Sunday, 5 September 2021

It's the demography, stupid

I don't often write about macroeconomics. A lot of the research on macroeconomics is highly mathematical, and a lot of it is, frankly, voodoo. Macroeconomics has rightly taken a beating since the Global Financial Crisis for unrealistic models (see here and here, for example). One of the things that most surprises me about macroeconomic models is the absence of demography. So many models ignore the population, as if it's only something that matters in terms of the size of the labour force, and as a denominator to turn GDP into GDP per capita. But the population age structure matters. Labour force participation, and saving and borrowing behaviour, depend on the age structure of the population. So population ageing matters (for example, see this post).

So, I was interested to recently read this 2018 article entitled "The demographic deficit", by Thomas Cooley (New York University) and Espen Henriksen (BI Norwegian Business School), published in the Journal of Monetary Economics (ungated presentation version here). Cooley and Henriksen calibrate overlapping generations models for the U.S. and Japanese economies for 1990 and 2007, and include increasing life expectancy and the age distribution of the populations as key inputs into the model. As they explain:

Growth accounting shows that that growth differentials both across countries and over time are not only driven by TFP and capital accumulation, but labor supply on the extensive margin, labor supply on the intensive margin, and (obviously) population growth. One straightforward way in which demographics impact changes in aggregate economic activity is through their impact on aggregate factor supply. Data show that households steadily decrease labor supply both on the intensive and extensive margin in the latter part of their working lives. This is in contrast to the usual assumption in overlapping-generations models, that households supply labor inelastically until retirement age. Changes in life expectancy and cohort distributions will therefore affect both labor market participation and average hours worked. Faced with in- creases in life expectancy individuals need to provide for more years in retirement during their working life. In addition, aging populations means more people will be in their highest savings years. This may lead to changes in aggregate capital supply. Lastly, demographic change affect the composition of the work force and its productivity. Changes in the average efficiency of the individuals working will manifest itself in changes in TFP.

Cooley and Henriksen show with their calibrated models that:

...about 1/6 of the level of growth for both United States and Japan, net of population growth, can be accounted for by changes in life expectancy and in the cohort distributions.

There is clearly a non-trivial share of economic growth attributed to demographic change. And that means that demographic change might help explain some of the growth slowdown since the Global Financial Crisis. Older populations have fewer people working, workers working fewer hours, and less saving. All of those contribute to slower economic growth. The contribution of demographic change to slowing economic growth is complementary to the other recent explanations for the growth slowdown, including secular stagnation (from Larry Summers), and technological slowdown (from Robert Gordon).

Cooley and Henriksen's article is complemented by a comment in the same issue of the journal, by Etienne Gagnon, Benjamin Johannsen, and David López-Salido (all Federal Reserve Board). If you don't understand Cooley and Henriksen's article, then Gagnon et al. provide a summary that is actually much simpler to understand. However, what struck me was this from the conclusion of the comment:

As populations in the advanced economies continue to age, understanding the consumption and labor supply decisions of older workers is becoming an increasingly urgent task for deriving projections of aggregate variables. Henriksen and Cooley’s paper is a most-welcome step in this direction.

That is both good, and bad. It's good that macroeconomics is taking steps towards meaningfully including demographic change in its models, but bad because we're not already there.

Read more:


2 comments:

  1. This paper is another addition to a growing literature showing that much of business cycle fluctuations is due to changes in productivity be it of technology or of labour.

    Jamie Fryrer wrote a clever paper showing that 20% of the productivity slowdown was due to baby boomers lowering the average age of managers in the labour force by six years. With so many people promoted before that time, inefficient management of labour lowered labour force productivity.

    Prescott and McGrattin also do good work showing that investment in intangible capital is as large or larger than investment intangible capital.

    This is in addition to the straight forward literature showing that technology unfolds at uneven rate even if only because there are general purpose technologies. The computer revolution from the 1970s obviously resulted in a large amount of intangible investment in capital including human capital which was not properly measured.

    Added to that is a growing literature showing the importance of news of future productivity on current investment levels. but How you measure that is difficult because the sharemarket can drop in the face of good news about productivity because existing traded firms will become obsolete. Most of the new firms will be initially privately owned and not floated on the stock exchange until much later.

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    1. Thanks Jim. You're right that there is some good work in macroeconomics that does take into account demographic change. Unfortunately, I still get the feeling that there isn't enough of it, and too much decision-making is still made on the basis of DSGE models that essentially assume ergodic (i.e. long-run equilibrium) population structures.

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