock price is less important than in non-dividend stocks).

Falling birthrates (I assume local moreso than world, at least in the short-term (years) and near-long-term (millennia)) don't necessarily equal population decline, if certain tangentials/orthogonals are moving in the right direction.

Those currently starving in Africa and contributing nothing to the world economy.

Or workforce and WDP increase due to non-retirement, etc... can help negate somewhat, if not taken to extremes.

Errant speculation on something I have almost no knowledge of (formal or informal) is FUN!

Posted by: rse | Mar 13, 2005 1:39:40 AM

The large positive is the increase in the capital stock per capita. instead of building new powerplants (or whatever,) you just scrap the one that goes bad and keep using the one that is working.

the big negative is the asset return (either private holdings or public program like social security) as you save toward retirement

Posted by: yoyo | Mar 13, 2005 1:55:28 AM

One way of clarifying the issues is to use wages as the numeraire, that is, to price everything in terms of an hour of average-quality labour. It's easy to see, then, that an increase in the price of land or of existing capital is bad, not good, since it's an indicator of scarcity.

Greg is right that productivity is what counts. I'll try to think some more about this and maybe write something more substantive a bit later.

Posted by: John Quiggin | Mar 13, 2005 1:56:25 AM

This might be a concern in Europe and Japan, but I don't see it happening in the U.S., Canada, or Australia in the next half-century or so.

Posted by: Julian Elson | Mar 13, 2005 2:15:54 AM

On productivity: I always get the sense that it has a sort of "magical" quantity to some economists. Sure, productivity growth can counterbalance population decline -- but can you have those two at the same time? Too much of what I hear in American economics seems to be predicated upon perpetual growth, whether that growth is in population or productivity or GDP or technological innovation or whatever.

The reality is, nothing, and I mean ABSOLUTELY NOTHING, grows forever. At the end of the day, we are all governed by physics, and the perpetum mobile does not exist. You're not getting around that one, unless you believe that God in going to suspend entropy for us.

So I worry about our current system of prosperity hitting a brick wall. But then again, I am not an economist, nor do I pretend to be, so I take comfort in the fact that I am probably just full of shit.

But I think MY is right: why isn't there more research into what our economy would look like if growth were anemic or nonexistent for a long period of time? Ah, we're back to my assumption that perpetual growth is just too obvious to question ...

Posted by: Timothy Klein | Mar 13, 2005 3:43:26 AM

...what our economy would look like if growth were anemic or nonexistent for a long period of time?

What about Japan - don't they provide an example?

Posted by: abb1 | Mar 13, 2005 3:59:32 AM

OT:

Yglesias is no longer the top Matthew in Google.

The expired MatthewYglesias.com may have something to do with it.

Posted by: Graeme Knight | Mar 13, 2005 4:59:53 AM

You asked for economists, but most who know me would say that I'm a mathematician masquerading as an economist...caveat emptor.

Fundamentally, the economy is about people cooperating to solve their problems and achieve their desires. The specific institutions of any era function in that era's environment, and can be maladapted to another environment. But the institutions we're used to are the product of an environment in which just about everything is growing at a seemingly exponential rate, and the dire predictions concerning population decline seem to be mostly a matter of projecting these institutions into a world in which they couldn't work in the way we've grown to expect. But capitalism and democracy have considerable capacity for adjusting to circumstances...

In the long run there had better be periods of population decline, because the Earth is finite. And in the long run this shouldn't be a problem, because when there are fewer of us sharing the planet, each has more land, more claim to the fruits of the ocean, more wilderness to savor,...

There are two ways in which we might not achieve this utopian vision.

First, in the span of our own lives, population decline might entail a relatively small population of young people servicing a large population of boomers in rocking chairs listening to "Satisfaction" on their Ipods for the umpteenth time. Speaking as a boomer, the possibility that these young people might command an exhorbitant wage is a serious issue. But from a world-historical perspective, if the most prosperous generation in the most prosperous nation in the history of the planet is a little less prosperous in its old age, why should anyone give a shit?

The much more serious concern is that this era's fundamental institutions, primarily markets and nation-states, will, in spite of their adaptive capacity, be inadequate to the task of passing on the Earth's blessings to future generations. The rape of the world's oceans, global warming, ozone depletion, etc., are not idosyncratic failures of existing institutions. These phenomena are logical consequences of the way we conduct our affairs.

In many respects existing institutions serve us very well indeed, and modifying them to address global concerns will be neither simple nor costless. A natural logic suggests that the smaller the population, the easier it is to deal with institutional perversity. A more sophisticated view is that this simplistic reasoning is likely to be wrong in many particular instances, but our current knowledge of economics cannot reliably predict the exceptions. Caveat emptor...

Posted by: Andy McLennan | Mar 13, 2005 6:13:26 AM


The US is unlikely to have this as as serious problem, but Japan, Russia, and the EU arguably already are, so it's certainly worth discussing.

As labor gets scarce, returns to both automation and education/training will increase. If people are going to get pricy, you want them as geared up and trained as possible. I expect the automation will come largely in the form of job assistance and enhancement rather than job replacement, but there will likely be some of the latter as well. Further expect a lot of effort into trying to increase our capacity to provide education and training. Our current educational system depends on enormous and increasing labor inputs, hasn't done any serious thinking about it's productivity in decades, and simply won't work in an era of static or declining populations. There's room for improvement here that would help a lot.

Additionally, there's the political issue of the existence of enormous sumps of people in Asia, Africa, and South America who have the potential for enormous productivity increases, since they are starting from a low base. We could import them, or export capital to them in any of dozens of ways, all with serious political implications.

There's room for productivity increases to offset population decline, particularly since both processes are likely to be gradual. Enough to keep asset values up? Probably not. Enough to ensure an increasing standard of living? Almost certainly. Will there be transition issues? Yup, thousands of 'em, more and more varied than we could possibly anticipate.

For an even more distant and sexier problem, consider what happens when there simply aren't enough people to maintain an increasing technology level. I've heard estimates that one simply couldn't have our current level of technology with less than 100M people. There wouldn't be enough folk around to build the tools to build the tools to build the tools. As technology increases, that number increases. Eventually, the number of people necessary to maintain the necessary degree of labor specialization is going to intersect with the total global population number...

Posted by: dave | Mar 13, 2005 8:24:03 AM

Check into the economic ramifications of the Black Death. If you were a plague survivor, things got better. The lesson is that if we are going to shrink our population, we should do it in one go.

Posted by: Wren | Mar 13, 2005 8:38:55 AM

Whoa...

There is no population decline, only birthrate decline, in some parts of the world. Manichean pressures will be with us for years to come. A new economy based on fixing the environmental damage of the last fifty years just might bring enough quality of life to justify the inevitable rough adjustment phases but the greedheads in charge lack the necessary imagination.

Instead it's "let's find more oil and resort to feudalism".

Posted by: Les Ismore | Mar 13, 2005 8:58:53 AM

"Manichean pressures will be with us for years to come."

Manichean pressure? Pressure toward a "syncretistic religious dualism originating in Persia in the 3d century A.D. and teaching the release of the spirit from matter through asceticism"?

I'm not following this discussion, I guess . . .

Posted by: rea | Mar 13, 2005 9:05:37 AM

Economics seems completely committed to continual growth both of population size and per capita income indefinitely into the future. Herman Daly wrote a book called "Steady State Economics" which apparently was ignored.

Posted by: John Emerson | Mar 13, 2005 9:19:09 AM

Sorry...

Wrong word. I f****d up.

Posted by: Les Ismore | Mar 13, 2005 9:36:58 AM

"Malthusian"?

Posted by: John Casey | Mar 13, 2005 9:50:55 AM

Imagine a future where folks look upon capitalism as we do on feudalism--a primitive, quaint, and cruel system of relations suited for its time, but doomed to be smashed by the rather obvious forces of history and the inevitability of "human progress".

Posted by: wandering fool | Mar 13, 2005 9:55:58 AM

Mr. Longman's argument is the same old empty-headed Americanism: "Of what a little is good, more--much more!--is obviously better!" Accepting quantity for quality. So you get supersized fries in place of food, SUVs in place of vehicles, Wal-Marts in place of stores, a houseful of brats rather than a couple of well-behaved children.

So here comes Longman dishing up more of this same old slop, dressed up in fancy language intended to distract from the fact the he and his ilk don't understand the difference between aggregate and per-capita measures. They also don't have a clue about sustainability ("Aw, don't worry--the Rapture will come before then!") Someday when this bozo's little light comes on, maybe he'll merit the effort of reading. Probably not.

Posted by: some guy | Mar 13, 2005 10:02:24 AM

Hi -

Gee, am I the only economist in the neighborhood?

I'm in Germany and work privately, i.e. I'm not a government economist, but work on the economy.

Long-term population decline is something that no one has really seriously analyzed. The first implication is that with fewer workers and fewer consumers, there will be an adjustment in GDP downwards, i.e. the economy will go into stagnation at best and recession at worst, according to the standardized definitions. That is exactly the case in most of Europe: stagnant growth rates based on very, very weak domestic consumption demand.

But the more fundamental problem is the implications of an aging population. Slowing population growth means fewer are born, moving average and median ages up. This means that the structure of society shifts from the young to the old. The problems here are manifold: when the average age of the population is heading towards 40 and beyond, it strains the social security system and the health care system severely.

In Germany the social security system is already bankrupt, held together only by the (probably illegal) use of gasoline taxes to compensate for the fact that there aren't enough younger workers to finance the income transfers that characterize German social security. The problems really arise when the younger generations realize that they will have to carry a vastly disproportionate amount of social costs *and* that they will be for the foreseeable future a political minority that is, effectively, disenfranchised.

Why disenfranchised? Because in order to avoid massive cuts in public pensions, income transfers will have to increase significantly. No politician and no political party, if it is to be elected, can avoid taking from those working and give to those retired: this means that under current demographics and political systems, retirees will become the largest, dominant political group, the 500 kilo gorilla that can't be ignored. Given the political mythologies here in Germany, it means that public pensions cannot be cut and that even if 100% of those under the age of 40 vote to cut pensions, the number of retirees and those over the age of 40 will handily defeat any and all such measures.

Now, given a falling GDP restraining the country's ability to invest - GDP is, after all, the sum of value added into the economy, meaning that when GDP falls it reduces the monies available to be spent on investments - the infrastructure of the country, taken in aggregate, will suffer. Companies will be stuck with an excess of capacity, i.e. they will have to write off investments because the demand for their goods will undergo a more or less permanent drop. When you write off an investment, you reduce your profitability significantly, reducing further your ability to invest (and banks will take a dim view of lending you money, since you've shown that you make mistakes).

Others here point out that a shrinking labor force means ceteris paribus stronger demand for trained labor, since it makes little sense to use a scarce resource in a way that generates lower value added. The problem here is how to finance training and new investments, especially when the market is shrinking.

Ultimately shrinking demographics means that the country involved will have a very, very painful and disruptive reallocation of resources if it is to remain competitive. Those sectors serving consumption - and even in Germany this is the majority of the economy - will have to shrink, destroying capital and vastly reducing employment opportunities. It also means that a shrinking economy will have to cover the costs of transition, making it unlikely to afford much in the way of new processes and technologies while the costs of dismantling the old are being carried.

Hence the outlook is uniformly poor: the real decline in population - there will probably be no less than 20 MILLION Germans fewer by mid-century! - means shrinking markets, which means shrinking demand and shrinking sales. Where these can be offset - higher-quality to replace mass consumption - the offset will not be enough to compensate for the major decline in demand. A town of 20,000 people declining to 12,000 over 30 years means that stores will close and services will decline. While, with perhaps increasing average wages, you may find a shift from mass-produced shoes, for instance, to higher-quality shoes, the number of people earning a living making shoes will decline, as will the amount stores can earn selling shoes.

And don't get me started on real estate implications. These are really, really frightening, since we are talking about the need to massively destroy productive stock without replacing it. Remember, in Germany we are talking no less than 20 mio fewer Germans: that means some 10-15 mio apartments and dwellings will be empty. If you don't tear them down, they will massively depress the prices for all dwellings, which has truly apocalyptic implications for the German banking system. But if you do tear them down, it will cost so much that building activity will be depressed for decades.

Fundamentally, it's largely a no-win situation, lose-lose all the way around.

And given the truly abysmal German record on immigration, the idea that Germans will be able to import enough workers to make a difference is laughable and deserves to be viewed with scorn. It's not merely the politicians who are clueless here: the entire society has no clue of what it means to be an immigrant society.

Depressing.

John

Posted by: John F. Opie | Mar 13, 2005 11:08:03 AM

Marx and Malthus look up from their gin game.

-You saving nines?

Posted by: Jeffrey Davis | Mar 13, 2005 11:15:32 AM

Lots of interesting thougths, here, but one is still left with the answered question: where does productivity come into play, and how does population decline affect it?

One would think that, in theory, if, say, a certain country's labor force declines by 20% over a number of decades, but worker productivity grows lustily over this same time period, then economic growth should continue over this time period, and said country's residents ought to grow richer. Why is this not possible, or likely?

Now, under such a scenario, one would imagine that sectoral adjustments would occur (a slumping housing market, say, or booming sales of domestic servant robots), but I still don't understand why, in the aggregate, population decline triggers economic decline.

But it does appear to be quite clear that, no matter what's possible in theory, in practice it's tough to grow an economy, and avoid prosperity-threatening problems, sans at least a modicum of population growth. I doubt even a study of past population implosions (such as the Black Death) will shed much light on the problem, because in such cases the population decline was usually quite swift, and was quickly followed by a resumption of normal population increase (which leaves me with the thought that perhaps the last 150 years or so of the Roman Empire's life -- at least in the West -- would be a more appropriate predictive model of the world's current population dilemma).

I predict that one day rich Westerners will longingly look back on the days when state resources had to be employed to actually bar immigrants from coming in! I furthermore predict the return of child labor (with a vengeance!) to rich countries. In 60 years' time 14 year-old Johnny and Sally will spend several hours each day (perhaps even while in school) working on code, or monitoring information systems, or manning call centers. Perhaps eventually the economic incentive to have kids will return.

Posted by: P. B. Almeida | Mar 13, 2005 12:19:20 PM

Reminds me of the old saw about a slide rule being the way engineers could prove that 2+2=5. Demographics are apparently the tool used by economists to 'prove' that birth control is REALLY BAD.

So, some economists reach conclusions that are desired by wealthy rightwing publishing houses and thinktanks. This is news?

This is so silly that in order to believe it you have to be a) totally ignorant of the dynamics of industrialization and social change, b) never worked at a job that got progressively smaller because tools got better, and c) A TOTAL MORON. How else could you fail to notice that a house that took two months to build 30 years ago now takes two days? How else could you miss the shrinkage of the post-operative stay in the hospital from weeks to days or even hours?

Ironically, two great wars were fought in the last century because the demographics of growing German population threatened stability in Europe- and now we're told the tide is going the other way. If 30 million people died for no reason other than the alarmist and wrong assertions of economists and demographers, it's time to look at those predictions with a newly jaundiced eye.

Posted by: serial catowner | Mar 13, 2005 1:18:23 PM

Calling Dr. Solow! His 1956 growth model argues that a fall in the growth rate in population relative to the savings rate would lead to capital deepening and rising real wages. I guess this fellow also wants less savings so as not to upset the delicate balance of aggregate demand. Of course, Lord Keynes up in heaven is screaming that this is a gross misrepresentation of the General Theory.

Posted by: pgl | Mar 13, 2005 2:29:15 PM

Hi -

I'm afraid people here are placing too much emphasis on productivity gains. While theoretically they can compensate for a decline in the number of workers, the fundamental problem is that DEMAND falls: if your demand falls off, then everything else is off as well.

And as far as construction is concerned, take a close look at German building codes: you cannot build a house in Germany in less than 14 days, and the vast majority of housing in Germany has a capital life of 70 years, twice that of a house in the US. But that is a completely different topic entirely...

And the wars fought were not fought because of what economists said, but rather what fanatics thought. The German concept of "Lebensraum" was not based on economics, but in racist thought: Germans *thought* that they were superior and *deserved* the land to the east. Any economic justification served that goal...

The decline in German demographics didn't start after WW2, but has been an ongoing decline since even before Germany was around. You have to dig, but the numbers are there (you'll need German in order to find them).

John

Posted by: John F. Opie | Mar 13, 2005 3:01:11 PM

Economists who think hard about population concern themselves with the developing world where reducing population growth is seen as deepening the capital stock, raising real and etc. Same would then hold true for the first world.

What Matt is asking that is different is how this feeds back through the value of assets, which in the developing world isn't much of an issue, no one cares about stock markets in Africa, but matters in an economy like America where stock market returns seem to have macroeconomic effects (though, which way does the causality run?). Anyway, a simple first slice at this is that...you can't pull out any determinate outcomes. Think about housing prices. Currently, housing prices rise because of various tax issues which make them a good investment, and also because already built housing tends to be better located (more desirable) than not-built housing so already built housing rises in value as more people move to a city. Have negative population growth and you might expect those pressures to relax. But people may still want to move to cities and away from rural, thus, city housing prices could continue to rise. Plus, there is no rule that people spend a fixed proportion of their budget on housing, so maybe with people moving into cities and competing for housing, spending on housing rises as a proportion of expenditure.

Seems to me that something similar holds for stock market returns. Though there have to be generalizations that can be made at a system-wide level....

Posted by: Isaac | Mar 13, 2005 3:16:49 PM

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