#198 The Answer To Demographic Drag
Macroeconomics
Working population declines threaten the prosperity of the next generation. McKinsey scales the extent of the problem.
A Five Minute Read
The decline in the working age population is a direct result of the fall in fertility. Even if fertility were to bounce back to replacement level today it would have little impact. For the next twenty to thirty years at least. It would take that long for the babies to start work. To offer the next generation an improving lifestyle means that GDP per capita must grow. This is an average across the whole population and not just those in work. The challenge is a growing population of over 65s that work less. Combined with a declining working age population. In previous Newsletters I have discussed various solutions. A McKinsey Report published this week quantified the scale of the problem.
Possible Levers to Pull
There are some obvious levers that cannot be pulled. In multiple Newsletters I have looked at the reasons for the decline in fertility and the policies to increase it. The causes are deeply rooted in societal changes. The result is that Government policies have failed to have any impact on the decline. Governments will keep trying but it is not a short term fix. Immigration would seem to be a solution. To replace the missing workers with people from other countries. The barriers are social and political.
McKinsey instead focuses on the three basic levers. GDP per capita depends on the number of hours worked, times the productivity of each of them. The number of hours in turn depends upon the number of people in employment and the number of hours per week they work. To use the example of Western Europe. In the period 1997 to 2023 the number of people working increased significantly. More women went to work. Older people continued working later in life. Women and older people also increased the hours that they worked per week. The result was a 0.4% annual increase in hours. Productivity in the same period also grew by 0.8% per year. Unfortunately, the demographic drag took its toll even then. The population age mix was changing. This reduced GDP per capita growth by 0.3%. The result was that GDP growth per capital was 1% per year during those years (allowing for rounding).
Scaling the Task
McKinsey quantified the size of the problem facing each Government. It sets a simple target. For each country to maintain the growth in GDP per capita at the average of the last twenty-five years. This offers future generations the same opportunity as the current generation. It looks at each of the levers in isolation. It asks what would have to happen to meet the target with this lever alone.
To take the example of Germany. GDP per capita has grown by 1.1% per year over the last twenty-five years. Productivity grew by 0.9% over that period. Going forward the age mix will reduce GDP per capita by 0.4% per year. To fill the gap McKinsey estimates that 2.2 more hours per week of work would be required per capita. All other things being equal, this means 5.1 hours per week extra for those in work. If young men alone were to fill the gap, they would have to work 12.7 hours per week more than they do today. If the over 50s filled the gap they would have to work 6.1 hours extra. Those hours can come from existing workers or from people not currently in the workforce.
The numbers show how constrained these opportunities are. German participation in the workforce is already high amongst the different cohorts. To meet the targets by getting more people into work alone is nearly impossible. Amongst young men and young women participation would have to be over 100%. In the age group 65-79 participation would have to increase from 45% to 63%. Clearly no single lever will be enough to fill the gap. Productivity must play its part as well. It is unclear whether the politicians and voters have grasped the problem. Policies are pointing in different directions. Today in Germany experiments are in place to reduce the working week to four days. Enhancing education means that fewer under 29 are in the workforce. Conversely the retirement age has already increased from 65 to 67.
Countries at different starting points.
The scale of the problem faced by each country depends upon its demographic starting point. We can use “the increase in the number of hours per capita per week” to scale the problem. Amongst the countries now facing demographic drag there is a huge range. The UK and the US need only 0.7 hours per week. Germany needs 2.2 and China 2.7 (with a reduced target growth rate). South Korea is at 3.4 and Spain 4.7. The problem is compounded by the extent to which the state offers support to older people. Of the total expenditure of older Spaniards 73 % comes from state pensions compared to 45% for the UK.
Each country will have to find its own mix, including productivity improvement. If the promise of AI is realized, then the problem fades. At the moment productivity in many countries is moving in the wrong direction. Each country will have to solve the social and cultural problems implied. In France there are still huge issues in raising the retirement age to 64 from 62. Many other countries already have much higher pension ages. The French “weekly hours worked” now starts to decline steeply at 50. This is many years before similar developed countries.
Getting Rich Before Getting Old
Each country must decide on a target for GDP per head growth. That will determine the future prospects of the current generation. Are the past 25 years a good benchmark? McKinsey points out that this will be an issue for the next tranche of countries to face the “drag”. They are still “developing” and want to raise the prosperity of their citizens. Projecting the last twenty five years will not be enough. They have to get rich before they get old.
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