Demography, a long-term driver of economic growth.

By Dr. Thomas K Swift
Chief Economist and Managing Director of the American Chemistry Council

With the agonizing slow economic recovery, much of the focus has been on aggregate demand, another name for gross domestic product (GDP), the sum the output of goods and services. That is, consumer spending, business investment, residential construction, government spending, and our nation’s trade balance.

Meet Alfred Marshall.

But as Alfred Marshall, the great 19th century economist, was wont to repeat, demand and supply are two blades of the same pair of scissors. Economic growth can be viewed from the supply side as well, by focusing on aggregate supply. From this supply orientation, economic output as measured by GDP is said to be dependent upon several things. First and foremost is the quantity of available labor. (Note: Quality as exhibited by skills and knowledge plays a role but let’s set that set that aside for now.) This is measured by the number of people available for work. Second, is the amount (and quality) of the capital stock (computers, machine tools, trucks, etc.) available for those workers. And third is a residual that is largely technology change (which includes not only product and process but also managerial/organizational innovations). Technology innovation is steady in nature during the short-term and probably slowing. Capital formation is improving but is also playing catch-up as depreciation (i.e., wear and tear on the capital stock) likely exceeded capital investment during the recession. From a cyclical viewpoint, once the current uncertainty among business leaders is overcome, it will likely provide a positive impetus to growth.

What about labor? The civilian working age population, and its likely path in upcoming years, is fairly well known as these people were born more than two decades ago. With reasonable accuracy, one can estimate how many will be available next year, in five years, etc. The attached chart measures the civilian labor force. Excluding those people not in the labor force (retired, stay-at-home moms or dads, etc.) the civilian labor provides a reasonable and almost real-time monthly measure of potential growth of the labor input. The chart is benchmarked to where the end of the recession (or business cycle trough) is equal to 100. (To read this chart, if a data point is at 105, the number of people in the labor force is 5% above the end of that recession.) The growth of the civilian labor force is then plotted for the most recent business cycle recovery (which began in June 2009) and for the last two recoveries (both of which were described as jobless recoveries) as well as the upper and lower (best and worst) showing of recoveries from the 1940s through the 1980s. The data aren’t encouraging. Whereas at this point in time some 15 or so months into the recovery the civilian labor force has grown (by 1-3%) in this most recent recovery (green line) it is still below the trough levels of June 2009. Moreover, its underlying pattern lags that of the “jobless recoveries” of the 1990s and last decade. The retiring of the baby boom generation and a slowing number of entrants into the labor market are prime factors.

With fewer labor inputs available, economic growth will thus generally lag in this recovery. And this is before such factors as deleveraging by consumers are taken into account. Whereas a 3.0% per year long-term growth rate for the economy was the norm in the past two decades, a long-term growth rate is now in the 2.0 to 2.5% per year range. The economy is the victim of underlying demographics, which will determine (pre-ordain) a lower growth pace.

This is a worldwide phenomenon. The second attached chart shows the annual average growth in working age population for the US, a number of other developed nations, as well as some emerging nations. The 10-year period leading up to 2010 (blue bars) and the 10-year period after 2010 (red bars) are provided.

If long-term trends are for slower gains in the US, the long-term trends are downright miserable for Japan and most European nations. In France, Germany, Italy, and Spain working age populations will shrink, and in Japan and Russia shrink by a significant amount each year. With a key input to economic growth falling, these latter two nations will have a hard time maintaining an economy of its current size. A 1.0% per year long-term growth rate for the Japanese economy might at times seem robust. Underlying demographics bode ill for the social welfare and pension programs of many of these nations; hence the new austerity. In comparison the US and Canada will experience somewhat more dynamic gains in their working populations, the result of encouraging immigration and higher birthrates.

But even in the emerging markets, growth in working age population will slow, most notably in China. The latter is the result of the “one child” policy. It is hard to believe but within two decades China will experience labor shortages.

Demography is a major long-term driver of economic growth; a sort of economic determinism. How does one offset rather dour demographic trends and enhance economic growth? Expanded immigration and longer careers play a role as will policies that promote technological innovation and capital spending to enhance worker productivity. That is, augment the other factors of economic growth.

Dr. Thomas K Swift
Economic Advisor

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