Demographic transition on a global scale

By the early 1980s, the product of  the postwar Baby Boom (people born between 1946–1964) were all in or about to enter the labour force of high-income countries. In the following decades, China’s integration into the world economy, and in particular its accession to the World Trade Organization in 2001, secured a further, ample supply of low-cost labour to fuel global growth and keep inflation stable.

This trend, however, has largely run its course and may now be going into reverse due to the ‘demographic transition’, whereby a decline in both fertility and mortality rates leaves economies with smaller workforces having to support growing numbers of retirees. This structural shift in demography is particularly evident in developed economies, with old-age dependency ratios (the ratio of the elderly (65 and over) to the working-age population (15–64)) rising dramatically in countries like Japan, South Korea and Italy.

The working-age population may well soon begin to decline in Asia as a whole — and at a faster pace than in the developed world, mainly driven by China. The median age in the EU and US rose from 30 to 40 in the space of half a century (1970–2020), but in Japan this process took just 23 years (1976–1998), in South Korea 16 years (1999–2015) and in Taiwan 20 years (1998–2018). China is on the same trajectory as Japan, with the median age set to reach 40 by 2025, according to United Nations projections.

While the world population is still growing, the countries with the highest population growth — almost all in Africa — tend to be less politically stable and integrated in the global economy. Consequently, population ageing will probably lead to structural labour shortages over the long term.

US: the post-covid labour shortage

The world’s largest economy by GDP, the US, has been facing a persistent labour shortage since the covid pandemic. There are many possible reasons, such as an ageing population, workers’ demands for better benefits, and fewer immigrants. One particularly important factor is the rise in those in the 55–64 age group choosing early retirement for reasons that may include health concerns and a sharp rise in asset values. According to the US Federal Reserve, the retired as a share of the US population in late 2022 was almost 1.5 percentage points above its pre-pandemic trend level, meaning around 1.6 million people have left the labour force earlier than might have been expected. Between 2020 and 2022, the prime-age (25–54) working population in the US increased by around 1.1 million, significantly below the 5.3 million increase in the old-age (65 and over) population. The large number of early retirees, coupled with reduced growth in younger age groups, means the labour force is not being fully replenished from native sources, resulting in a widening gap between labour demand and supply.

Looking forward, the rising number of people dropping out of  the workforce for various reasons is reducing the labour participation rate and exacerbating labour supply problems. Without meaningful productivity gains, the structural decline in available workers may lead to sharper rises in wages, ultimately pushing inflation higher.

Asia: divergences in the ‘demographic dividend’

In 2021, Asia’s population reached around 4.3 billion, which is 2.6 times larger than in 1960. By 2050, Asia’s working-age population is expected to be 3.3 times bigger than in 1960, according to United Nations projections.

However, population growth in Asia has been declining over the past four decades. After reaching a peak of 2.5% in 1966, annual population growth slowed to an average of 0.7% in the period 2018–2022. The region’s demographic outlook is changing  fast as a result of the constant decline in the total fertility rate (TFR, the average number of children that a woman will have over her lifetime).  In the period 1960–1965, only 5.4%  of Asia’s population lived in countries with a fertility rate below the replacement level (a TFR of under 2.1). This figure surged to 43.9% in 1990–1995, when China’s fertility rate fell below the replacement level. By the late 2020s, when the fertility rate in India is projected to fall below 2.1, 80% of the Asian population is expected to be living in countries where fertility rates are below the replacement level.

The speed and timing of this transition vary considerably within Asia. China, the main driver of global economic growth in the past two decades, is currently undergoing unprecedented demographic change. According to government statistics, the country’s population declined in 2022 for the first time since the Great Chinese Famine of 1959–1961. In response to the sharp decline in the fertility rate, in 2016 the government ended the one-child policy it had inaugurated in 1980. The government’s efforts to increase the birth rate have achieved little success so far. Barring an unprecedented turnaround in the birth rate, the Chinese population will probably continue to decline and  the dependency ratio will continue to increase over the course of the  21st century. This will put China in the same camp as Japan, South Korea and Taiwan.

By contrast, demographic conditions in South and Southeast Asia are much more favourable. Countries like India, Indonesia and Philippines are still enjoying their ‘demographic dividend’ (in other words, their working-age populations are growing and child dependency ratios falling). With sensible government policies, this demographic dividend can be turned into faster economic growth in the years to come.

Slower growth, higher prices

The accelerating pace of population ageing will have major implications for the world economy, probably contributing to a slowdown in growth. Without substantial productivity gains, a smaller workforce could lead directly to less output. In addition, there may be reduced demand for real estate and related spending from an older population. In turn, this could lead to lower investment in production capacity, infrastructure and the like.

The impact of demographic change on inflation is more complicated. A shrinking working-age population will probably exert upward pressure on wage growth, which could feed into higher inflation. But Japan’s experience over the past three decades shows that the relationship between population ageing and inflation may not be as simple as some theories suggest. In particular, recent research shows that the ‘younger’ old-age cohort (65–75) tends to push up inflation, while the rise of the ‘older old’ (75+ years) is highly deflationary. Overall, however, we think demographics will probably contribute to higher inflation in the decade to come.

Inflationary pressure could be mitigated by the positive impact of improved education on worker productivity or more rapid adoption of automation and other productivity-enhancing technologies such as artificial intelligence. While such technologies appear promising, they open up new debates about their impact on employment and income distribution.