Demographics matter for growth, inflation and rates

Demographics are increasingly becoming an important economic variable to understand due to the impact they can have on potential growth rates. 

A simple measure to demonstrate this impact is the size of a country’s working age population, which is defined as everyone aged 15 – 64. 

The number of people available for work in an economy is a key economic statistic, as Gross Domestic Product (GDP) reflects the total output of every person working in the economy.

The more people an economy can employ, the greater its potential GDP will be. 

When an economy’s working age population is increasing it means the economy has more people to pull into employment.

Conversely, when it declines it becomes more likely that people will drop out of the workforce.

This makes the working age population a rough measure of how many people we can expect to be employed.

Falling labour pools

In 2011, the developed world started a process of retirement as the baby boomer generation started hitting age 65. As a result, many countries are now facing declining labour pools, as more people are retiring than can be replaced by younger workers. 

To put this change into perspective, the United Nations DESA population statistics show that from 1950 to 2008 the developed world was adding between 2 – 6 million people of working age per year.

Since 2011, however, this projection changed to a decline of 2million people per year. This retirement process is a structural trend that will take a number of decades to play out.

A recent International Monetary Fund  publication stated that participation rates — a measure describing how many people are employed or looking for work — in the developed world are set to decline by close to five percentage points over the next three decades, which “could have negative implications for advanced economies’ potential growth and… the sustainability of their social security systems”.

A change of this nature results in a change in economic fundamentals, which the developed world has never dealt with before.

Looking at the performance of the developed world over the past seven years provides strong evidence for why these factors matter.

Clear hierarchy

During this period, a clear hierarchy in growth and inflation evolved, which is based on how large (or small) a country’s working age population has been.

Focusing on the top 10 developed countries in the world shows the strongest working age population growth has been in Australia, US and Canada averaging a 4 per cent increase over the period.

This has brought with it higher levels of growth and inflation, averaging 1.8 per cent and 2.4 per cent respectively.

Over the same period, Japan, Italy and Spain saw the worst working age population declines, averaging -5 per cent. These nations have also seen lower levels of growth and inflation at 0.9 per cent and 0.6 per cent respectively.

Interestingly, the countries with negative working age population growth are those with the most aggressive central bank policy, such as negative interest rates and ongoing quantitative easing programs.

These changes highlight why demographics matter. Prior to 2011 almost all developed economies had positive working age population growth and hence positive growth fundamentals.

However, the change in demographics since 2011 has delivered vastly different trajectories for develop economies as labour force sizes change at different paces.

These demographic changes have flow-on effects for growth, inflation and interest rates.

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