The Silver Lining in the Demographic Deficit

The trend of ageing populations is becoming a global one. Even regions enjoying youthful demographics will eventually undergo population ageing. This will become increasingly relevant even for developing countries. In fact, some ASEAN economies, such as Thailand and Vietnam, have already found themselves in the intermediate stages of demographic transition. The transition has begun even in younger Southeast Asian economies such as the Philippines, where fertility has fallen below replacement level.

The conventional wisdom is that population ageing inevitably leads to labour shortages, which, in turn, constrain an economy’s productive capacity. But new research is shining some light on this problem. There are two key takeaways here. First, the silver dividend — where older workers remain longer in the labour market — could mitigate the impact that ageing has on economic growth. Second, the adverse effects of ageing arise not from a reduction in the size of the labour force, but from its detrimental impact on the growth of total factor productivity (TFP). TFP refers to an economy’s ability to generate outputs or income from inputs such as labour and capital. A higher TFP is achieved when a country raises its total income without using more inputs, or when it maintains its income level using fewer inputs.

The most prominent channel emphasised in the literature is the decline in the working-age population, which slows the growth of the labour force. As populations age, the growth-enhancing effects of the demographic dividend are gradually being replaced by a demographic deficit, thereby adversely affecting countries’ economic prospects. Generally, a relatively large labour force or demographic dividend benefits economic growth. This was a key driver of the remarkable economic growth in Asian countries. According to the UN’s definition, an ageing society is one in which 7 per cent to 14 per cent of its population is 65 years old or older.

Yet, a more optimistic view has emerged recently as longevity increases and the older population becomes healthier. A silver dividend is generated when the adoption of new technologies, such as robots and AI, helps older workers work better. This helps to mitigate the negative effects of ageing on economic growth. The silver dividend could substantially increase GDP.

While the silver dividend generally portends well for economic growth, ageing populations can impact economic growth through three channels. First, older populations tend to save less; this reduces aggregate savings and investment and affects capital accumulation and economic growth. Conversely, a reduced labour supply may encourage the substitution of physical capital for labour, leading to higher investment. Second, a decline in the number of children allows parents to invest more in fewer children, which can contribute positively to economic growth. Third, while older populations affect productivity growth, the exact effects are still unclear.  One view argues that a higher proportion of older individuals slows technological development, which negatively affects TFP. But an opposing school of thought argues that population ageing can positively influence TFP. For instance, ageing-induced labour shortages may accelerate the adoption of robots and automation, thereby speeding up technological progress.

“… policymakers in aging countries should prioritise strategies aimed at sustaining and enhancing TFP growth, rather than focusing solely on mitigating labour shortages

In this context, it is important to examine the various channels collectively. To fully understand the effects of population ageing on economic growth, a rigorous analysis should not neglect the potential silver dividend. Most existing empirical studies fail to account for the silver dividend or the three aforementioned channels.

The authors sought to address this gap by incorporating six major channels through which ageing affects growth. In recent research, the authors examined physical capital, human capital, average working hours, labour force participation rate, the share of the population aged 15 and over, and TFP.  The fourth channel represents the silver dividend, while the fifth channel is the demographic deficit due to population ageing. The study utilised a sample of 166 countries, including both advanced and less developed economies, spanning the period from 1960 to 2019.

The empirical analysis yields some interesting and significant findings. As expected, population ageing had a negative and significant impact on economic growth. More specifically, a one percentage point increase in the old population share leads to a 0.23 percentage point reduction in the annual per capita GDP growth rate over the next five years. However, a negative impact on the labour force is not the main channel through which population ageing affects economic growth. In fact, the demographic deficit is completely offset by the increase in the labour force participation rate.

The authors also found that the increase in labour force participation rate is driven primarily by increased participation of older individuals. The primary channel through which demographic transition reduces economic growth is by reducing TFP. Indeed, the evidence indicates that the negative growth impact of ageing can be fully explained by reduced TFP (in other words, a country achieved the same income level by using more inputs, or saw lower output from the same level of inputs). Additional analysis suggests that the negative economic impact of older populations is more pronounced in advanced economies than in younger emerging markets.

The most significant and policy-relevant finding of the empirical analysis is that the adverse economic impact of population ageing primarily stems from its negative effect on TFP growth, rather than from a reduction in the size of the labour force. This challenges the conventional wisdom that population ageing inevitably leads to labour shortages, which, in turn, constrain an economy’s productive capacity.

Consequently, policymakers in ageing countries should prioritise strategies aimed at sustaining and enhancing TFP growth, rather than focusing solely on mitigating labour shortages. Therefore, Southeast Asian economies can sustain growth during demographic transition by investing in technological innovation and adoption, human capital development, market efficiency, structural change and infrastructure. The spectre of population ageing adds a much-needed sense of urgency to improving productivity in Southeast Asian economies. This is vital as they seek to move up the global value chain and transition from middle-income to high-income.

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