Population growth is mostly considered an exogenous production factor in economic models, for example in Solow’s growth model or the Cobb-Douglas production function. But as birth rates and labor productivity are declining, countries face a “labor problem”: how to keep up growth?
Observations
- Using World Bank data on population growth and real GDP growth, we find a positive but moderate relation between population growth and economic growth (correlation is 0.201).
- Using data from the Total Economy Database, we find a very strong and positive relationship between labor productivity growth per person employed and economic growth for countries between 1991 and 2017 (correlation is 0.831).
- Data from OECD shows that labor productivity has declined significantly in the past decades.
- We find that annual labor productivity growth was several percentage points lower for the period 2007-2017 compared to the period 1996-2006 for most advanced economies: Euro area (0.52), European Union (0.94), OECD group (1.01), U.K. (1.92) and U.S. (1.30).
- Fertility rates are globally declining, however, this varies strongly across the world. In overview, Sub-Saharan African countries have the highest fertility rates (4.9 on average), and Latin America is at replacement rate (2.1). In Europe and East Asia, populations are expected to decline in the coming decades.
- Data from the Total Economy Database shows that total factor productivity (TFP) has slowed significantly between 2008 and 2016 compared to 1995 and 2007: from contributing 0.8 percentage points to GDP growth to decreasing GDP growth with 0.6 percentage points.
Analysis
Economic growth is a function of TFP, capital and labor inputs, and higher population growth, ceteris paribus, spurs economic growth. However, most advanced economies will experience a population decline in the coming decades, hence a declining labor force. Assuming TFP, capital investments and marginal capital productivity to be constant, only an increasing labor productivity can make up for the declining labor forces. But many advanced economies also experienced significant slowdowns in labor productivity and thus face a “labor problem”.
Since a labor-less future because of AI, algorithms, and automatization is still far away, the labor problem will redefine the future of some economies and will continue to shift power balances between countries.
However, not all regions in the world experience this problem. Plotting labor productivity growth onto population growth, we get a quadrant that shows us the position of countries in terms of labor inputs. For example, countries in Sub-Saharan Africa experience an explosive population growth, hence a rapidly growing labor force. Their issue, however, is that their labor productivity has been slow or even declining. Positioned in the lower right corner, African countries and some Arab countries are “productivity potentials”: if they ramp up their labor productivity, they give their economies a powerful push. In the top-right corner are countries who succeeded in doing this: high population growth coupled with high labor productivity growth. Here we find several South and Southeast Asian countries, like India, Bangladesh, and Cambodia as well as some Latin-American countries (Peru and Colombia) and some African countries (Ethiopia and Kenya). These “labor stars” are bound to benefit from the stimulus their labor inputs will give their economies. Down in the left corner, the worst position, we find the most advanced economies: “labor puzzlers” who will have to find new solutions to keep up growth despite the negative effects of their labor inputs. Lastly, we mention countries with a slow or negative population growth but an increasing labor productivity that are mostly Central and European countries, like Latvia, Georgia, and Uzbekistan. This group of “labor rushers” is in a hurry to reap the benefits from the labor inputs, as the effects of declining populations might offset increases in labor productivity in the future.
Declining population growth and labor productivity growth are not a fact yet, and can be countered. For example, migration (replenishing the labor force) and new technological innovations (spurring TFP) can offset the negative effects of worsening labor inputs. However, in advanced economies, immigration has become politically difficult and it is still a debate whether or when technological innovations will boost productivity. Furthermore, countries across the world are increasingly indebted and face fiscal restraints, and are decreasing the role of capital inputs in economic growth stimulation. Since a labor-less future because of AI, algorithms, and automatization is still far away, the labor problem will redefine the future of some economies and shift power balances between countries.
