Home > jobs > The reality is that changes in productivity swamp the impact of demographic change.

The reality is that changes in productivity swamp the impact of demographic change.

from Dean Baker

Tyler Cowen is worried that rich countries won’t have enough people to do the work. This concern seems more than a bit off the mark given that almost every rich country continues to have large numbers of unemployed and underemployed workers, but I suppose pondering this question can at least create some jobs for economists. Anyhow, two of the countries Cowen highlights are Japan, which he tells us has seen a declining working age population since 1997 and China, where he warns about the difficulties that working couples will face supporting four parents as well as their own children.

Taking these in turn, a key part of the story that Cowen leaves out is hours worked. These vary hugely across countries and across time within countries. For example, the OECD reports the average work year in Germany at 1388 hours in 2013. By comparison South Korea, which has a comparable per capita income, had an average work year of 2163 hours in 2012.

This means that in terms of hours worked, each worker in Korea puts in 55 percent more hours than a worker in Germany. If Germany felt it was short of workers, obviously they could try to encourage their workforce to put in more hours. If they just made up half the difference with Korea it would be equivalent to a 28 percent increase in their workforce. That is equivalent to an awful lot of additional kids.

This is directly relevant to the Japan story, since the OECD reports that the average work year in Japan has declined by 7.0 percent since 1997, the year its working age population began to decline. This doesn’t suggest that a shortage of workers has been a major problem for Japan.

Turning to China, we should first recognize that Cowen is using a bit of hyperbole. He doesn’t really think that the typical Chinese couple will be supporting four parents. However China is seeing a rapidly aging population, so somewhere in the next two decades, the ratio of workers to retirees may fall to near two to one, which will also be the ratio in the United States at that time. 

The key issue in this story is the standard of living at which China’s elderly will be supported. The International Labor Organization reports that real wages in China have been growing at double digit rates. This means that workers have seen enormously rapid increases in living standards over their working lifetime. Over a five year period, real wages would have increased 60 percent, assuming a 10 percent rate of annual wage growth.

This means if a person has been retired five years, and had a standard of living equal to 80 percent her last working year (this is much better than most U.S. retirees can expect), it would be just half of a current workers’ pay. At this rate of wage growth, sustaining this retiree’s standard of living would require 30.8 percent of the worker’s pay after 10 years, and less than 12 percent after 20 years.

Assuming a ratio of two workers for each retiree, the implied tax would be half the size noted above. If we assume that the average retiree has been retired for 10 years, then this 80 percent target would require a tax rate of 15.4 percent, almost exactly the current tax rate in the United States for Social Security and Medicare taken together. Are you scared yet?

But no one expects that the 10 percent real growth rate will continue. Let’s assume that it falls sharply in the years ahead to 5 percent. Let’s assume that they need a 20 percent tax rate to support retirees at level near 80 percent of their final working salary. If they build up to this tax rate over the next twenty years at the rate of 1 percentage point annually, then this would mean that the 5 percent before-tax real wage growth would translate into 4 percent after-tax real wage growth. Now that is pretty terrifying!

The reality is that changes in productivity swamp the impact of demographic change. A country with decent productivity growth has no reason to fear a slow growing or even declining work force. Conversely, a country with weak productivity growth is likely to find rapid population growth to be a serious burden, not an asset. The key factor in determining living standards will be productivity, demographics is a distraction.

  1. November 11, 2014 at 9:21 am

    Comment on Dean Baker

    You write “The key factor in determining living standards will be productivity, demographics is a distraction.”

    Yes, indeed, and here is the exact formula for the real wage in the pure consumption economy (2014, p. 12, eq. (16)). From this elementary case one can proceed to the more complex formula including investment, foreign trade, and government.

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2511741: 1–29. http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=1210665.

  2. Karthik Rajeshwaran
    May 17, 2016 at 10:31 am

    think abt the malthusian prediction on world going hungry. same analogy here. productivity will trump it.

    • blocke the
      May 17, 2016 at 1:41 pm

      But who wants to live in a world with people in every nook and cranny, and flora and fauna trampled to death.

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