What age has to do with a country’s economic fortunes
4 min read 26 Jul 2022, 10:05 PM ISTThe ageing of countries can impact variables like inflation though India may be an outlier with our low labour participation
PremiumThe rise of China after 1990 led to two profound effects on the world economy—the global price of labour was driven down while global commodity prices went up. The former has been a deflationary impulse while the latter has been an inflationary one, though the former overpowered the latter in advanced countries whose commodity intensity has come down because of a shift to services.
There are now signs that China is slowing down as well as ageing. The latest population estimates released by the United Nations earlier this month suggest that there will be 120 million fewer Chinese citizens in 2050. And more importantly in terms of the economic impact, the Chinese labour force will shrink by 220 million by then because of ageing.
Many have earlier written about the “Japanification" of the world, as countries with rapidly ageing populations deal with economic stagnation, deflation and a growing pile of public debt. What has happened in Japan is just an advance warning. Other countries will follow.
Some economists have also argued that the politics of young versus ageing societies is different. In the former, young workers prioritize jobs over inflation. In the latter, retirees want the government to protect the value of their savings through low inflation; job creation is not a hot- button political issue. So the underlying politics in ageing societies will drive governments to prioritize low inflation over high job creation.
But is there another possibility?
In a book published just before the pandemic struck, The Great Demographic Reversal: Ageing Societies, Waning Inequality and an Inflation Revival, economists Charles Goodhart and Manoj Pradhan argued that a decline in the labour force of most major economies, including China, will bring the world to an inflexion point. Among the effects they anticipate is an inflation revival, a shift in the distribution of national incomes from capital to labour, low economic growth unless there is a new productivity revolution, and changes in sectoral financial balances.
The current burst of global inflation is too sudden to be explained by demographic change, which usually proceeds at a glacial pace. It is better explained as the result of a large stimulus to aggregate demand in the midst of an aggregate supply shock. However, Goodhart and Pradhan write about three interdependent ways in which the demographic reversal will push up inflation in the years ahead. Their argument is worth paying attention to, even as policymakers struggle to control the cost of living in their respective countries.
First, a shortage of workers in countries where the size of the labour force has peaked will push up wage rates. That is likely to be inflationary in the absence of a countervailing increase in labour productivity. Higher wages will also increase the share of labour incomes in national economies, and affect inflation to the extent that the savings rate on labour incomes is lower than that on capital incomes.
Second, the nature of the trade-off between unemployment and inflation has changed. The Phillips Curve that charts this trade-off flattened in many countries. What economists called the natural rate of unemployment fell. In other words, inflation could be kept low even with very low rates of unemployment. In their book, Goodhart and Pradhan argue that this will now change, as the weaker bargaining power of workers in advanced economies combined with the informalization of labour will reverse.
Third, economists usually see the financial balances of the private sector and the government as mirror images of each other. For example, a large increase in government deficits is matched by an increase in the financial balances of households and firms which buy the additional government debt. As countries around the world age, an increase in the global dependency ratio—a measure of how many children and retirees each worker supports—will drive household savings down. Corporate savings are expected to come down as well, say Goodhart and Pradhan. The logic of accounting will make governments move from running deficits to surpluses, and higher inflation will help such a transition in macroeconomic balances.
It is well known that these large demographic shifts will open an opportunity for countries such as India, where the working-age population will continue to grow for many more decades. However, a lot depends on whether Indians (and especially women) in their working ages have either the opportunity or freedom to join the workforce and get high-productivity jobs.
India’s labour force participation rate has been falling over the past decade, though part of it could be explained by young Indians staying back for longer in schools, colleges and universities. Yet, less than half of Indians above 15 years of age are either working or looking for jobs. Nearly three out of every four Chinese above 15 years of age was in the labour force 15 years ago, when China was broadly at the stage of development than India is today. That leads to a paradoxical situation in which India has a young population but a high dependency ratio.
Niranjan Rajadhyaksha is CEO and senior fellow at Artha India Research Advisors, and a member of the academic advisory board of the Meghnad Desai Academy of Economics.
