Tuesday, December 19, 2006

Demographic Dividend in India and the US?

by Edward Hugh

I would just like to draw readers attention to two recent blog posts which tackle very similar demographic ground, but in very different contexts. First off is The Indian Productivity Miracle, a post from Nanubhai on the Indian Economy blog. Then in second place there is Tim Duy's latest FedWatch on Mark Thoma's Economist's View (Claus has already discussed this post here).

Now the theme which holds these two - apparently unrelated - posts together is the fact that they both consider the impact of a changing demographic environment on economic performance. In the US case, it is clear that a period of very favourable demography is now about to come to an end (not exactly a demographic dividend, but damn near one). What follows comes from Tim Duy:

This - his expression of his inflation concerns - is not, however, the most interesting point in Bernanke’s speech. Nor was his view on the housing market. More interesting was his clear words on potential output:

With regard to the labor force, research by the Board's staff highlights the role of demographic factors in determining the number of people available to work in the years just ahead. Most notably, the impending retirement of the baby boomers and the fact that women are no longer increasing their participation in the labor force at the rate they were in the past will tend to restrain the future growth rate of the U.S. labor force….Even if productivity growth is sustained at a reasonably good rate, the slower expansion of the labor force will imply some moderation in the rate of growth of potential output over the next few years. In the very near term, that slower growth in the labor force needs to be taken into consideration when assessing the sustainability of given rates of expansion in economic activity.

I myself am not convinced on the outlook for baby boomers. But that shouldn’t distract from Bernanke’s point that the Fed is looking at a lower level of potential output than market participants – which translates into a lower acceptable rate of growth. Of course, this point has been made before, but I don’t think the Fed believes market participants were listening. Indeed, Fed officials apparently felt a need to reiterate the point further that week. The same day, Philadelphia Fed President Charles Plosser noted:

Of course you might ask, what is trend growth? … Up until July, most economists would have said that the rate was somewhere close to 3.5 percent, assuming labor force growth of about 1 percent and productivity growth of almost 2.5 percent. However, in July, the government issued a benchmark revision to its estimates of GDP for the last three years. The fallout from that revision was that wages and employment grew somewhat faster than was previously estimated and productivity growth was slightly lower than we thought. As a result, the commonsense estimate of trend growth has now been lowered slightly. My own view is that trend growth is closer to 3 percent than 3.5 percent. Some even claim that trend growth is as low as 2.8 percent. I don’t think it is useful to quibble over two-tenths of a percentage point, since our ability to measure productivity is so fraught with problems. Nevertheless, almost everyone agrees that estimates of trend growth are now lower. Thus, when I say that growth should return to trend in 2007, I am expecting that growth will be near 3 percent. Note that this means that it should not surprise or concern us to see growth slowing from its pace of the last few years.

(NB all of the last extract has been either Tim Duy, or Bernanke and Plosser in the indents, Edward).

Now for Nanubhai on India:

Ajay Shah, the Economist, and various investment banks (including Morgan Stanley and HSBC) have repeatedly said that India is overheated – evidenced most clearly by the run-up in inflation, and also by ‘bubble-like’ real estate and equity prices. Skittishness about the policy direction of the current governing coalition supports the prevaling belief that a crash (or, for the less brave, a “cooling down”) is imminent. According to them, economic growth and/or asset prices are both set to decrease in the near-medium term.

They may well be right. Nevertheless, it is worth taking a look at the numbers and seeing exactly what has been powering economic growth in India over the last couple of decades. If we want to figure out where the Indian economy is headed over the next 4-5 years (as opposed to say, the next 4-5 quarters), surely this is better than looking only at the short-term indicators.

Our potential workforce (defined as people aged 15-64) has been increasing at about 2% a year – and is projected to continue at that rate at least till 2020. However, labor force participation rates vary substantially from state to state, between the sexes, and between rural and urban areas – as do unemployment and underemployment. Given that labor force growth (potential workforce x overall participation rate) has been averaging about 2% over the past 10 years, in the absence of better statistics, it is a safe assumption that overall employment is growing in the range of 1-2% and gradually accelerating. (If the projections are to be believed, then the real demographic dividend is expected to come between 2009-2015 when labor force growth will accelerate to about 4% per year).

Now the real heart of the capacity debate centers around this question: what is India’s trend rate of growth now and what will it be for the next few years?.....If you add up the numbers, it seems to me that at a minimum, trend growth is at 8% (5% TFPG + 2% labor force growth + 1% capital deepening) with the capacity to reach 10% (4.5% + 3.5% + 2%) in the coming years. The 6.5% baseline level of growth that the Economist and others use to form their assessments of the Indian economy is fundamentally flawed.

Two final points from me (Edward). Firstly all of this is about trend growth, and how quickly (or slowly, Germany, Japan, Italy) an economy can grow depending on the underlying demography, and secondly: WHO THE HELL EVER HAD THE TEMERITY TO SUGGEST THAT DEMOGRAPHY DOESN'T MATTER TO ECONOMICS.


jwenck said...

Here is an extended syllogism for you:
1) African countries do feature the demographics, but not the dividend.
2) India has both the demographics and the dividend.
3) Other things are not equal.
4) Therefore, the dividend India profits from is not a demographic dividend, but a dividend from things that are not equal (education, institutions, policy etc.)
5) Since there is no such thing as a demographic dividend, there is also no such thing as "good demographics".
6) If such a thing as "good demographics" doesn´t exist, a thing such as "bad demographics" doesn´t exist either.
7) Assuming that Germany, Italy and Japan have economic problems, these are problems that do not result from their demographics - however much those may differ from those of India (and those of Mali, Niger etc.)

The only possible line of attack here is to claim that population growth without a resultant economic payoff is a good thing regardless. Anyone going this route would prove that economics does not matter to demographers.

Edward said...

"Since there is no such thing as a demographic dividend,"

Look Joerg, I understand that you don't agree with this idea, but you could take the trouble to try and think about what is actually being argued.

I think this particular phrase expresses the problem:

"African countries do feature the demographics, but not the dividend."

Which demographics would we be talking about here Joerg? Outside possible S Africa (and of course the Maghreb) I doubt there is any African country which has DD demographics, and in SA there is only the fertility component, and not the life expectancy one (due to the presence of AIDS).

The DD is associated with:

1) fertility at or rapidly approaching replacement level

2) A very rapid increase in life expectancy, normally associated with the improved health and education of the reduced number of surviving children.

Edward said...

Continuing, where I left off in the las comment, Joerg, since (1) falls, I'm afraid the entire edifice comes crashing down around your ears.

Nice try though :)

Honestly though Joerg, instead of trying to argue against something you evidently haven't understood (just because you have a predisposition to feel it might be a bad thing - again pure conjecture - because it might imply that the US was able to economically outperform Germany.

I don't think we can look at things this way. I think the first thing you need to do is to try and understand what it is exactly that is being argued. Then, of course, there is no obligation to agree. You can then safely fire at will :).

jwenck said...

a) No, I am not specifically motivated by a comparison of Germany to the U.S. I have referenced Japan often enough to be able to credibly claim that I have a different view of the ageing issue - rather than just feeling a need that if one goes about "identifying winners and losers", "my country" has to be among the winners (I do, however, think that your idea that macro might somehow be about "identifying winners and losers" is wrongheaded. What would you do with that knowledge - decide which country´s stock index to invest in? In micro, there is indeed a clear definition of what constitutes winnning and losing. In macro, there are demonstrable differences between, e.g., Human Development Index data and GDP data. Finally, losers can always study the winners in order to find out how to catch up - which looks more like what macro might be about to me -, but in the ageing process of societies there definitely is - well, there SHOULD - be no way to return to an earlier stage in the sequence. BY DEFINITION, GROWING OLD MEANS WINNING. The inhabitants of the poorest municipality in Britain die at an average age of 67, while those of the richest municipality in Britain become 93 on average. Now just go out asking people which group they would prefer to be in.

b) I admit that I knocked down a straw man version of your argument (i.e., it´s all about the percentage of young people in the population). Trouble is that over the years your posts helped crystallize my counterargument to your thesis in such detail that I can´t possibly present it in comments. I would have to write a full post - and most likely more than just one - to isolate all the sub-issues and take them on sequentially. I don´t have the time at this moment, but if I´m invited, I will put it on my to-do list. I don´t feel tempted to continue throwing about random tidbits, however.

Edward said...


Well obviously I agree with you. But when we are old we still need to eat. I think that is one part of the problem.

"The inhabitants of the poorest municipality in Britain die at an average age of 67, while those of the richest municipality in Britain become 93 on average. Now just go out asking people which group they would prefer to be in."

Well this isn't as true as you seem to imagine. What you need to do is break down the components which affect people in those two areas a bit more. If you tell the people in the "67" expectancy area when they are 20 that what they need to do is stop smoking, or eat less fast food, then they may well tell you to go take a running jump.

Otoh, if you look at two countries instead of two regions in one and the same country - let's call one France, and the other the US - then you may find that those in the latter country are quite happy to trade a little less life expectancy in the later years, for some more money in the earlier ones, and they say they are very happy with this choice. I can only believe them.

Colin Reid said...

"Otoh, if you look at two countries instead of two regions in one and the same country - let's call one France, and the other the US - then you may find that those in the latter country are quite happy to trade a little less life expectancy in the later years, for some more money in the earlier ones, and they say they are very happy with this choice. I can only believe them."

But if you make such a comparison, you have to ask what exactly is being traded in. If I were to guess at why France's life expectancy is better than the US's, I'd say 1) healthier diet and 2) better provision of healthcare, both of these especially pronounced for more disadvantaged groups. Now while both of these cost money in theory, there's no simple trade-off: US-style healthcare is so incredibly expensive that even their inferior levels of care may actually cost more in total than French-style healthcare, and French food improves the French quality of life as well as quantity, while American food doesn't have the same long-term feel-good factor (junk food gives an immediate rush, but makes you feel worse afterwards). You might argue that the aspects of American culture which lead to commercial success, but uneven healthcare and poor nutrition are partly linked, but that doesn't mean they couldn't be decoupled if the will were there.

An even more extreme example would be to compare the US and Cuba. IIRC Cuba has the second best health indicators in the western hemisphere (after Canada, and a long way ahead of the US) but it's also one of the poorest countries in the western hemisphere. Again though, there's far more going on than a simple trade-off between money and life - Cuban health spending might be massive as a proportion of GDP, but in $/capita terms it's by necessity far behind any Western country, never mind the US.

All this goes to show is that changing life expectancy is a complicated and uneven process. But however it comes about, we still need to provide for those who live to a great age, as you say.

S.M. Stirling said...

In the case of the US, the fact that TFR's bottomed out in the 1980's and have grown since means that each successive generation since has been a bit larger -- witness the increasing pressure on schools and so forth over the past two decades. And the fact that the absolute number of children born annually is now exceeding the Boomer years of the 50's and early 60's.

Which in turn means that these people will be hitting the labor market soon, a slow uptick at first and then a more and more rapid one over the next decade.

S.M. Stirling said...

As far as society as a whole is concerned, growing old does _not_ mean winning.

In fact, the consumption of resources by the elderly (and their political power) is an important factor making reproduction expensive, and so locking the countries concerned into a downward spiral.

It's a dilemma. In ancient Greece, on the island of Keos, it was considered public-spirited to take hemlock at 65, to free up resources for the young adults.

That's probably not practical these days... 8-).

Allan said...

Watch Allan Fernandes express his viewpoint on India’s Demographic Dividend to the Chairman of a high level advisory body to the Prime Minister of India.

Visit http://www.youtube.com/watch?v=-rqlKyJ3xbM

Star rating, comments and suggestions would be appreciated.

Thank you.

Edward Hugh said...

Hello Alan,

Thanks for the link. Nice work. I will try and think of something to do with it.