New World Economics

By: Nathan Lewis
all contents copyright Nathan Lewis 2005-2013

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Economic Abundance with a Shrinking Population: Why Not?

August 28, 2014

(This item originally appeared in on August 28, 2014.)

Perhaps one of the silliest myths around today, in my opinion, is the notion that a shrinking overall population naturally causes or leads to economic decline. This is gradually becoming more immediately relevant, as the fertility rate is below replacement on every continent except for Africa today.

It’s true that a larger population will have a higher total GDP, simply because you are counting more people. However, you can have a large population with a relatively low per-capita GDP (all of Africa, 1.1 billion), or a small population with a high per-capita GDP (New Zealand, 4.5 million). So, obviously, just piling people together doesn’t create wealth and personal abundance.

As most any economist should know, per-capita incomes – what we usually mean by “wealth” – are largely a factor of productivity. Of course this includes the productivity of the employed, but it also includes productivity within the household or in other nonmonetary realms – the real-life economy, not the “economy” of statistical abstraction.

Let’s take, for example, Japan. The country has had a lowish fertility rate (1.42 births per woman) for some time, although not all that much lower than Thailand (1.50) or Germany (1.43), and higher than Poland (1.33) and Hong Kong (1.17). However, someone has to be first in these matters, and it just happens to be Japan.

The population of Japan is estimated to have peaked in 2008 at 128,083,960 people, and was estimated for 2014 at 127,220,000. So, it declined an estimated 0.7% total over six years.

The total population is projected to fall to 95.2 million in 2050. Which is still a lot of people for a smallish island, without much flat land. It is roughly the population of 1960. New Zealand is actually only 29% smaller than Japan by land area, and almost the same size if you omit Japan’s sparsely-populated Hokkaido island. If New Zealanders can be reasonably prosperous on about the same size island with 4.5 million people, why can’t Japanese be prosperous with “only” 95 million people? Or 50 million, or ten million?

The picture gets a little more interesting when looking at the working-age population (15-64). It peaked at an estimated 86,908,333.3 in 1995 (sorry if I chuckle at estimates that go down to the partial-human), and had declined to an estimated 79,144,166.7 in March 2013. This is a total decline of 9% over eighteen years, or 0.53% per annum. The present rate of decline is about 1% per year in working-age population.

This is not a particularly fast rate of change. Why can’t those working-age people be productive and prosperous, and perhaps become more productive and prosperous? A 2-3% annual increase in real productivity is common in economic history, and in the best of times it can reach 5% or more. In other words, the variance between “high growth” and “stagnation” in the productivity of the working-age population is far more important than these modest trends in population.

At the same time, the population over 65 has been growing, as a percentage of total population. In 1989, 11.6% of the population was over 65; in 2006 it was 20%; and in 2055, it was estimated to climb to 38%. Unlike most wildly-incorrect economic projections, these demographic projections are likely to be fairly accurate.

This is a real issue, and a rather novel one. Care of elderly has been a part of human society from prehistory. However, most people died before 65, so there were never so many elderly.

But, I see no reason here why those who are in their productive years, 15-64, can’t be as productive as they are today, or more so. The fruits of production (in practical terms, income) will be used for whatever the highest-priority goal is, and care of elderly will probably rank high on that list.

We have two basic conclusions thus far: first, that working-age people can continue to be productive, or become more productive, no matter what the overall demographic trends are; and second, that there is a real demographic shift here which is somewhat new in all of human history. This will involve some challenges and changes, but the pace is actually rather slow, and an excellent solution can be found.

The main problems are, in my view, related to existing government policies and programs, which are based, overtly or implicitly, on expanding population. Basically, they are Ponzi schemes, which need to grow or die. This includes public pensions (“Social Security” in the U.S.), existing healthcare programs, and patterns of government debt and deficits. Many of these were conceived in the late 19th century, and expanded during the mid-20th century. They may have been appropriate for 1960 or 1970, but are not appropriate today.

For example, a pattern of continuous government deficits and growing total debt can be sustained for some time if nominal GDP is also growing quickly. The “debt dynamics” allow debt/GDP ratios to maintain some semblance of sustainability, at least until a politician’s term of office is ended. Alas, this continuous-growth Ponzi doesn’t work well in an environment of population shrinkage.

Today’s calls for increased immigration and so forth are, I find, mostly motivated by the urge to keep the Ponzi running and thus maintain the status quo. The solution is rather to establish an arrangement that is appropriate for demographic realities. Japan’s deficit and debt problems will be resolved either via currency depreciation or formal default. But, this is just a shuffling of paper. Who cares. In 1949, Japan’s government made it illegal to run a deficit or issue government bonds; this lasted until 1965. At that time, the existing debt had already been eliminated by postwar hyperinflation.

The Japanese government thus had no debt and no deficits. Perhaps such a time will come again. Perhaps it would be a very prosperous time, as the 1950s and 1960s were for Japan. Perhaps the working-age population would become more and more productive, and thus enjoy higher and higher real incomes, even though there happens to be slightly fewer of them each year.

Public pensions and healthcare are another system that worked fine in 1970, but aren’t working today. The total cost of both programs, plus other welfare-related programs, was 5.77% of National Income (similar to GDP) in 1970; in 2012 it was 31.34%. Obviously, the programs which worked fine in 1970 aren’t working today.

This just means you need some new solutions. Japan will eventually have new health and welfare-related arrangements of some sort. We know this because the existing ones will obviously perish at some point.

Unfortunately, the attempt to maintain these existing, inappropriate arrangements itself is leading to the impoverishment of working-age people, whose productivity is indeed the “economy” itself.

For example, taxes have been rising continuously. The recent increase in consumption taxes (national sales taxes) has gotten a lot of attention. However, one of the biggest taxes in Japan is what we would call a payroll tax on income. It was apparently 14.42% for companies in 2013, and 13.94% for individuals, for a total of 28.36%. And, there is no upper limit on income.

I don’t have good data on historical payroll tax rates in Japan, but as a percentage of National Income, the revenue from the tax was 5.4% in 1970, 13.6% in 2000, and 17.1% in 2012. The consumption tax did not exist in 1988; in 1989, it was introduced at 3%. It is scheduled to rise to 10% in 2015.

The secret to making people prosperous is what I call the Magic Formula. It is: Low Taxes, Stable Money. This is actually what Japan did in the 1950s and 1960s, as I documented in my book Gold: the Once and Future Money. The government is doing the opposite today, and getting the opposite result. This has nothing to do with demographics, but is the simple cause-and-effect of government policy.

If Japan is going to have another period of prosperity, with a graying population, the eventual solution will be the same: to make working-age people as productive as possible.

This means the Magic Formula, combined with other government policies that address the realities of our time, rather than relics of the past that should be abandoned before they cause any more problems.

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