Long-term growth: the demographics challenge

The aging baby boomer generation engenders a monumental shift in the makeup of the workforce in advanced economies, and with this shift comes the challenge of how these global economies will adapt and continue to grow. With a large proportion of baby boomers exiting the workforce in the coming decade or two, and with the government spending required to provide the resources needed for this generation in retirement, the consensus amongst economists is that most, if not all, advanced economies will see their GDP growth stagnate or contract.

In their recently published study looking at the impact of demographic trends on future economic growth, Scope Ratings state that demographic factors explain a significant part of the downward trend in advanced economies’ economic growth and are likely to remain an important factor in coming decades.

In their study, Scope Ratings covered the period of 1960-2050 for advanced economies, and isolated one of three drivers of GDP growth, the working-age population, while maintaining the productivity and employment rate factors constant at 2014-19 levels.  This allowed them to estimate a country’s growth prospects based only on its demographic trends which are less likely to fluctuate.

As the figure below illustrates, growth prospects are structurally declining in all advanced economies, but significant differences exist across selected countries, with the US, UK, and France likely to continue growing thanks to relatively favorable demographic trends. Germany and Spain, on the other hand, are likely to see growth stagnate whereas Japan and Italy are likely to experience a marked decline in their GDP levels in the next decades unless the adverse demographic trends are offset with productivity and employment gains not seen during recent years. 

Demographics are a key source of economic growth 

It is fairly easy to understand, in general terms of a smaller workforce, how aging populations will remain an important factor constraining GDP growth in advanced economies, but what will be the direct effects be on the economy as baby boomers retire?

As Scope described, demographics impact economic growth through different channels. First, an aging population reduces the availability of labour inputs as the size of the working-age population declines. Secondly, aging has an impact on whether a population tends to save or consume and how people balance work and leisure. Thirdly, the changing structure of the population also affects productivity growth though the direction is not clear-cut: older workers may enjoy higher productivity due to the accumulation of work experience; younger workers may benefit from better health, the ability to adjust faster to technological changes and pursue entrepreneurial ventures leading to more innovation. These two countervailing forces may produce an inverted U-shaped pattern between age and productivity, with the age groups in their 40s being the most productive. 

For economies that are more exposed to these channels than others, as we will see below, policies specifically addressing these issues may help in limiting the adverse effect they have on economic growth.

Wide variation across advanced economies 

In their study, Scope Ratings evaluated the economies of Germany, France, Italy and Spain in the euro area, the UK, the US and Japan. Their model confirmed that growth prospects are structurally declining in all advanced economies, however, it also shows very different prospects across selected countries, which they divided into three groups based on their demographic impact: less affected (US, UK, France), somewhat affected (Germany, Spain), and strongly affected (Italy, Japan).

Comparing the best (US) and the worst (Italy) performer over time, Scope says, highlights the magnitude of the problem: For 2050, US GDP could be as large as 115% of its 2020 level in real terms, while the projection for Italy suggest its GDP may be only around 90% of its 2020 level. 

Scope Ratings also noticed a varying importance of growth drivers over time. While productivity growth and demographics were positive before 2000 in both countries, now and in the future, productivity growth is structurally declining as is the growth contribution from the working-age population. 

Overall, growth prospects are set to decline in both countries, but in the US the working age population is expected to continue to increase, though at a slower pace. Italy, on the other hand, saw a rapid – and to date irreversible – productivity decline after 2000, in addition to severe working age population reductions projected in the next decades. 

View the full Scope Ratings report here.