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.