Population growth is projected to turn negative in China (2025) and Brazil (2040). Russia’s population has been declining for over a decade. This is worth keeping in mind when analysing the “rise of the BRICs”. The BRICs (with the exception of India) will sooner rather than later be confronting significant demography-related challenges, including a shrinking labour supply, a potentially declining pace of innovation, declining domestic savings, rising pension and healthcare expenditure and, more arguably, a structural decline in inflation. Moreover, both developed and emerging economies must not discount the non-linear effects population decline is bound to trigger.
Demographic trends will diverge sharply over the coming decades. Germany and Japan, the world’s third- and fourth-largest economies, are already experiencing population decline. Less often-mentioned is the fact that most top-tier emerging markets, including the BRICs, are also rapidly approaching an inflection point. Population growth will soon turn negative in China (2025) and Brazil (2040). Russia has been experiencing population decline since 1995. Only India’s population, projected to overtake China’s by 2020 or so, will continue to grow past the middle of the century. By contrast, the UN projects the populations of France, the UK and the US to expand, albeit gradually, until the end of the century.
Population aging, even more so population decline, is bound to have important political, economic and social consequences. First, labour supply, defined as the population aged 15-64, will shrink. Increasing labour market participation, let alone raising working hours, will only go so far. Sooner or later, man hours worked will decline. Only in Brazil, India, the UK and the US will the potential labour force be tangibly larger in 2030 than today.
Meanwhile, the dependency ratio (population aged younger than 15 and older than 65 relative to the rest) will be rising in both the BRICs and the G5. This will likely reduce savings. If investment remains unchanged, interest rates will have to rise. If investment declines, too, as is likely, a rise in interest rates will be avoided, but economic growth will diminish. Either scenario is negative for government debt sustainability.
Second, there is some evidence that innovation and technological progress is furthered by large, expanding populations (Kremer 1993), all other things being equal. The older populations become, the more reluctant they will be to adopt new technologies (demand) and the less able they will be to innovate (supply). This may, however, be offset by the greater economic incentives to innovate in the context of a declining labour supply and the resulting upward pressure on wages. A declining ability to innovate is arguably less relevant for the less advanced economies – not least because they can simply import (and adapt) existing technology. By contrast, advanced economies operating at the “technological frontier” and facing declining capital and labour supply will have to rely, even more than before, on total factor productivity growth. Just when innovation is becoming more important, the capacity to innovate may be declining!
Third, an increase in the old-age dependency ratio will typically raise pension and healthcare expenditure. Not only will this weigh on the domestic savings rate but it will also raise government outlays, putting pressure on the fiscal accounts. Entitlements are significant in all advanced economies and, if left unreformed, will put major pressure on fiscal positions at a time when household savings are declining. More likely than not, this will put downward pressure on public (and private) investment and thus negatively affect the economy’s growth potential. It may also raise interest rates.
Fourth, and admittedly more speculatively, a declining population and a rising old-age dependency ratio may drag down inflation due to decreasing demand (Ezer 2011). Empirical support for such a view is mixed. In the context of a zero (nominal) interest rate, Japan has been suffering from deflation over the past two decades. While this can be largely attributed to the “debt overhang” following the financial crisis two decades ago, it is possible that demographic factors have also contributed to deflationary pressures. If there is some truth to this, population aging may lead to low inflation. A very low level of inflation, let alone deflation, would negatively affect debt sustainability by setting a floor for real interest rates or even raising the real value of debt.
As such, this is bad news, especially for the initially more rapidly aging G5. As regards Japan and the US at least, potential growth may already have declined due to on-going post-crisis deleveraging. The structural fiscal position has deteriorated sharply and public debt has moved onto an unsustainable path. Over the medium term, the situation will become even more challenging due to a declining labour supply, declining savings and investment, diminished growth, rising age-related (government) expenditure and a more limited ability to diminish the real debt burden due to lower inflation. By contrast, a (generally) more favourable demographic outlook, a much more sustainable initial fiscal and public debt position and a significant (and undiminished) post-crisis growth potential puts the BRIC in a very different position – at least in the short- to medium-term.
It would be a mistake to underestimate the possible lateral (or non-linear) effects of population aging/ decline by disregarding economic, political and financial feedback loops. Mathematically, population growth tends to turn exponential, as does population decline – speaking of non-linearities! Negative population dynamics tend to intensify in the context of positive feedback loops and negative externalities. For instance, a rising fiscal burden, diminished growth prospects and less innovative society may drive young entrepreneurial types into emigration, while fiscal pressures and declining public investment may lead to a general deterioration of economic, financial and social conditions, which might further accelerate population decline (positive feedback). On other hand, rising labour incomes amid a declining workforce may attract greater immigration, softening the demographic downward trend (negative feedback). Last but not least, it may raise fertility against the backdrop of rising labour compensation.
Politically, the emerging “grey majority” might make reforms aimed at lifting economic growth or reforming public finances by limiting pension and health care expenditure well-nigh impossible. Domestically, this may result in political stalemate and intensify economic stagnation/ decline. In foreign affairs, the “grey majority” may diminish the tendency to pursue aggressive policies, while fiscal weakness may diminish the inclination to engage in financially costly armed conflicts. Incidentally, fewer children may make parents less inclined to lend support to armed conflict, while a smaller share of young people may make it more difficult for governments to garner domestic support for a high-stakes foreign policies, as the risk-averse, older majority prevails.
To sum up, demographic change will have important, if somewhat underdetermined economic, financial and political consequences. While virtually all top-tier emerging markets and advanced economies are aging, different countries will be confronting demography-related challenges with greater or lesser urgency. Interestingly, the dividing line is not as clear-cut as might be expected. China and Russia will be characterised by a rapidly aging demographic, while among the advanced economies the Anglo-Saxon countries will be confronted with less dramatic change – relatively speaking. This should be borne in mind when analysing the “rise of the BRICs” and the “decline of the ‘West".