Discussions of the population problem have always had the capacity to stir up public sentiment much more than most other problems....In fact, the discussion of the population problem seems at all times and in all places to be more strongly dominated by the volitional elements of political ideals and interests than any other part of the established body of social and economic thinking. Here, as in perhaps no other branch of social theorizing, the wish is very often father to the thought.
Gunnar Myrdal, The Godkin Lectures
All theory depends on assumptions which are not quite true. That is what makes it theory. The art of successful theorizing is to make the inevitable simplifying assumptions in such a way that the final results are not very sensitive.' A "crucial" assumption is one on which the conclusions do depend sensitively, and it is important that crucial assumptions be reasonably realistic. When the results of a theory seem to flow specifically from a special crucial assumption, then if the assumption is dubious, the results are suspect.
Robert Solow, A Contribution To the Theory of Economic Growth
What is Neo-Classical Growth?
The last two centuries have been marked by extremely rapid increases in standards of living in some countries (generally known as the developed economies). Measured GDP per capita in the United states is perhaps ten times higher today than it was 125 years ago, and with a growth mismeasurement of one percentage point per year, this factor could easily be more than thirty (Brad DeLong, 1998, see reference at foot of this post). Also remarkable is the relatively brief span of history during which this rapid growth has occurred. Conservative estimates suggest that humans were already distinguishable from other primates 1 million years ago, yet it was not until the agricultural revolution - some 10,000 or so years ago that the long march to the modern era really beagan, and it is only during the last two hundred years that we have seen the steady and continuous increases in economic growth which have lead some to speak of a modern growth era.
It has been estimated that over the last century the average rate of per capita GDP growth in the United States has been somewhere in the region of 1.8 percent per year. Using data are from Angus Maddison (1995), Charles Jones (2002) estimated the growth rate of the US economy between 1950 to 1994 as an annual 1.95 percent, slightly higher than the growth rate from 1870 to 1929, which he estimated at 1.75 percent. However these aggregate numbers conceal a considerable degree of variance, and the growth rate in the 1950’s and 1960’s - at 2.20 percent - was considerably higher than the post 1970 growth rate of 1.74 percent, reflecting the well-known productivity slowdown which lead Solow famously to declare that "we can see the computer everywhere except in the productivity numbers".
Such aparent stability of U.S. growth rates has given rise to the conventional view that the U.S. economy is, and has been, running at close to its long-run steady-state balanced growth path, as can be seen in the chart below.
This traditional view is often supported by reference to a number of "constants" such as the absence of trends in the U.S. capital-output ratio and in U.S. real interest rates, as emphasized by Nicholas Kaldor (1961), who proposed a series of stylized facts about economic growth which have been more or less influential in the history of thinking about what neo-classical growth actually means. Kaldor argued that:
1. Per capita output grows over time, and its growth rate does not tend to diminish.
2. Physical capital per worker grows over time.
3. The rate of return to capital is nearly constant.
4. The ratio of physical capital to output is nearly constant.
5. The shares of labor and physical capital in national income are nearly constant.
6. The growth rate of output per worker differs substantially across countries.
Now the question I want to address here is a very specific one, namely is there, or isn't there an ageing impact on our economies? In attempting to assess this we would do well to keep Kaldor's stylised facts in the forefront of our minds, and in particular how it can be that in societies where fertility has fallen considerably the shares of labour and capital in gross national output can remain more or less constant. After all, doesn't standard theory tell us that as labour supply comes under greater pressure, wages should rise and technical change should occur? But this does not seem to be what has been happening.
As Charles Jones points out (Jones, 1992) this conventional view is challenged by phenomena we have been observing in the context of the US economy 50 years or more now. First, time spent accumulating skills through formal education, which we can think of as some form or other of human-capital investment, has increased substantiallyin the last half century. In 1940, less than 25 percent of adults in the United States had completed high school, and only about 5 percent had completed four or more years of college. By 1993, more than 80 percent had completed high school, and more than 20 percent had completed at least four years of college. Second, the search for new ideas has intensified. An increasing fraction of the United States workforce - and indeed of workforces throughout the OECD - consists of scientists and engineers engaged in research and development (R&D). In 1950 the U.S. fraction was in the region of 0.25 percent. By 1993, this fraction had risen threefold to more than 0.75 percent. Unsing the assumptions of virtually any of the standard models of economic growth, these changes should lead to long-run increases in rates of per capita GDP growth.
Under standard neoclassical models, such changes should generate transition dynamics in the short run and “level effects” in the long run. That is the growth rate of the economy should rise temporarily and then return to its original value, but the level of income should be permanently higher as a result. On the other hand under typical endogenous growth models, such changes should lead to permanent increases in the growth rate itself. However, as we have noted above, the growth rate of U.S. per capita GDP has been surprisingly stable over the last 125 years with the level of per capita GDP being well represented by a simple time trend.
One distinction which may help us here is the one Jones makes between a constant growth path and a balanced growth path. Along both paths, growth rates are constant, but the former is driven by transition dynamics while the latter is associated with a steady state.
A balanced growth path is normally defined as a situation in which all variables grow at constant geometric rates (possibly zero). (Jones, 2002 )
A natural question arises at this point. If a large part of U.S. growth in recent years has been associated with transition dynamics, then why do we not see the traditional signature of a transition path, e.g., a gradual decline in growth rates to their steady-state level? Why is it that U.S. growth rates over the last century or more appear to be so stable.
At some level, could it be that transition dynamics associated with the various factors of production have worked in some way to offset each other so as to leave the growth rate of output per worker fairly constant? We will return to this issue below, but first let's take a more general look at population dynamics and growth.
Demographic Components in Growth
One reasonably concrete starting point for addressing the issue of population ageing and economic performance could be by examining the evolution of GDP growth rates in some of the most directly affected countries. As we have already noted, it is a key postulate of neo-classical growth theory is that each economy has its own long run steady state growth rate, and the reason for making this assumption is not in fact that hard to see, since on this view as the demographic transition is left steadily in the past (the demographic transition remember is associated with large fluctuations in levels and growth rates of population) then a steady growth rate in the labour force (achieved in part via institutional efficiencies in the labour market) and a supply of savings regulated by effective monetary and interest rate policy, should mean that any given economy would have its own given balanced growth rate. The problem with this, of course, is that the demographic transition is still far from lying in the past, and considerable movements in fertility and life expectancy are still being observed, and in particular many countries are sustaining long term fertility rates which lie well below the population replacement level. This will mean that far from having assured sources of entry level labour supply, many developed economies will soon be facing the prospect of a steadily declining working age population.
This neo-classical long run steady state growth rate needs, of course, to be understood as a theoretical postulate, a sort of ideal limit case, but nevertheless the concept continues to orient and inform a good deal of conventional economic thinking about economic growth. Whatsmore it forms a kind of collective "ideal type" default setting in many peoples mindsets when it comes to thinking about business cycles and growth prospects. The growth rate which people anticipate will be "recovered" after a recession has passed is probably some version or other of the long run steady state (or constant equilibrium path) one. The question we are left with though is really, does the idea of convergence to steady state growth constitute one of those suppositions which are assumed - in Solow's words - to be nearly true, and what are the consequences for the theoretical edifice of modern macro economics if the idea turns out to be not quite as "nearly true" as was previously thought to be the case.
The idea of steady state growth is also normally ssociated with the idea of growth being determined exogenously to an economic system, an idea which is normally associated with the Solow model of economic growth where long-run economic growth is seen as being determined by exogenous factors such as technical change, aggregate saving rates, schooling rates, and the growth rate of the labor force.
Mankiw, Romer and Weil begin their highly influential paper - A Contribution To the Empirics of Economic Growth (see bibliography below) - as follows:
This paper takes Robert Solow seriously. In his classic 1956 article Solow proposed that we begin the study of economic growth by assuming a standard neoclassical production function with decreasing returns to capital. Taking the rates of saving and population growth as exogenous, he showed that these two variables determine the steady-state level of income per capita. Because saving and population growth rates vary across countries, different countries reach different steady states. Solow's model gives simple testable predictions about how these variables influence the steady-state level of income. The higher the rate of saving, the richer the country. The higher the rate of population growth, the poorer the country.
The first thing to notice is that Solow predicts two linear relations, more population-less growth, and more saving-more growth. As we will see below, there is now considerable empirical evidence that among developed economies, those with the fastest rates of population growth are also those who experience the highest rates of per capita income growth (the United States is the most obvious example, but as we will see this is also the case of France and the United Kingdom), and there is some evidence that countries who previously enjoyed among the highest levels of saving (Italy, Japan, Germany) have not ended up with the highest rates of economic growth, while others who have had very low levels of net private saving - the UK, the US, Greece, Spain - have tended to enjoy relatively higher levels of economic growth. The central point I wish to make here is that these relations do not seem to be linear ones, and I think what has thrown many researchers off track in the past in this area is that they have tried to treat them as if they were.
The idea that economies tend to converge towards some sort of balanced growth path is in many ways a highly questionable assumption and is one which, with the notable exception of the US, is very hard to sustain empirically over the longer term. Economic performance tends to fluctuate, the big question is: does it fluctuate following any kind of identifiable pattern?
Well, lets take a look at the Japanese case. Here's a convenient graph of Japanese economic growth from 1955 to the present prepared using statistics made available by the Japanese statistics office.
What is obvious from looking at this profile is that Japanese growth has been far from uniform over the last 50 years or so. And indeed far from converging to a steady state growth rate, Japans growth seems to have peaked in the 50s and 60s, and have been steadily reducing ever since. Arguably, after peaking, there may be a trend there, but this trend would seem to be towards ever lower annual rates of economic growth. And there is no evidence at this point to justify the supposition of a hypothetical "homeostatic point" around which Japanese growth would stabilise and fluctuate. As far as can be seen at present the process of decline is secular and ongoing.
A reasonably similar pattern can be observed if we come to look at long term growth rates for the Italian economy.
Again, Italian growth seems to have peaked, and then entered decline. In Italy's case the peak seems to have been in the 1970s (but it may have been earlier, since I don't at this point have data for the pre 1970 period), and indeed since 1990 Italian GDP growth has only managed an average of something like 1.4% growth per annum.
Age Structure and Productivity
Curiously enough, in this neoclassical speculation on population the factor of age distribution was for a long time not studied, and it was never studied
intensively as to its economic implications. It is remarkable, because this
factor could to a large extent be taken care of in a stationary model of theory.
When a certain trend of the population development is maintained for such a long
period that a stable age distribution has been reached, the difference between a
progressive, a stationary, and a regressive population -- apart from a different
development of population numbers -- is that in the first more than in the
second, and in the second more than in the third, the number of children is
relatively large and the number of old people relatively small. A
corresponding difference rules even within each major age group taken by
itself. If we thus compare a regressive population with a stationary one, we
find that in the first young children are relatively fewer than older ones and
that the center of gravity is also higher in middle age as well as in old
age.Now people in different ages are productive in different degrees, and --
within a given standard of living -- their consumptive demands, their cost of
living, also differ. Here intensive empirical studies ought to set in...........to ascertain the average productivity and the cost of living in different age groups.
Gunnar Myrdal, Godkin Lectures, Lecture Six, 1939
So why is it that national growth rates rise to a peak, and then seemingly gradually peter out again. Well the outcome - while it may be a little disagreeable - should not actually be so surprising if we start to think about economic theory a little. However as Gunnar Myrdal argued so cogently (see quote above), and now almost seventy years ago, for some reason or another the mainstream opinion has remained rather blinkered when it comes to taking into account the potential explanatory power that changes in age structure seem to have.
Key components of economic growth are the proportions of the total population working, and the kinds of activities they are engaged in. Now if we look at the early section of the above graphs from Japan and Italy we can see that these economies exhibited very high growth rates at one point (a phenomenon which we can also find today in emerging economies like China and India ). Such "strong" growth rates are basically the result of two factors. On the one hand there is an ever greater proportion of the total population who become involved in economically productive activity, and on the other there is a technological 'catching up' process. Since emerging economies tend to start at some distance from the existing technological frontier the growth they achieve can be proportionately more rapid as they close this distance (again this can be seen now in the Eastern European EU accession economies), and this would almost certainly be one form of what is known as "conditional convergence", as techological levels and institutional structures become more uniform globally.
But there is another dimension to growth, and in this sense societies almost certainly do not converge (except possibly over the very, very long term, where we might postulate that all societies could converge to a similar - and very high - median age, although even this theoretical idea would need to be treated with some caution, since so many features of this situation may ultimately turn out to be "path dependent"). This second dimesion revolves around age structure related productivity and consumption patterns.
In any given society, with the passage of time, the intial "input accumulation" growth spurt (produced as more and more units of capital and labour are systematically applied) eventually slows. Normally the loss of momentum on this front is largely offset as emerging economies move up the through the median age brackets, since this movement produces a growing preponderance of what have come to be known as 'prime age workers'. The prime age wage/productivity effect can be seen in the chart below which shows how the age related earnings structure has altered in Japan over the years between 1970 and 1997.
We are making here the generally accepted assumption that wage levels bear some statistically significant relation to productive output levels (ie wages can serve as a proxy here) and what can be easily seen from the chart is that wages generally peak somewhere in the 50-54 age range (even though many workers in Japan currently continue to work to 75) . One very significant and revealing detail to note is that while the shape of the hump has changed somewhat over the years there has been little noticeable drift to the right, which should alert us to the possible presence of an age-related productivity problem.
Going back to the original Japan chart, we can see that post-bubble Japan has grown significantly more slowly, although thanks to the strong export position (and China related demand) the economy has still managed an average of 2.5% a year since the end of 2001. The same cannot be said of Italy, which due to its much weaker product profile cannot expect the export vibrance that a Germany or a Japan can attain.
The German case, whilst it is significantly better than the Italian one, still shows some similar characteristics. According to the Federal Statistics Office:
Measured in terms of gross domestic product changes at 1995 prices, the rates of economic growth in the former territory of the Federal Republic of Germany and - since 1991 - in Germany have continuously declined since 1970. While the average annual change was 2.8% between 1970 and 1980, it amounted to 2.6% between 1980 and 1991 and to 1.5% between 1991 and 2001.
Recent years have been worse rather than better, and the German economy shrank (0.2%) in 2003, and grew by only around 1% in both 2004 and 2005. As can be seen from the chart below, the German economy has picked up notably in 2006 and 2007, hence all the excitement in the press about "Goldilocks" and sustainable recoveries, but what is noticeable is that internal demand has not responded to the export stimulus, and it is notable from the chart that the feedback from the strong performance in 1999 and 2000 was the very weak performance 2002-2005, so if I am right, unfortunately, we can expect something similar to happen now. In any event what happens next in Germany will be an important test for everything I am saying here.
Now for some more charts. This time they are based on data prepared by Eurostat, and show the volume index of GDP per capita as expressed in Purchasing Power Standards (PPS) (with the European Union - EU-27 - average set at 100). If the index of a country is higher than 100, then this country's level of GDP per head is higher than the EU average and vice versa. Basic data is expressed in PPS which then effectively becomes a common currency eliminating differences in price levels between countries and thus making possible meaningful volume comparisons of GDP between countries. Please note that the index, since it is calculated from PPS figures and expressed with respect to EU27 = 100, is valid for cross-country comparison purposes rather than for individual country inter-temporal comparisons. Nonetheless these charts are extraordinarily revealing.
As can be seen the compartive US PPS per capita GDP, after correcting somewhat post 2000, as the value of the dollar has fallen vis-a-vis the euro and the pound sterling, has maintained a reasonably steady path, while the UK comparative per capita GDP has risen, and the French one has dropped slightly, the picture is very different in Italy, Germany and Japan.
I have presented these charts in two separate groups. The first is a high-population-growth (near replacement fertility) group, and the second is a low-to-declining-population growth (lowest-low fertility) group. As we can see, in PER CAPITA income growth terms all three of the former hold their comparative position much better than all (or any) of the latter three.
The reason why we should be seeing this difference is not that hard to get at, I think, since the UK, France and the US are all ageing much less rapidly than Germany, Japan and Italy. And this comparative measure is interesting, since while - for catch up growth reasons - that some societies should lose their relative standing vis a vis emerging economies would only be expected, but that one group among the more established economies should be losing impetus when measured against another group, and that this difference should be reasonably correlated with both population growth and rates of ageing should strike some at least as a rather interesting result.
So population median age does seem to matter. Worse, for conventional theory, rising population is not necessarily a negative factor for economic growth.
At the present time Germany, Japan and Italy are in fact the leading countries globally by median age.
But others are not far behind, and the future development of the economies in these countries will provide an interesting and useful opportunity to test what is being said here. The next group by median age are basically Finland (41), Slovenia (41), Sweden (41), Austria (41), Belgium (41), Bulgaria (41) Greece (41), Croatia (41) and Switzerland (40). Now Slovenia, Bulgaria and Croatia form a rather special case here, since they belong to a group of countries who have passed through a very special economic and demographic transition, so really it is well worth treating these countries separately. So, if we come to look at Sweden, Austria, Belgium, Greece and Switzerland, what can be observed?
What we can see from the above chart is that while Sweden starts off in 1990 relatively older than Finland, and especially Greece, by the time we get to 2020 the order has reversed. Both Sweden and Finland fare rather better than Greece, which undergoes a period of rapid ageing. Of course many ideosyncratic factors can influence this process, such as the moment in which the demographic transition was initiated, the speed with which it occured, or the impact of WWII and its aftermath, and of course rates of immigration are clearly a factor. But what is so striking about this chart is the way in which the fertility effect seems to predominate, since Sweden and Finland have much higher levels of fertility than Greece.
If we now look at the median age comparison for Austria, Belgium and Switzerland, we will again see that (while all three are ageing quite fast) one country - in this case Austria - is ageing much more rapidly than the other two.
and again it is Austrian fertility, which falls significantly below that of the other two and effectively stays there that seems to carry most of the burden in explaining why the Austrian population is now about to age so rapidly.
And if we now move on to look at some the longer term growth charts.
Bibliography
DeLong, J. Bradford, “Estimating World GDP, One Million B.C. - Present,” December
1998. U.C. Berkeley mimeo.
Jones, Charles I, "Was an Industrial Revolution Inevitable? Economic Growth Over the Very Long Run" Advances in Macroeconomics (2001) Volume 1, Number 2, Article 1.
Jones, Charles I, "Sources of U.S. Economic Growth in a World of Ideas", American Economic Review, March 2002, Vol. 92 (1), pp. 220-239
Kaldor, Nicholas, “Capital Accumulation and Economic Growth,” in F.A. Lutz and D.C. Hague, eds., The Theory of Capital, St. Martins Press, 1961.
Mankiw, N. Gregory, David Romer, and David N. Weil, “A Contribution to the Empirics of Economic
Growth”, Quarterly Journal of Economics, 107, May 1992, 407-37.
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