Neo-Classical Growth?

by Edward Hugh


Is there, or isn't there an ageing impact on our economies? Well one way of addressing this issue is to look at the recent economic performance of some of those who are most directly affected. Now one of the key postulates of neo-classical growth theory is that each economy has its own long run steady state growth rate. This is in many ways a highly questionable assumption and is one which, with the notable exception of the US, is very hard to sustain empirically over the longer term. Economic performance tends to fluctuate, the big question is: does it fluctuate following any kind of identifiable pattern?

Well, lets take a look at the Japanese case. Here's a convenient graph of Japanese economic growth 1955 to 2003 prepared by US economist Michael Smitka from Japanese data available here.



What is obvious from looking at this profile is that Japanese growth has been far from uniform over the last 50 years or so. This really shouldn't be so surprising when we think about economic theory a little. Key components of economic growth are the proportions of the total population working, and the kinds of activities they are engaged in. Now if we look at the early part of the graph we can see very high growth rates (which we can also find in eg China now). These are due in part to an ever greater part of the total population becoming involved in economically productive activity, and to a technological 'catching up' process. As developing countries tend to start at some distance from the existing technological frontier then growth can be proportionately more rapid as they close the distance (again this can be seen now in the Eastern European EU accession economies).

With time this growth spurt eventually slows, but the loss is to some extent offset as a society moves up the median age brackets by a growing importance of what have come to be known as 'prime age workers'. The prime age wage/productivity effect can be seen in the chart below which shows how the age related earnings structure has altered in Japan over the years between 1970 and 1997.



The most important point to note is that wages generally peak somewhere in the 50-54 range (even though many workers in Japan currently continue to work to 75) and this wage profile may be assumed to be some sort of proxy for what actually happens to productivity. One very revealing detail is that while the shape of the hump has changed somewhat over the years there has been little noticeable drift to the right, which should give some indication of the age-related productivity problem.

Going back to the upper chart, post-bubble Japan has grown significantly more slowly, although thanks to the strong export position (and China related demand) the economy has still managed an average of 2.5% a year since the end of 2001.


The same cannot be said of Italy, which due to its much weaker product profile cannot expect the export vibrance that a Germany or a Japan can attain, but as can be seen from the accompanying graph, trend growth in Italy has been steadily declining since the end of the 1960s:




Indeed since 1990 Italian GDP growth has only managed an average of something like 1.4% growth per annum, as can be seen is the next chart.

As the Economist (from whom the accompanying chart is drawn) points out Italy's average economic growth over the past 15 years has been the slowest in the European Union, and all the years of low growth take a toll, since it's economy is now only about 80% the size of the UK one.

The German case, whilst it is significantly better than the Italian one, still shows some similar characteristics. According to the Federal Statistics Office:

Measured in terms of gross domestic product changes at 1995 prices, the rates of economic growth in the former territory of the Federal Republic of Germany and - since 1991 - in Germany have continuously declined since 1970. While the average annual change was 2.8% between 1970 and 1980, it amounted to 2.6% between 1980 and 1991 and to 1.5% between 1991 and 2001.

Recent years have been worse rather than better, and the German economy shrank (0.2%) in 2003, and grew by 1.1% in both 2004 and 2005.

So there we have it. Japan, Germany and Italy are the three oldest societies on the planet (median ages 42.64,42.16 and 41.77 respectively), and the economic growth record seems to bear out the suggestion that ageing does have a noteable impact on economic performance.