Financial Mail and Business Day

Why a shrinking population is bad news

Karl W Smith

The US’s population may be shrinking. That’s mostly because of Covid-19, but it’s also part of longer-term trends in fertility that show no signs of abating.

These trends, which are worldwide, have already caused economic dislocation and are likely to continue to do so.

First, some data. From 1936 to 1956, the US fertility rate rose from 1.8 to 3.2. At the peak of the baby boom, the average American woman was having at least three children who survived until adulthood. (A rate of 2.1 is considered replacement level.)

The result was a huge generation that not only transformed American culture, but also created a market and labour pool for would-be entrepreneurs and growing corporations. From the 1960s to the mid-80s, net domestic investment by private businesses averaged 5.4% of GDP each year. One dollar of every $20 spent in the US economy was directed towards expanding private enterprise. After the baby boom, there was a baby bust. In 1978, the fertility rate was 1.7, a near match for Great Depression lows. The fertility rate rebounded in the next decades, reaching a high of 2.1 in 2007 before starting its downward march to 1.6 in 2020.

Domestic business investment followed this pattern. From the late 1980s to the late 2000s, only once did it eclipse the previous generational average just before the dot-com crash, in the second quarter of 2000, when it reached 5.6%.

Demographic shifts weren’t the only things affecting the economy over that period. The rise of the internet, growth of the Chinese economy and a regime shift in monetary policy played their part. But it’s hard to overstate the impact of demographics, which were a steady tailwind of the US economy after World War 2, then became a headwind in the late 1980s and have remained so. A lot of commentary on the economic effects of an ageing society focuses on the strain they will put on the entitlement system. There will be ever fewer workers to pay the benefits of an ever larger pool of retirees.

But the impact on the overall economy is more wide ranging. Without a growing supply of new workers, new private investment has a harder time generating consistent positive real returns. It’s no accident that market returns over the past 25 years have been dominated by the tech sector, which uses comparably fewer workers, while real interest rates on savings generally have declined.

An ageing, shrinking population creates national quandaries that are more than just fiscal. One is that, as the real return on physical investment falls, so does the interest rate necessary to keep the economy humming.

The developed world first saw this phenomenon in Japan, which had no postwar baby boom. Despite a technologically advanced, export-orientated economy, the Bank of Japan’s policy rate fell from 6% in 1991 to 0.5% in 1995. Japan experienced an infamous “lost decade,” during which neither huge government spending nor persistently low interest rates could fully revive the economy.

That roughly matches the US experience after 2008. Indeed, Japan experienced an enormous property bubble in the late 1980s that burst and brought down the economy. This pattern persists because when businesses cannot generate enough profitable investment to match the savings rate of an older population, the excess ends up driving up the price of land.

In the formal economic models of this phenomenon known as secular stagnation land prices can theoretically go to infinity. In the real world, they are prone to bubbles. A propensity for bubbles is another problem

was the peak of the US fertility rate in 1956 which was a rise from 1.8 in 1936

resulting from declining demographics. Though the US has instituted tighter financial regulations in an attempt to mitigate against bubbles, the underlying pressure remains.

So, what can be done about all of this? My Bloomberg colleague Matt Yglesias collected suggestions in his book One Billion Americans. Yet many of the most politically feasible ideas such as increased government spending on child care and other support for young families would offer only a modest boost in population growth. Meanwhile, the ideas that offer the greatest potential for population growth, such as comprehensive immigration reform, are the least politically feasible.

The upshot is that demographics are likely to be a drag on the US economy over the next few decades. That means a sluggish, bubble-prone environment and a non-trivial risk of another Great Recession.

INTERNATIONAL

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2021-08-02T07:00:00.0000000Z

2021-08-02T07:00:00.0000000Z

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