Observers were predicting that Human Population was too big and would soon strip the World of Resources

March 20, 2020 8:00 AM




Demographic change is having a fundamental impact on the global economy—but not in the way we once thought it would.

A mere five decades ago, some observers were predicting that the human population was too big and would soon strip the world of resources, leading to mass starvation, collapse of the global economy, and a host of other ills. But the doomsday scenario of mass overpopulation did not materialize. Rather, for the first time in modern history, the world’s population is expected to virtually stop growing by the end of this century, owing in large part to falling global fertility rates.

Japan’s unique population, fertility, and immigration history make it a leading exemplar of this trend. The impact of an aging and shrinking population is already visible in everything from economic and financial performance to the shape of cities and public policy priorities (such as the long-term solvency of public pension, health care, and long-term care systems).

With demographics having such a clear and accelerating impact, Japan is the test kitchen for “shrinkonomics”—a laboratory from which other countries are beginning to draw lessons.

The IMF’s work on the Japanese economy has focused heavily on demographics in recent years—mirroring the intense debate within Japan on how best to respond to the pressures from a rapidly aging and shrinking population. While each country’s experience will be different—and prompt different solutions—some of the key macroeconomic and financial effects can be identified from Japan’s recent experience.

First, aging and dwindling populations can have a direct impact on a country’s labor force and labor markets—particularly the size of the working-age population. Demographic change has been a driving force in Japan’s labor market for several decades. Japan’s potential labor force—those between ages 15 and 64 as a share of the total population—peaked in 1991–93 at just under 70 percent. Since that time, however, the potential labor force has fallen quickly to just above 59 percent, the lowest level among the Group of Seven countries and well below levels seen in the mid-1950s.

Given current low fertility and accelerating death rates, this ratio is expected to continue to decline well into the medium term. With a limited inflow of foreign workers, this implies insufficient workers to maintain current levels of economic activity. Such a linear view of the future is more dire than Japan’s experience, however. The continued demand for labor has spurred both more women and more elderly (those outside the traditional 15–64 working age) to join the labor force. Automation, artificial intelligence, and robotics (including technology to increase productivity per worker) will also be critical to Japan’s response to shrinkonomics.

An older and smaller population also has implications for productivity and long-term economic growth—and IMF research suggests Japan is a valuable case in point (Westelius and Liu 2016). First, older workers may enjoy higher productivity because of their accumulation of work experience, while younger workers benefit from better health, higher processing speed and ability to adjust to rapid technological changes, and greater entrepreneurship, leading to more innovation. These two counterforces suggest an inverted U-shaped relationship between age and productivity, with productivity lowest at the beginning and ending phases of a career. Second, aging is likely to increase the relative demand for services (e.g., health care), causing a sectoral shift toward the more labor-intensive—and less productive—service sector. Third, the size or density of the population may also have an impact on productivity (i.e., productivity rises with greater size and density of a working population).

A more elderly and reduced population—which means relatively more retirees, a smaller labor force, and a shrinking labor-based tax pool—also points to the challenge of financing social security frameworks. As the population ages, public expenditure on health care, long-term care, and pensions naturally rises. But in a shrinkonomics context, in which the active, taxpaying labor force is in decline, financing this rise in public spending can be problematic. Japan’s challenges are particularly severe, given that the entire baby-boom population is passing the 75-year milestone in just three years (starting in 2022 and ending in 2025) and the country’s public debt as a share of GDP is already the highest in the world.

Meeting social security–related obligations while maintaining a sustainable fiscal position and intergenerational equity is a thorny task for Japan’s authorities and will likely require important changes to both the benefits framework and its financing structure. IMF studies on Japan have explored possible policy options.

Among options related to financing, a continuous and gradual adjustment of the consumption tax dominates other potential measures to finance the cost of aging, including higher social security contributions, delaying fiscal adjustment (with an implied prolonged period of debt financing), and increased health copayment rates. Relative to these options, increases in the consumption tax—which apply across age groups—have smaller adverse effects on long-term GDP and welfare, according to one IMF study (McGrattan, Miyachi, and Peralta-Alva 2018). This study also suggests that postponing adjustment through debt financing results in a large crowding-out of private sector investment—by up to 8 percent—with detrimental effects on long-term GDP and welfare. Finally, a uniform increase in health copayment rates for the elderly—which would imply shifting a part of aging costs to current generations—would have regressive consequences.

Demographic trends may also exacerbate income inequality between generations. Growing income inequality between young and old is a concern in Japan, particularly as an increasingly smaller share of the population is asked to shoulder the financing costs for rising social security transfers.

Older generations, who benefit most from fiscal redistribution (via taxes and transfers), are significantly wealthier than younger generations. Wealth poverty is significantly lower for older generations. Moreover, the wealth ratio of older to younger cohorts is relatively high in Japan compared with Germany and Italy, though lower than in the United States. The evidence thus points to significant wealth inequality across generations.

The relative wealth of older generations in Japan calls into question the costly fiscal redistribution mechanism in place that aims to reduce elderly income inequality mainly via pensions. These and other aspects of public social security frameworks are being actively debated in Tokyo policy circles.



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