Economic growth in an ageing world


  • Nation
  • Monday, 12 Sep 2016

MOST people take growth for granted. We expect living standards to increase over time and that our children will enjoy a better quality of life than us.

But growth is not a given and it is driven by economic processes that can and do change. There has been a gradual slowing in global growth over the past couple of decades, and some of this can be pinned on structural factors that form the very foundation of growth itself.

First, let’s examine the historical record. Before the industrial revolution, economic growth was extremely slow and haphazard.

Between the years 1AD and 1700AD, the global economy nearly quadrupled in size, but this amounted to an annual growth rate of just 0.07% a year. Nearly 80% of this growth came from global population expansion, as growth in per capita output amounted to just 0.02% (and that’s after rounding up!).

Given this very slow pace of growth, punctuated as it was by famine, war and pestilence, most people never felt any improvement in their standards of living.

Enter the industrial revolution. Growth rates exploded as labour- saving devices, a shift from agriculture to higher value added manufacturing, urbanisation, and increasing specialisation and trade boosted not only overall output but individual living standards as well. By the end of the first era of globalisation just before World War I (1914-1918), per capita output was 90 times higher than in 1700.

Economic theory basically categorises the sources of growth into three distinct areas – labour, capital and technology (a catch-all term that includes not just technology but industrial organisation and political and economic institutions too). In those terms, the industrial revolution and what followed saw growth accelerations of all three sources.

The problem the global economy is facing now is that growth is slowing, and even reversing, across all these categories. This has enormous ramifications not just for economic growth but also for the future of humanity.

Testing the limits

English cleric and scholar Rev Thomas Robert Malthus wrote in 1798 that since population growth proceeded geometrically and food production arithmetically, sooner or later the limit to population growth (and thus prosperity) must be reached. Growth could not go on forever.

Over the years, however, humanity has proceeded to disprove Malthus’ predictions by increasing the efficiency and abundance of resource extraction and use.

Nevertheless, the idea of a Malthusian catastrophe remains popular even as technological advances improve our ability to feed, clothe and shelter ourselves.

Mankind has so far proven more ingenious than mere mathematics. However, there now appears to be a limit on growth but from an unexpected direction.

We are not running out of land and resources; we are instead running out of people. Demographics are perhaps underrated as a driver of growth. Faster population growth provides more workers while simultaneously providing more consumers, even as rising healthcare standards improve longevity so people can work and consume longer than before.

On top of that, the spread of basic education since the 19th century meant that not only was human capital more numerous, it was increasingly of better quality as well. This cycle underpins the emergence from poverty for every advanced and developing economy over the past two centuries.

Population decline

But a funny thing happened along the way to prosperity. As societies got richer, fertility rates began to drop to the point where, like in Japan and China today, populations are beginning to shrink.

At the same time, the level of education in most advanced economies has reached the point where additional investment in education is reaching diminishing returns. Not everybody needs a PhD, and we increasingly hear stories of overqualified graduates working menial jobs. Raising the education level of the workforce will undoubtedly raise the quality and quantity of output but cannot permanently raise growth.

Moreover, investment in education is linked to the decline in fertility. As children become more expensive to raise, families focus more on quality rather than quantity.

The phenomenon of population stagnation and decline is also no longer the province of advanced economies. Based on UN forecasts, most of the developing world is expected to see population growth of zero or less within the next century. Even in the least developed economies (such as sub-Saharan Africa) population growth will drop below 1% in the next 50 years.

Worse, population decline is occurring at successively lower and lower levels of development. China and Thailand are the most egregious examples of this, with populations beginning to tip into decline despite neither economy having reached higher income status.

Some have postulated that immigration can help boost population and economic growth, especially if immigrants are well educated. But this can only be a temporary solution as the phenomenon is global, not local. If global population growth itself is in decline, immigration can only delay the inevitable.

Overall, what this means is that one of the biggest drivers of global growth since the industrial revolution is gradually, and inexorably, in terminal decline.

Nor is Malaysia immune from these trends.

The average growth rate of the population has dropped from 2.6% in the 1980s to 2.2% in the 2000s, and is projected to decline to 1.2% by 2020 and 0.6% by 2040.

The youth dependency ratio (age 0-15) is projected to fall from 25.4% in 2015 to 19.6% in 2040, while the old age dependency ratio (age 65 and above) will more than double, from 5.8% of the population to 11.4% by 2040.

In line with this population growth decline, economic growth has dropped from an average of over 7% in the 1980s and 1990s, to 6% in the 2000s and 5% in the 2010s. By 2040, economic growth is likely to fall to 2%-3%.

As societies age, we need to acknowledge that growth will also naturally slow. Malaysia’s ageing will have repercussions on economic structure, policies and the very fabric of society.

Recognising that fact is a necessary first step to deciding what we can or should do about it.

Nurhisham Hussein is Head of the Economics and Capital Markets Department of the Employees Provident Fund. He sees his job as telling stories about the world around us, and gets excited over vector autoregressive models, monetary aggregation theory and principal component analysis.

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