Asymmetrical Information - Megan McArdle

12.04.12

Our Demographic Decline

Birthrates are falling. Will the economy follow?

Over the weekend, Ross Douthat published a column arguing that we are unbreeding ourselves into extinction.  This attracted a fair amount of criticism from fairly predictible quarters, along the lines that Douthat is a misogynist troglodyte who doesn't understand that women have better things to do than bear huge broods of children, and also, that people are bad for the planet.  There were also some more interesting responses, such as Conor Friedersdorf's and Adam Ozimek's; the former points out--in reasonable, thoughtful tones!--that working women who have access to birth control are probably going to have fewer children no matter what we do; the latter, that Ross does not address the obvious solution of more high-skilled immigration.  

This shouldn't need saying, but apparently it does: those who say that this is not a real problem, just something that Douthat made up because he thinks that wives should be barricaded in the kitchen until they've birthed at least a basketball team, are just wrong.  They're wrong because, well, if you've mett Ross's wife, you know they're just wrong, is all.  But that's a sidenote.  They're wildly wrong about the policy side.  Population decline presents us with big, big problems--ones that we have in no way figured out how to solve.  

Our whole economy and social system are designed for a growing economy, and a growing population.  Without future growth, savings and investment become more necessary, but less attractive.  Without growth, people become less generous towards strangers and more unhappy about their own circumstances. And without the growth around which all of our modern welfare states have been structured, the modern safety nets that governments have spent the last century establishing may not be politically or economically sustainable.  

If you think that population decline is going to be a net boon to society, take a long hard look at Greece.  That's what a country looks like when it becomes inevitable that the future will be poorer than the past: social breakdown, political breakdown, economic catastrophe.  

Start with a simple equation: economic growth equals the growth in the workforce plus the growth in the productivity of that workforce.  If the workforce shrinks, then productivity growth needs to be higher, in order to compensate; otherwise your economy shrinks.  In theory, we can compensate for the coming demographic shift with higher productivity.  A shrinking population, after all, means a higher capital to worker ratio.

But this doesn't quite work, because our population will not simply get smaller; it will also get older.  If everyone was going to suddenly die at 45, we might be able to get the requisite productivity boost.  But as the population ages, it will change dramatically, becoming less innovative, more risk averse, less physically capable.  Just as we desperately need productivity to speed up, it is probably going to slow down.

Here's me, a year ago:  

IS STRONG GROWTH still possible once the demographic dividend has been paid out? Of course it is, at least in theory. Even if the workforce isn’t expanding, strong-enough gains in worker productivity can substantially lift the economy. Longer hours and longer careers can theoretically have the same effect. But it is far from clear that in practice, these solutions will work, given the advanced age of Europe’s workers.

To see why, picture two neighboring towns, sharing all the same infrastructure and economic opportunities, with one key difference: their median age. In the first town, which I’ll call Morningburg, the average resident is 28. In the second, which I’ll call Twilight City, the average householder is 58.

Research indicates that even with all the same resources at their disposal, these two places look very different, and not just because one’s grocery store does a booming business in diapers while the other’s has a whole aisle devoted to Centrum Silver.

In Morningburg, young workers are rapid, plastic learners, eager to try out new ways of doing things. Since they’re still hoping to make a name for themselves and maybe get rich, they take a lot of risks. They push their managers to expand into new markets, propose iffy but innovative product lines, maybe start their own firm if the boss won’t let them advance fast enough. For the right opportunity, they’ll put in 18-hour days for a year or more.

In Twilight City, time horizons are shorter—people aren’t looking for projects that will make them rich or famous 20 years from now. They are interested in conserving what they have. That’s mostly rational, given Twilighters’ life stage; but studies show that older people worry more than younger ones about losses and are therefore especially averse to risk. Twilighters also tire more easily and need more time off for illness, so hours worked slowly decline each year. Wages stay steady, however; Twilighters, like most people, get very angry if you try to cut their salary.

That makes Twilighters expensive—so when they lose a job, finding another is tough. As a result, Twilighters tend to cling fiercely to their positions, and may block younger workers from getting a foothold in the labor market.

The difficulty of reemployment contributes to Twilight City’s surprisingly high, but somewhat deceptive, rate of entrepreneurship. Looking closely, we find that businesses there are disproportionately owned by semi-retirees who have hung out a consulting shingle, or become part-time caterers, or invested in a hobby business like an antique store. These businesses typically don’t have much growth potential, in part because cautious Twilighters won’t (or can’t) borrow money for expansion.

Morningburg is a boomtown, prone to periodic savage busts when the young strivers realize that those fur-bearing-trout farms they invested in aren’t going to make them rich. Twilight City is a less volatile place—but little change also means little growth.

In theory, smart policy could make Twilight City look a little more like Morningburg: public investment and forced savings could boost research and business development; employment laws could be reformed to make labor markets more flexible; heavy investments could be made in education to improve the productivity of Twilight City’s few young workers.

In practice, all of this is likely to be fiercely opposed by Twilight City’s citizens, who tend to vote against change, particularly if it threatens their pensions or health care. Many of the most vehement public demonstrations in Europe over the past two decades have followed attempts at pension reform.

As if that weren't bad enough, there's another reason to expect productivity to decline: on average, more people means more invention.  Innovation comes from ideas, and from people with ideas interacting with each other.  As the population falls, so will our capacity for innovation, even independent of the demographic distribution of the people who are left.

Just to get it out of the way, I do understand the arguments from personal liberty, and the environmental effects of overpopulation.  I agree that people cannot simply multiply without limit, and as a working woman myself, well, let's just say I'm a fan of equal opportunity.  But this does not therefore mean that it will be an unalloyed good.  Liberals who dismiss Douthat's concerns are no different from Republicans who insist that because tax cuts are desireable on economic liberty and economic efficiency grounds, they must also raise the government's revenue collections and create millions of new jobs.  

We are facing an unprecedented transition, and it is going to be nasty.  All of our institutions are based around the expectation that the economy will be bigger in the future, not smaller.  When I pointed this out on twitter yesterday, a couple of people asked why this was a problem: wouldn't a shrinking population allow for higher per-capita incomes?  Real estate would probably be a pretty sweet deal, for example.  

The problem with this is that our economic system revolves around a lot of debt.  Biblical and Islamic bans on "usury" (lending money at interest) strike most modern people as pretty silly.  But in the very-low-growth world of historical Palestine, they probably made a lot of sense.  These days, it's easily possible to borrow money at 5%, invest it in something productive, like an education or a car to get you to work, and end up with both parties better off: the lender gets their 5%, and the borrower has so much extra income that the 5% will not be much missed.  But at a time when economic growth was under 1% a year, this would have been extraordinarily dangerous behavior.  Many, maybe most people who borrowed money at interest, would end up dramatically worse off.  So the bible forbid it.

In an era of economic growth, on the other hand, debt has become an integral planning tool for almost everyone.  I mean debt, broadly construed, not simply actual bonds and loan documents.  Social Security is a debt.  So are pensions, and Medicare.   And of course, savings accounts and and t-bills and municipal bonds are also debts.  They are all promises to pay folks later, out of future earnings.  And those are not per-capita promises; they are fixed.  If GDP shrinks, those promises become unpayable, which is what we've already seen it Greece.  

Those promises can be abrogated, of course.  By law, Social Security will stop paying benefits in excess of its intake as soon as the "trust fund" is exhausted.  And even in the absence of such provisions, governments can default, companies can declare bankruptcy.  Or debts can be inflated away.  But then what happens to the folks who planned futures around those promises?  

Video screenshot

In an October op-vid, Megan McArdle argues that it's delusional to ask the president to restore the country to prosperity.

This is an important question for everyone, not just the unlucky retirees or welfare state beneficiaries who find themselves on the wrong side of fiscal history.  This kind of mass default is going to undermine social cohesion and create a great deal of economic chaos.  It's also going to radically alter the incentives to save and invest.  Any form of saving beyond simply stockpiling food and ammunition is a sort of trade deal with the future: you create capital stock now, on the assumption that workers of the future will let you share in the extra productivity your savings helped create.  If the future reneges, people may decide that they might as well be a grasshopper, since the ant gets just as screwed.  

Benjamin Friedman has argued pretty convincingly that societies in which the economy is stagnant or shrinking are much more selfish than societies in which incomes are growing.  When we feel rich, we are expansive, generous--a behavior that may have its roots in the reciprocal obligation networks of hunter-gatherers.  When we feel our prospects dim, we turn inward to ourselves and our families.  Liberal cosmopolitans and fans of generous social safety nets should be very worried by the prospect of a future in which everyone is grimly trying to make do with less.

In theory, you just export capital to younger societies, or import young immigrants.  But there are some problems with this theory, the largest of which is that the whole world is getting older almost all at once.  Every country is facing (or soon will) the same looming demographic pressure.  

Which means, first, that there are fewer big growth opportunities than there otherwise would be, and second, that if you send a bunch of capital abroad, it may be very hard to get paid when you're ready to consume.  Nationalism has not gone away, particularly not in the developing world; I find it somewhat unlikely that cash-strapped Argentinians or Brazilians or Chinese governments are going to allow their countries to ship output abroad for the benefit of comparatively rich American retirees.  

And third, that the supply of immigrants may not be what folks are expecting.  All the immigrants that we want to import have parents and grandparents--and unlike in previous generations, those immigrants will increasingly have few siblings and cousins to stay back in the Old Country and take care of Mom.  They're often in countries with poor and weakening safety nets.  How many will abandon them to their fate in order to come here?  Are we going to import all the old people in order to get access to the labor of their children?  Will we import only the orphans, and the callous?  And given Friedman's thesis, how will we muster the social capital to welcome all these strangers with open arms?  

Especially since, after years of working for us, those immigrants will themselves become consumers of social security benefits and retirement savings.  That means we do not just need more immigration, but accelerating immigration, even as the rest of the world shrinks.  Meaning that at best, this is a short-term patch for a long-term problem.

Even without the political dynamics, I think there are practical limits to how fast immigrants can be absorbed.  I'm a big fan of immigration, but I think it needs to happen at a speed where they can be assimilated.  Much of the western world's higher productivity is simply what you might call our "cultural operating system": a set of shared assumptions about how things are done, what is right (refusing to pay bribes) and wrong (using your government job to procure stuff for your relatives).  If you import new migrants too fast, the operating system breaks down.  

I don't mean to say that we have too many immigrants now--I think we could take more than we do.  But I don't think that we could import enough people to make up for, say, Italian or Japanese-style birthrates.  The percentage of the population that is foreign born is already pretty close to its historical peak--at least, the part of our history in which we were a settled, industrialized country.  And if the issues are large for us, they are probably insurmountable for countries like Japan, where a big part of the cultural operating system consists of trusting other Japanese people.

Brookings Institution
From Brookings Institution Report on Immigration ()

In short, we face gigantic challenges to which we have so far discovered no obvious solutions.  This transition may be inevitable; it may even be good.  It is certainly the result of trends which are themselves good: longer lifespans, more female autonomy, better birth control.  But for all that, it is still going to be enormously difficult. Not "we're all headed back to the stone age" difficult.  But situations well short of "nuclear winter" levels of misery can still be pretty awful.  Especially if we respond to warnings by yelling that the people who offer them hate women, progress, and the planet.