An excerpt from Graeme Leach’s article, ‘The Future of Demography’.
The French philosopher Auguste Comte is often quoted as the source of the phrase “demography is destiny”. In other words, the assertion that population trends determine the future of a country and the world – and by implication business. Whilst the phrase is a much-overused aphorism, there is still much demographics can teach us about the future. Comte’s words are traditionally associated with 2 demographic trends: (1) The rate of population growth. (2) The changing age structure of the population. This paper examines the profound impact of both on the UK economy over the coming decades. In so doing it challenges many shibboleths and much received wisdom.
UK Population Projections
Back in 1950 the UK population was around 50 million. Over the next 50 years it increased in size to 58.9 million by 2000, and over the past 2 decades it further increased in size to 67.1 million in 2020.
Table 1 highlights the most recent official population projections for the UK published by the ONS. The latest 2020-based official interim projections show the UK’s population rising to 69.2 million in 2030 and reaching 71 million by 2045.
Over the period of Table 1, roughly the same number of births and deaths will occur and the rise in population is projected to be the result of net migration over 2020-2030 period projected at 2.2 million. Up until mid-2027 UK net migration is projected to average 232,000 each year. Thereafter it is projected to average around 205,000 per annum.
This is shibboleth number one to be shattered. In the wake of Brexit annual net migration into the UK was meant to fall into the 10s of thousands from the 100s of thousands. In reality net migration has surged due to special effects (see: Figure 2); such as overseas British nationals returning during the pandemic, overseas nationals returning from Hong Kong in the wake of the Chinese crackdown, new visa routes for Ukrainian nationals and via the Afghan Resettlement programme. The ONS projection of net migration of 2.2 million over the 2020-2030 period is a prediction, but it is also the reality of intended government policy. The ONS wouldn’t project net migration figures at odds with government policy.
Below the level of overall population, there is of course considerable variation within different demographic groups. Between 2020 and 2045 the number of people of pensionable age (allowing for changes in the state pension age) is projected to grow from 11.9 to 15.2 million – a 28% increase on the level in 2020. Conversely, the assumed fertility rates result in fewer children, which decline in number from 12.7 to 11.2 million over the 2020-2045 period.
Fewer Workers?
Perhaps the most notable change by life stage is the growth in the working age population (WAP), which increases in size from 42.5 to 44.6 million over the 2020-2045 period. Indeed, most of the increase occurs over the 2020-2030 period, from 42.5 to 44.4 million. These projections drive a coach and horses through shibboleth number two, the idea that an ageing population will result in fewer people and therefore workers - and a shortage of labour.
This is a matter of great concern across the global economy, because if we look back over recent decades, three factors stand out with regard to the supply of labour. This is the triple boost to the supply of labour from the growth of the baby boomer generation, increased female labour market participation and the collapse of communism.
In 2007, the economist Richard Freeman wrote, ‘The Great Doubling’. In it he argued that before the collapse of communism and economic reforms in China (and India), globalisation spanned about 1.46 billion workers in the developed economies, Latin America, Asia and Africa. He asserted that in the 1990s the global pool of labour doubled to around 2.93 billion workers. This massive boost to the global labour supply now appears to be reversing or stalling.
Whilst this is a deep concern for many businesses, it is something which is simply not borne out by the data in the UK. Indeed, closer inspection reveals that there is likely to be a positive stimulus to the size of the WAP and the labour force. The size of the WAP is not the sole determinant of the labour supply. Labour supply also depends on so-called participation rates – the proportion of the labour force actively engaged in work. Both the size of the WAP and participation rates determine the supply of labour.
We will delve a little deeper on each, across the world’s leading economies, to show how the idea of labour shortage has developed and where it is or isn’t a major issue for business. For it most definitely is an enormous future problem in many economies.
A demographic shock wave is about to severely undermine the supply of labour. Decades of working age population growth are turning into decades of steep decline or sharp slowdown, as shown in Table 2. The demographic support to economic growth is being savagely undermined in economies such as Japan, Italy and Russia.
An economic technique known as growth accounting decomposes the sources of GDP growth into the contributions from: (1) Labour. (2) Capital. (3) Total or multi factor productivity growth, which is seen as a proxy for technology and/or innovation. If one of the sources weakens, then another must strengthen in order to maintain existing growth rates. With this in mind, and reference to the EU, the European Central Bank (ECB) stated in 2017 that, “times will get particularly difficult after 2020 as working age population will continue declining”. The depth of the demographic problem is evidenced in the ECB’s assertion that “the EU’s productivity growth would have to double in order to keep the EU economy growing at the same pace as it did before the [financial] crisis started”.
In the final 25 years of the 20th century the secular force driving the dramatic increase in participation rates was women’s entry into the labour force. A flattening in labour force participation is now occurring at the same time that working age population is slowing or shrinking.
The International Labour Office (ILO) in Geneva has produced total labour force projections across all the world’s economies, based on 2017 UN population projections and their own modelling of participation rates. These standardised projections help identify whether or not increased rates of labour participation could help offset in part or in full the decline in the size of the working age population. The ILO’s projections for the 2020s generally show one of three things:
A very sharp slowdown in labour force growth.
A shift from positive to negative labour force growth.
An intensification of the negative effect.
Even where the size of the labour force continues to increase, there is a very marked slowdown in the cumulative decadal rate of growth, such as in the UK, from 4.9 to 1.6 percent between the 2010s and the 2020s. But crucially, the labour force is still projected to expand in the UK. The fewer workers story requires a little more nuance, with analysis of the natural rate of working age population growth i.e. working population change in the absence of net migration. Table 4 shows that across the leading economies natural working age population change is almost uniformly negative over the coming decades. Large declines in the 2020s intensify into the 2030s. The sea of red numbers justifies the description demographic death row. Without continued mass migration the world’s advanced economies face demographic implosion. So, whether it is the UK (far less adversely affected) or more deeply affected economies, the future labour supply is heavily dependent on net migration of workers. They appear to be on demographic death row without it.
Or are they? There is one more influence we should consider as well, namely the potential for post-retirement working. Many countries could in theory expand labour force participation in work after the age of 65. The OECD average for participation rates over the age of 65 is 13.5 percent, with countries such as Spain, France, Germany and the UK below even this level. Moreover, various studies suggest that workers in the UK will have to ‘work until they drop’ in order to make-up for inadequate pension provision. There is a ‘misery gap’ between what people are paying into their pension and what they need to, in order to maintain the lifestyle in retirement they desire.
Newspaper reports of market research by Canada Life in the UK, suggests that 72 percent of the working population, around 23 million people, believe they will need to keep working beyond retirement age because they simply cannot afford to retire. 20 percent expect to be working in their mid to late 70s. A Chatham House report estimated that 15 million UK households in middle income groups risked a reduction in their income of almost 60 percent from pre-retirement levels. Around 10 million households, the poorest 40 percent, risked having to live off little more than the state pension, with a minimum standard of living. This strongly suggests that labour force participation beyond the age of 65 could expand significantly in the future. If so, the slowdown in the growth of the labour force could be far less than suggested by WAP change. Indeed, labour force participation might well expand not contract.
So, what is the UK view? The number of economically active people over the age of 16 grew by 5.8 million (21 percent) between 1995 and the eve of the pandemic. The Resolution Foundation has estimated that if we hold activity constant at 2019 participation rates, and apply these rates to projected population cohorts, then the UK workforce could be expected to grow 790,000 between 2021 and 2030 – an increase of 2.3 percent. Further out, the UK workforce could be expected to peak at 35 million in 2035, before gradually declining thereafter. Even in the absence of higher participation rates beyond the age of 65, the UK’s labour force should continue to expand well into the 2030s.
The UK would appear to be in a transition. Historically, it has been population change which was the primary driver of the growth in the labour supply (86% over the 1994-2000 period, declining to 71% over the 2001-2011 period and 24% over the 2011-2019 period), but that has now flipped to economic activity rates.
Younger and More Dynamic?
The Resolution Foundation has analysed lifecycle flows and predicts that they could reach record highs in the coming decades. The number of people reaching state pension age (SPA) is expected to surpass 800,000 in 2028 for the first time ever. The number of people turning 22 and entering the labour market will exceed 900,000 in 2032 for the first time this century. This shatters another shibboleth, the idea that the workforce will be ageing over the coming decade. These numbers are striking because they mean that despite an ageing population, the age composition of the workforce will become marginally younger by the mid 2030s (between 2019 and 2035 the share of workers aged 16-29 will increase by 1 percentage point). A younger workforce will tend to be a more flexible one. However, from the mid 2030s onwards the share of the UK’s workforce in the mid and older aged groups does begin an inexorable rise.
The idea that the workforce and the economy could become more, not less dynamic, between now and the mid 2030s will surprise many. Standard economic theory shows that labour productivity is a function of both capital deepening and total factor productivity growth. The potential for the substitution of labour by capital is therefore an important consideration. Recent research by Acomeglu and Restrepo has found no negative relationship between an ageing population and economic growth stating, “there is no such negative relationship in the data. If anything, countries experiencing more rapid ageing have grown more in recent decades … this counterintuitive finding might reflect the more rapid adoption of automation technologies”.
Acomeglu & Restrepo are basically saying that fears over the economic consequences of an ageing population are overdone, because we can substitute robots (tangible or intangible capital investment) for people and done correctly this might even accelerate economic growth. Acemoglu and Restrepo argue that population ageing may give incentives to automation and, hence, to higher productivity growth, which may even increase long-run GDP per capita growth.
Fiscal Insolvency?
One of the economic narratives most associated with an ageing population is that of fiscal insolvency due to unfunded public sector liabilities. There is no doubt that the world’s advanced economies have pledged far more than they can afford with regard to the future public sector costs associated with state pensions, health and social care and the retirement incomes of former state employees. However, the shibboleth is that this is a manageable problem, because many have ‘cried wolf’ for decades regarding this threat, and it has failed to come to pass. The truth is that it will not present a significant constraint for the next 15-20 years but thereafter it will explode. Let’s examine the evidence.
According to the most recent 2022 estimates from the Congressional Budget Office, US federal debt held by the public will rise from 98% of GDP in 2022, to 117% of GDP in 2035 and 185% of GDP by 2052. According to the CBO projections federal deficits over the 2022-2052 period will average 7.3% of GDP. This is more than double the average over the past half century. The deficit rises continually, reaching 11% of GDP in 2052.
These projections are actually overly cautious. Continued growth in entitlements together with future economic downturns are likely to add further impetus to the upward pressures. Moreover, the projections don’t incorporate the negative effects on the incentive to work, save and invest, from higher taxation. This lessens the future size of the economy. Deficit financing will also drive-up bond yields and thereby impede long term growth. A recent IMF book, Post Crisis Fiscal Policy, has examined the impact of public debt on the economy and concludes that: “a range of econometric techniques suggest an inverse relationship between initial public debt and subsequent growth … on average a 10-percentage point increase in the initial debt-to-GDP ratio is associated with a slowdown in real per capita GDP growth of around 0.2 percentage points a year”. On this reckoning the 87% of GDP increase in the public debt to GDP ratio in the US by 2052 could wipe-out growth.
So, there is good reason to believe that the 2035 figure will be higher than 117% of GDP. But that is not a crisis. The comparable public debt figure in Italy already exceeds 135% of GDP and in Japan has reached 172% of GDP. We are a good 15 years out from any fiscal crisis demanding sharp reductions in entitlement spending and/or higher taxation. That day will come however, and it is a grave mistake to misinterpret the lack of crisis to date as a lack of crisis full-stop.
A different – and more alarming - approach has been taken by the American economist Laurence Kotlikoff, who published a paper in the journal of the Federal Reserve Bank of St Louis way back in 2006, entitled: Is the United States Bankrupt? By bankrupt he meant the US Government, in the sense that it would be unable to pay its creditors i.e. recipients of future Medicare and Medicaid etc. Kotlikoff’s focus wasn’t on existing debt and future projections, but a holistic assessment of future unfunded liabilities. In 2012 Kotlikoff stated that the debt problem of the US Government was worse than for Italy, citing figures that the unfunded liabilities of the US Government amounted to $220 trillion – around 11 times the total public debt of the US government at present. Kotlikoff answered his own question saying that “the US Government is indeed bankrupt in so far as it will be unable to pay its creditors”.
The US figures are quoted because of their severity in an economy hitherto considered fiscally sound. Comparable figures for the UK show a similar story. Projections on fiscal sustainability from the OBR show public sector net debt still around 98% of GDP mid-century. But thereafter it is projected to explode, reaching, 267% of GDP by 2071-72. As with the US and other nations, these projections are highly sensitive to initial conditions. For example, the UK fiscal sustainability projections from the OBR assume public spending – total managed expenditure – averages 42% of GDP over the next 20 years, but it is already projected at much higher levels over the coming years, around 45% of GDP in the November 2022 economic and fiscal outlook. There is also a rising tide of statism in politics, with people looking to the government to solve every problem. This and/or future economic downturns are likely to worsen the public debt situation and bring forward a day of reckoning, but as with the US, probably not in the next 15 years. The can will be kicked down the road for a good time yet.
(Continued in PDF).
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See other articles from Kingsgate:
The Future of the UK Housing Market - Graeme Leach
The Future of the UK Commercial Property Market - Jonathan Gibson
The Future of Cyber Security - Rhys Gillespie
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