More on the Fertility Trap

Not too long ago I did a post on the fertility trap hypothesis which states that once a country sees its fertility rate (TFR) drop below 1.5 it will for various reasons (see post) face tremendous difficulties in raising the bar back up. This was of course also something very relevant to publishing over at Demography.Matters and Edward Hugh also takes time to elaborate on the idea. Now, what he comes up with is a pretty solid idea I think of what might happen to country once fertility has dropped to such low levels and the population accordingly ages rapid pace. In fact, my economic analyses are to some extent at least guided by the framework put forth by Edward and which we are trying to advance and tune as time goes by. Here is an excerpt of the relevant section ...

Essentially the argument, as it is presented here, is that as median ages rise beyond a certain point - 42/43 let's say - the structural characteristics of the economy change. While younger economies - let's say with median ages in the 35 - 39 range - are driven by large scale borrowing (on aggregate), domestic consumption surges, and, of course imports and current account deficits to match the domestic savings weaknesses, the more elderly ones can exhibit higher relative savings levels (Japan, German, Italy, Finland, possibly Switzerland), can no longer rely on domestic consumption to anything like the same extent, and increasingly come to depend on export growth for GDP growth.

Now, of course, this produces a mechanism whereby four things happen:

1) In order to compete for exports these economies have a permanent pressure on their tradeable sectors, whereby outsourcing is continuous and ongoing, wages are continuously compressed, and structural reform is permanent. Since the very export dependence is only further reinforced by the continuing process of change in the population pyramid (ie domestic demand never "recovers" as such) this is all self-reinforcing. That is the more time passes the more there is downward pressure on the wages of young people.

2) Due to the comparatively lacklustre economic growth performance there is a constant shortfall in the tax income necessary to guarantee existing welfare and pension commitments. This shortfall is produced by the low levels of trend growth (think Italy, Germany and Japan) which you can generate exclusively on the basis of export growth. Since the changing pyramid structure (here is another part of the feedback loop) means that an increasing part of the voting population comes to be over 50, the tendency, as we are in fact seeing, is to attempt to maintain welfare commitments by increasing the tax burden, which affects the consumption and earning possibilities of the young directly.

3) Migration factors. The general lack of growth in the economy, and the tendency towards increase retirement ages and higher participation rates at the older ages, all mean that there is a relative lack of well paying jobs at the entry level, a phenomenon which makes outward migration an increasingly attractive proposition for educated young people (again, as we are seeing in Germany and in Italy). This out-migration once more feeds back into the structural evolution of the population pyramid. If the out migration is in part compensated for by in-migration of lower skilled workers, then this tends to retard the process of moving towards higher value work, a feedback which one more time would seem to find reflection in lower wage levels on average in the younger age groups.

4) Impediments on pro-natal policies. The pressure on fiscal resources which result from the previous three factors mean that effectively it becomes increasingly difficult to generate the resources to finance really meaningful pro-natal policies which might attempt to "tease" fertility back up towards a higher level. As time goes by this problem only gets worse.

OK, these are really simply a set of working notes. Comments, as always, welcome.

As Edward says in the end we are really talking working notes here and I would not by a long shot say that we have it all right at this point but this is what we are working and thinking on at the moment at least.  As always, as data comes in and the empirical situation changes so does the theory. One of the most fundamental question is then not so much whether demographics matter or not but moreso how and how much it matters in countries such as Italy, Germany and Japan which are all set to age very rapidly. This should then be investigated on the basis of the individual countries and also in a global context as more and more countries inevitably will join the league of ageing societies in the next 10-20 years.