Economic Consequences of Population Decline

Cost of declining population (Source: Financial Times)

I have repeatedly discussed the economic consequences of global or country-specific activities throughout the 12 years of this blog. To my memory, the concept was never explained either by me or by any of the guest bloggers. In all cases, economic activity was always discussed in terms of GDP (Gross Domestic Product). This blog and the next one will be focused on the economic consequences of a declining population and what can be done to mitigate the negative impacts.

I will start with a short explanation of the concepts of GDP and GNP, using an accessible source of information for those of us who are not economists and want to know more.

Again, I will start by asking AI (through Google) to give us its take on the topic and the source of its information. In this case, the source the AI is using is a publication by the International Monetary Fund:

GDP measures the monetary value of final goods and services—that is, those that are bought by the final user—produced in a country in a given period of time (say a quarter or a year). It counts all of the output generated within the borders of a country. GDP is composed of goods and services produced for sale in the market and also includes some nonmarket production, such as defense or education services provided by the government. An alternative concept, gross national product, or GNP counts all the output of the residents of a country. So, if a German-owned company has a factory in the United States, the output of this factory would be included in U.S. GDP, but in German GNP.

In what follows I will use the concept of GDP.

Wikipedia has an entry dedicated to the economic consequences of population decline. Last week’s blog addressed some of the consequences of decreased fertility and the resulting changes to the population pyramid. These include the rise in the dependency ratio (the ratio of the nonworking segment of the population to the total population), crises in end-of-life care for the elderly, and the decline in military strength caused by a smaller pool of young adults who can be recruited (whether voluntarily or by mandate).

Wikipedia’s full list of a declining population’s negative impacts on economic growth is given below. The identity that defines GDP in terms of population is:

                             GDP = total population × GDP/person                                                   (1)

As populations grow more slowly, assuming no changes in growth of GDP/person, GDP will also grow more slowly.

The equation above shows that if the decline in total population is not matched by an equal or greater increase in productivity (GDP/capita), and if that condition continues from one calendar quarter to the next, it follows that a country would experience a decline in GDP, known as an economic recession. If these conditions become permanent, the country could find itself in a permanent recession

The possible impacts of a declining population that leads to permanent recession are:

1. Decline in basic services and infrastructure.  If the GDP of a community declines, there is less demand for basic services such as hotels, restaurants and shops. The employment in these sectors then suffers.^[7] A falling GDP also implies a falling tax base that would support basic infrastructure such as police, fire and electricity. The government may be forced to abandon some of this infrastructure, like bus and railroad lines, and combine school districts, hospitals and even townships in order to maintain some level of economies of scale.^[8]
2. Rise in dependency ratio.
3. Crisis in end of life care for the elderly.
4. Difficulties in funding entitlement programs.
5. Decline in military strength.
6. Decline in innovation. A falling population also lowers the rate of innovation, since change tends to come from younger workers and entrepreneurs.^[10]
7. Strain on mental health. Population decline may harm a population’s mental health (or morale) if it causes permanent recession and a concomitant decline in basic services and infrastructure.^[12]
8. A recent (2014) study found substantial deflationary pressures from Japan’s ageing population ^[13]
9. A Slovenian study from 2015 found that population ageing leads to higher rates of unemployment and less entrepreneurial activity.^[14]

The Wikipedia definition of productivity refers to the GDP/person in Equation 1 above. A much better definition of economic productivity comes from the US Bureau of  Labor Statistics, which defines productivity as the ratio between input and output and distinguishes productivity on different levels:

• Individual worker’s productivity
• Company’s productivity
• Industry or sector productivity
• Business sector productivity
• National productivity

On the national level, the input can be defined in terms of labor productivity (based only on the part of the population that works) and capital productivity (which includes the infrastructure that assists in producing the output).

The last two items in the list provided by Wikipedia (deflation and unemployment) are less intuitive and they are based on a single publication each ([13] and [14] refer to the article’s references). They are much too broad to be associated only with population decline and they will not be discussed further.

A much more serious issue associated with the Wikipedia list is that it is limited to suppliers to the GDP. The main reason is that the definition of GDP is limited to suppliers. It is connected to the demand side of the economy only through the connection to the prices that suppliers can ask for their goods. By not including the demand side of the economy, the list eliminates much of the resulting feedback of supply and demand.

Another issue not included in the Wikipedia list is the time dependence (i.e., the rates) of the population decline, the changes in the resulting population pyramids, and the lifetime of the infrastructures constructed to serve the population. A good example is the impact of the changes to the population pyramid on item 3 in the Wikipedia list. The increase in the non-productive elderly segment of the population compared to the productive younger segment will obviously have a negative impact on supply. But the growth of that segment will also increase the demand for healthcare. The fact that in democratic countries this segment of the population is fully entitled to vote on every level, and thus will require economic support, makes the increasing demand an important element in the allocation of resources.

Different rates of population decline and the lifetime of the infrastructure constructed to serve this aging population can be seen in the disequilibrium of supply and demand in housing that in many cases results in the creation of ghost towns. A good example is the abundance of ghost towns in Japan, where the decline in fertility is among the largest in the world:

The shrinking population in rural areas coupled with brain drain to the major cities has left behind numerous “ghost villages” scattered throughout the Japanese countryside.

In January, Prime Minister Fumio Kishida’s administration launched a programme that aims to revitalise rural areas by offering families relocating from Tokyo to the countryside 1 million yen per child. Though many have questioned its ability to lure people away from the capital.

According to official statistics, there are about 8.5 million abandoned homes – known as akiya – in Japan, but estimates suggest the true number could be closer to 11 million. Akiya are expected to become only more common as the population greys, with the government projecting them to make up 30 percent of the entire housing stock within the next 10 years.

Ghost towns can form for other reasons than declining population. They can be caused by nuclear disasters (Fukushima), bankrupt mines, or a decline in other economic factors that initially justified a real-estate boom. However, in many places, declining population is the main driving force behind the abandonment, especially in rural areas.

Next week’s blog will be dedicated to the steps that are being taken to mitigate some of the negative impacts of declining populations.