I thank the organizers for inviting me to speak at the Cato Institute’s 35th annual monetary conference. To some of us, 35 seems relatively young, but for a conference series, it is a ripe old age. The series’ longevity underscores the important contributions it has made over the years to the public discourse on monetary economics and policy. Whether you interpret 35 as young or old depends on the context, which brings me to my topic today: demographics and their implications for the economy and policy. This might seem like an unusual topic for a Cato conference, but demographics have been on my mind, and not just because I had a birthday last month.
The word “demographics” comes from the Ancient Greek: “demo” meaning people and “graphics” meaning measurement. There is a strong tradition of studying demography as part of economics. Malthus’s writings on population growth are a part of many history-of-thought courses in economics. More recently, as the economy has moved from financial crisis and the Great Recession to sustainable expansion, attention has shifted from cyclical aspects of the economy to structural factors. In addition, as policy has begun to normalize, the question has been raised: “what is normal?” To answer such a question, we need to understand how the underlying fundamentals of the economy are evolving. A critical factor is demographics. Demographic change can influence the underlying growth rate of the economy, structural productivity growth, living standards, savings rates, consumption, and investment; it can influence the long-run unemployment rate and equilibrium interest rate, housing market trends, and the demand for financial assets. Moreover, differences in demographic trends across countries can be expected to influence current account balances and exchange rates. So to understand the global economy, it helps to understand changing demographics and the challenges they pose for monetary and fiscal policymakers.
Today I will talk about some of these demographic trends and their policy implications. Of course, the views I’ll present are my own and not necessarily those of the Federal Reserve System or my colleagues on the Federal Open Market Committee.
Demographic Trends
Until the early 18th century, world population grew little because high mortality rates offset high fertility rates.1 But increased knowledge and technological change in the form of advances in medicine, public health, and nutrition began to lower mortality rates. Fertility rates also began to decline. In the U.S. there were shifting preferences for smaller families because of the rising opportunity costs of having children and the higher costs of raising and educating them. The shift in population from rural to urban areas reduced the need for large families to run farms. There were changes in social norms regarding the use and availability of birth control. The baby boom in the U.S. after World War II, and the subsequent echo when the baby boom generation began having their own children, were exceptions to a generally downward trend in the birth rate. Today, the fertility rate in the U.S. is 1.88 births per woman.2 This is less than the United Nations’ estimated 2.1 replacement rate needed to keep the population stable, and it is considerably less than the fertility rate in 1900, which was over 3.3
As these demographic changes have played out, the average life expectancy in the U.S. has risen and the population has aged. Average life expectancy at birth is now nearly 80 years old, 30 years higher than it was in 1900.The median age of the U.S. population is approaching 38 years old, nearly 10 years older than in 1970. By 2050, the U.N. projects that the median age in the U.S. will be 42 years old and that the number of people age 65 or older per 100 of working-age people, those age 15 to 64, will be more than double what it was in 1970.
Reflecting projections of relatively stable fertility rates and continued aging of the population, world population growth is expected to slow. It averaged around 2 percent per year in the latter half of the 1960s and slowed to 1.2 percent per year over 2010-2015.8 U.S. population growth, including net international migration, is expected to slow from about 0.8 percent in recent years to under 0.5 percent in 2050, with nearly two-thirds of that growth coming from net migration.
A number of advanced economies are further along in this demographic transition than the U.S. is, and the process of population aging is accelerating worldwide. In Japan, the population has been shrinking over the past five years, the ratio of older people to working-age people is the highest in the world, and the median age is almost 47 years old.11 Across Europe, fertility rates have been below the replacement level for some time. In China, the growth rate of the working-age population has slowed since the late 1980s, and partly because of its previous one-child policy, China’s population is also rapidly aging. The median age in China has increased from around 19 years in 1970 to 37 years in 2015.
On the other hand, many low- and middle-income countries are at a considerably earlier phase in the demographic transition, with young and faster growing populations, and rising labor force participation rates. In India, the median age is around 27 years and the annualized growth rate of the population from 2010 to 2015 has been 1.2 percent. The U.N. projects that, in seven years, the population of India will surpass that of China, currently, the most populous country, and that India’s population will continue to grow through 2050. Much of the increase in world population between now and 2050 is projected to be in Africa, where fertility rates remain high.
The implications of these global demographic patterns for the future of the U.S. economy are worth considering because they pose some challenges for policymakers. Indeed, the magnitude of the effects will depend on policy responses. The remainder of my talk will discuss some of the ways these changing demographics could influence the U.S. economy, in particular, labor markets and economic growth. Then I will turn to considerations for monetary, fiscal, and other government policies.
Demographic Implications for Labor Markets
Demographics influence the supply of labor. Typically, as mortality rates decline and people live longer, the supply of labor increases. We saw this pattern begin in the U.S. in the late 1960s and the 1970s, especially as women and the baby boomers began entering the workforce. The result was an increase in the available supply of prime-age workers, both females and males, and potential growth rates in the 3 to 4 percent range.
Even though increased life expectancy means individuals will need to work longer in order to save more for retirement, usually, population aging eventually leads to a downward trend in labor force participation in the aggregate.16 This is already happening in the U.S. Labor force participation peaked at 67.3 percent in early 2000 and fell to 66.0 percent in December 2007, as the Great Recession was beginning. Since then, it has fallen further, to 62.7 percent as of October. While some of the decline represents cyclical factors, research suggests that most of the fall in the overall participation rate can be attributed to demographics: the combination of an aging population and reduced participation rates at older ages.
As a result of lower population growth and labor force participation, the growth of the U.S. labor force has slowed considerably, from 2.5 percent per year, on average, in the 1970s, to around 0.5 percent per year over 2010-2016. It is expected to remain near that level over the next decade.18
The changing age distribution of workers can affect not only labor force growth and participation but also the longer-run natural rate of unemployment. Older workers typically have lower unemployment rates than other age groups, and they tend to change jobs less frequently.19 Young people now make up a smaller share of the labor force. All else equal, the combination of lower quit rates for older workers and lower numbers of younger workers should imply a lower natural rate of unemployment compared to the 1990s.20 Of course, the timing and magnitude of this demographic effect are not certain because there are some counterbalancing factors, including the fact that, so far, contrary to expectations, the retirement age for older workers hasn’t changed much, the productivity of a worker varies with age, and policies such as unemployment and retirement benefits can affect labor market choices.
Demographic Implications for Economic Growth
The expected slowdown in population growth and labor force participation rates will have implications for long-run economic growth and the composition of growth. The key determinants of the economy’s longer-run growth rate are labor force growth and structural productivity growth — how effectively the economy combines its labor and capital inputs to create output. Demographics suggest that labor force growth will be considerably slower than it has been in recent decades, and this will weigh on long-run economic growth.
In addition, in theory, the aging of the population may also have a negative effect on structural productivity growth. Over the past five years, labor productivity, measured by output per hour worked in the nonfarm business sector, has grown at an annual rate of only about a half of a percent; over the entire expansion, it has averaged 1 percent. While some part of the slowdown is likely cyclical, reflecting persistent effects of the Great Recession on investment spending, structural factors are also weighing on productivity growth. Older workers tend to stay longer in their jobs than younger workers, who are more likely to change jobs and employers. This allows older workers to gain deeper experience, which can be positive for productivity growth. At the same time, lower labor mobility means workers may remain in jobs that are not the best match to their skill sets. This would be a negative for productivity growth. Indeed, one study finds that both short tenures and long tenures adversely affect productivity growth. And historical evidence suggests a hump-shaped relationship between age and productivity, with productivity increasing when a person enters the workforce, stabilizing, and then declining toward the end of a person’s work life.Research also indicates that an individual’s innovative activity and scientific output peaks between the ages of 30 and 40, although that age profile has been shifting older over time.
Labor mobility and business dynamism, including the number of start-ups in key innovative sectors like high-tech, have been declining for some time. Whether dynamism will remain low is an open question, but the aging of the population is here to stay. So far, the magnitude of the negative effect of the aging workforce on productivity growth appears to be quite small. Even so, the demographics-induced slower growth of the labor force and the possible dampening effect on productivity growth suggest that longer-run output growth will likely remain below the 3 to 3.5 percent rate seen over the 1980s and 1990s, unless there is some effective countervailing policy response.
In addition to affecting the economy’s trend growth rate, demographics will likely affect the composition of growth by shaping aggregate consumption, saving, and investment decisions. Increased longevity means that people will need to save more over their working life to fund a longer retirement period. This is especially true given the degree of underfunding of public pension plans at the state and federal levels. Demand for healthcare will continue to rise, and an aging population will place different demands on the housing sector than a younger population, affecting the demand for single- versus multi-family properties, for owning versus renting, and for residential improvements that allow older adults to age in place. By affecting the composition of output, changes in the age distribution have the potential to affect the business cycle. Because of its cyclical and structural implications, demographic change also has implications for monetary policy. Let me talk about three.
