Fertility rates in advanced economies have been falling in recent decades. The average fertility rate across G7 countries in 1960 was 2.80, which had fallen to 1.47 by 2022. If left unchecked this phenomenon may cause populations in these countries to stagnate and even shrink in the coming years. One can attribute the falling fertility rates in these countries to a slew of positive outcomes: falling child mortality rates, increased availability of contraception, higher incomes and, importantly, female emancipation. However, the consequences of declining fertility rates may not be as positive, with many of these economies also reporting falling Gross Domestic Product (GDP) growth rates – a trend which decreasing fertility rates are set to exacerbate in the years to come.
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As the chart below indicates, there has been a marked reduction in the average GDP growth rates in the G7 economies over the preceding decades. The demographic consequences of falling fertility rates can play a part in explaining this trend. Falling fertility rates can cause a reduction in the working-age population, and create an ageing labour force, both of which can adversely impact GDP growth by reducing potential GDP growth, where potential GDP is the level of output when all resources, like labour, are fully employed.
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The ratio of older dependents (defined as the number of people aged over 64) to the number of people in a country who are of working age (aged between 15 and 64) has been increasing in each of these economies throughout the period that fertility rates have been falling. There are several issues associated with this sort of trend: first and most importantly, holding everything else constant, if there are fewer people working to produce goods and services per capita, GDP per capita will fall. Secondly, one must consider the fiscal conundrum of having a narrower tax base, while also having a population that will demand more healthcare services and pension payments. Third, older people typically buy more government bonds, and although this may provide a steady stream of liquidity to governments in the short term, it is unsustainable to have an ever-increasing level of domestic debt in these economies that are already quite indebted. These effects have been mitigated so far since these economies have managed to persuade a higher proportion of their working-age population to enter the labour force. Notably, the percentage of working-age females in the labour force has increased significantly. However, these economies will hit an upper bound of labour force participation across demographic groups, and so cannot expect this effect to offset that of a reducing working-age population indefinitely. Of course, immigration policies do provide a potential solution to this issue, but these are not always politically feasible, especially in today’s geopolitical climate.
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There is also the view that an older working population is less productive than a younger one. If this is the case, then the shift of the working-age demographic to an older age profile may explain some of the slowing productivity growth in advanced economies. One potential measure of this effect is total factor productivity (TFP) growth. TFP is a measure of the portion of economic growth not attributed to changes in capital and labour: it is affected by things such as innovation and technological adoption. The graph below illustrating the drop-off in TFP growth in the last 20 years in Europe and Japan could be evidence of an adverse productivity impact of an ageing population, although other factors including low-for-long interest rates (which lead to an increased prevalence of zombified firms) could also perhaps explain this.
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The issues discussed here do not solely concern advanced economies: China has also displayed the trend of plummeting fertility rates and an exploding age dependency ratio in recent years. If this trend continues, China may have to deal with the same issue of economic malaise associated with a shifting demographic profile, that advanced economies are facing at a much more mature stage of their economic development. In other words, this trend is a threat to China’s ability to ensure that it gets rich before it gets old.
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There are a variety of solutions that these economies may employ to combat the potential threats associated with low fertility rates; but it will be important to ensure that these solutions target the root issue. For example, there is an argument that it may make most sense for these economies to focus on boosting growth, since individuals may be making their fertility decisions based on their expectation of future economic outcomes. This hypothesis, and more on this topic, is explored in Fathom’s latest Viewpoint, which can be read on request.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
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