On the impact of an aging population on wages and inequality

A few days ago, José Ignacio Conde-Ruiz and Clara I. González published in Estudios Sobre la Economía Española (Fedea) a document under the title The Aging Process in Spain. In this report, they analyze the aging of the Spanish population and the implications this phenomenon can have until 2050, the year when, according to the most relevant demographic projections, Spain’s population will be one of the oldest countries in Europe and, therefore, also in the world. Specifically, projections anticipate that, by that year, our country will have become the fourth country in the European Union with the highest dependency ratio at age 65 (only Portugal, Greece, and Italy would beat us). Possibly we will also be the State of the Union where this indicator will have grown the most in this period (it will have practically multiplied by two).

In their final reflections, the authors warn us of the implications the accelerated aging of the Spanish population may have on issues such as the sustainability of public finances (as a consequence of higher spending on public pensions, health, and care), savings rates (for the increase in the number of retirees), and the productivity of the workforce (although regarding this issue I recommend you read this paper in which Francesca Carta, Francesco D’Amuri, and Till M. von Wachter analyze the impact a policy-induced sharp rise of the retirement age in Italy had on employment and productivity of companies in that country).

However, the authors conclude the document with a positive outlook. “The aging process that we are experiencing and that we will experience more intensely in the coming decades is probably one of the best news.” The increase in life expectancy is a consequence of the economic and social progress of the last decades, and forecasts suggest that our life expectancy will continue to lengthen in the coming years and decades, they argue.

About this issue of the possible consequences the rapid aging of the population (and the consequent increase in dependency rates) may have on the economy and, more specifically, on the labor market, the theses Charles Goodhart and Manoj Pradhan defend in their book The Great Demographic Reversal (2020) constitute, due to their originality, good food for thought.

For these authors, the deflationary scenario in which we have been living for the last three decades is a consequence of the increase in the global labor supply as a result of favorable demographic trends and the incorporation of China and the countries of Eastern Europe into the world trading system (they refer to it as a demographic “sweet spot”).

Between the last decade of the past century and the second decade of this century, the simultaneous incorporation of both the baby boomer generation and women into the labor market, in addition to the incorporation of the former Soviet bloc countries and China into the international trading system, doubled the planet’s labor supply, while pulled down dependency ratios.

Consequently, the real wages of less-skilled workers have fallen in many advanced economies, as their bargaining power fell due to the increase in the global labor supply, a growing portion of industrial production was automated (or relocated to those countries that had just arrived in the international trade system), and the service sector gained weight in the labor market.

But still, there have also been winners these years. On the one hand, the workers of the countries that came to the system in recent decades. (The ratio of the cost of a US worker to a Chinese worker dropped from 34.6 in 2000 to 5.1 in 2018). On the other hand, the holders of capital (whether financial or human). All this has meant that, although inequality between countries has decreased, internal inequality in many advanced economies has grown significantly.

However, for Goodhart and Pradhan, the scene is about to change. The aging of the world population, and the consequent increase in dependency ratios, can represent a turning point after decades of stunted wage increases, inflation rates, and interest rates.

In most developed countries, birth rates have been at their lowest for decades, life expectancy has steadily increased and, as baby boomers reach retirement age, dependency rates are on the rise.

From the perspective of the demand for labor, everything indicates that, as dependency rates increase, we will need more workers specialized in caring for the elderly, a type of activity that is difficult to automate (at least for the moment) or to relocate to countries with lower wage costs.

In parallel, from the perspective of the supply of labor, as the number of people who get retired outnumbers the young people who join the labor market (and the domestic labor supply shrinks), the bargaining power of local workers in front of their employers may increase, and so their wages.

Of course, the arrival of a larger number of immigrants may compensate for this imbalance, so the bargaining power of local workers remains as it has been until now or even decreases. However, the authors argue, it is likely that local workers, aware of this risk, tend to vote for political options that defend restrictive approaches to immigration, as we already are seeing in some European countries.

Something similar can happen regarding the option of relocating part of the economic activity to other countries with lower labor costs. Nowadays, China and Eastern Europe face demographic strains, and their wage costs are no longer as competitive as before. Besides, Goodhart and Pradhan anticipate growing political opposition to relocations to alternative destinations such as India or Africa, in addition to the less legal security these countries offer to corporations compared to what China provided at the time.

To finish the list of arguments why in the coming decades we can expect an increase in labor costs, the authors point out other two:

a) the inflationary effect of an increase in the proportion of the population that consumes more than what they produce;

b) the higher tax burden workers will foreseeably have to bear so that the Government can pay the pensions of an increasingly aging population (voters, let’s not forget). 

Arrived at that point, Goodhart and Pradhan argue, workers will ask their employers to increase their wages to compensate for the impact those price and tax increases will have on their purchasing power. And to do so, they will leverage the greater bargaining power they will have at that time.

In summary, for Goodhart and Pradhan, the contraction of the local labor supply, an increase in the demand for workers to perform non-automatable and non-relocatable tasks, growing opposition to migratory movements and globalization, and tax increases, are the key elements through which the aging of the population in advanced economies can end decades of low wages and even reverse the inequality that we have suffered in recent decades.

#foodforthought

References

Carta, F., D’Amuri, F., & Von Wachter, T. (2021). Workforce aging, pension reforms, and firm outcomes. NBER Working Paper, (w28407).

Conde-Ruiz, J. I. & González, C. I. (2021). El proceso de envejecimiento en España. Estudios sobre la Economía Española – Fedea 2021/07.

Goodhart, C. A. E., & Pradhan, M. (2020). The great demographic reversal: ageing societies, waning inequality, and an inflation revival. Springer Nature.