Demography, not productivity, is the issue of our time

Politicians offer a variety of fantasy solutions

“Productivity isn't everything, but, in the long run, it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” Paul Krugman, Economic Policy in the 1990s, 1990.

This quote lies at the heart of political and economic conventional wisdom in the developed world. Economic performance is mainly a matter of productivity, it is said. Looking at Britain’s lacklustre economic performance since the great financial crisis of 2007-09, almost everybody of influence points to poor productivity growth as being the root cause. Various ideas are mooted to solve this. The government persists in thinking that a spurt of productivity will enable them to roll back austerity while not increasing tax rates. But if productivity is important, it is not “almost everything”. Demographics plays an important part too.

Economic growth in the second half of the 20th Century was helped by a postwar baby boom entering the workforce, increasing the proportion of people of working age as they entered the workforce in the 1970s. It was also helped by the growing proportion of women entering the workforce. But the boomers are retiring in droves, especially since about 2010, and female employment is reaching saturation levels. One important source of income per capita is going into reverse, and another has moved to neutral. Growth in productivity is having to work that much harder to drive economic progress. Meanwhile people are living longer after they retire. On top of this the fertility rate - the expected number of children per woman - has declined to well below the replacement rate, meaning that there is reduced supply of new adults to make up the numbers. These trends apply right across the developed world.

It is actually much harder than it should be to disentangle demography from productivity. The only serious attempt I have read focused on the US economy: Dietrich Vollrath’s Fully Grown (2020). Mr Vollrath sought to establish the causes of America’s slowdown in economic growth per capita in the 21st Century. To his surprise he found that demographics accounted for about two-thirds of the slowdown. More than half of the rest was indeed slower productivity growth, arising for the Baumol effect - the channeling of the benefits of productivity growth into lower-productivity activities. Demographics swamped productivity, and much of the slowdown of productivity is actually a growth effect. There is no reason to think that in Britain it is any different. The demographic trends are indeed probably sharper. It is no wonder that growth rates are struggling - and yet the government explains this mainly in terms of productivity rather than demographics. But demographics should be a more prominent part of the debate.

There is one group who are more than happy to talk about the demographic crunch: the populist right. Take this piece from agitator Matt Goodwin. His particular thing is the “fertility crisis” - as being one of the many important things that the liberal elite won’t talk about. The low fertility rate is true enough (he quotes the ONS estimate of 1.44 for England and Wales - well below the replacement rate of 2.1). This decline in fertility is repeated right across the developed world, and in many medium income countries as well, like China; Britain is by no means the worst case. The right’s take on this is that the elites are encouraging the shortfall to be made up by immigration, diluting the the “indigenous” culture. They tend to blame such policies as contraception and abortion, alongside that great evil of feminism, for causing the decline. All this plays into the “replacement” narrative - that non-white people are replacing white people, will soon form a majority, and then take revenge for the perceived past evils of the former majority. Of course, you don’t have to accept this schtick to be worried about the fertility rate - but it gives its followers a bit of added jeopardy. What to do? Mr Goodwin says: “It’s time for a complete revolution in our cultural attitudes —we need, in short, a fundamentally different approach.” He is not explicit about what he means. He might just mean following Far Eastern countries, also afflicted by low fertility, but which also resist immigration for cultural reasons. But many of his followers doubtless think that the answer is to roll back feminism and ban abortion and contraception - as his talk of revolution suggests.

This idea has now been picked up by Reform UK’s leader, Nigel Farage. He is talking of an “existential threat”, justifying the abolition of the two-child cap on welfare payments, and a small tax break for married people. This is interesting because the two-child cap is very popular with his supporters: I suspect they associate large families with immigrants. This policy sits alongside Reform’s one-in, one-out immigration policy. The narrative of a fertility crisis at the heart of cultural jeopardy could be a powerful one. It appeals to older voters who want to turn the clock back 50 years or so; it might join to these many younger men, a growing disaffected group who are being persuaded that feminism is a modern evil; family-friendly policies may also draw in religiously conservative ethnic minorities - another important part of the new conservative coalition.

There is a lot of nonsense to this cultural panic in the face of low fertility. Looked at across the globe, reduced fertility is not correlated with feminism. In the Far East, culturally much more conservative than the West, the drop is generally faster. Clearly much more powerful forces are at work, and we don’t need to look very far to find them: economics. The opportunity cost of having children has rocketed (i.e. the direct costs combined with foregone income), making it much harder for people to afford large families. This is one of the many paradoxes of economic success. If the conservative dream comes to pass, with women staying at home to look after larger families, the economic consequences would be dire. At a time when conservatives want more working age people to enter the job market to reduce the dependence on immigrant labour, they also want lots of people to leave it. Such is the way of narrative-driven politics. But there is a wider point: raising the fertility rate implies some pretty serious costs, way beyond the tweaks that conservative politicians have in mind. The most effective public policy move would be improving access to subsidised childcare, at great expense.

But what are the serious policy implications? The first is a question of expectations management. There are severe economic headwinds, of which the demographic crunch is just one (others include: the stabilisation to reversal of trade gains; and the Baumol effect, which is especially severe in Britain with its sharp decline in manufacturing). The halcyon days of the late 1990s and early 2000s are gone; many liberal politicians and commentators don’t seem to realise that they are being just as nostalgic the conservatives. While short spurts of economic growth are perfectly plausible, we cannot expect a return to the steady growth of 1950-2007. That means we should be confronting tough choices on taxes and public services, not hoping that they will go away.

Then there is the politically sensitive topic of immigration. This has been one of Britain’s most important public policy responses in the 21st Century. First it was opening up to migrants from post-Communist Europe in the early 2000s. Tony Blair, prime minister at the time, now says he regrets this. But he also likes to take credit for his government’s record of economic growth which, in his telling, was only derailed by events elsewhere in the world. He forgets how dire labour shortages were in many parts of the country in the early 2000s; this spurt of immigration, alongside cheap imported goods from China, saved his government from a nasty economic shock. After Britain left the European Union, the government then opened up migration from the rest of the world. This was to meet real economic needs, and the current prime minister’s language of “incalculable damage” is just gutter politics. In fairness, though, some of the benefits of this recent wave of migration are open to challenge - there was a high proportion of people who did not come to the country to work or study - family members in particular - and there have been integration costs, especially to stretched public services. It has not helped the affordability of housing either.

Immigration is not the open and shut policy choice that some liberals claim. It postpones the demographic crunch rather than solving it. Immigrants soon follow the local trends in fertility, and then grow old and retire. And poor cultural integration, evident in some communities, has costs too. Many Far Eastern countries, like Japan, Korea, and, indeed, China set their face against mass immigration, and are managing the consequences. Regardless, the political appetite for such open immigration is now greatly diminished.

The next policy response is to persuade people to retire later. Here British public policy can claim one of its major successes. The state pension age has been raised; age discrimination has been outlawed; employer pensions have been hollowed out. The ratio of working people to the population as a whole has been maintained, and even increased, notwithstanding a deteriorating theoretical dependency ratio. This has done as much as immigration to head off the crunch, and probably more, although as a lot of older people choose to reduce their work rate, it probably doesn’t do much for the productivity statistics. All this with barely a political ruffle. Compare that to France! The state pension age will doubtless need to go up some more, but otherwise the hard work is largely done.

The next challenge is to manage the benefits and services largely directed at the elderly. The costs of these are escalating even as the taxes paid by their users diminishes. There are roughly three main categories: the state pension, health services, and social care. Here things don’t look so good. The state pension is not especially generous, but it is being gradually increased through the “triple lock”. This was a policy from the Conservative - Lib Dem coalition government of 2010-15 (it was in the Lib Dem manifesto if I remember correctly). There is much talk of it being “unaffordable”, but the government’s recent experience with the winter fuel payment has shown that the government tackles elderly benefits at its peril. A better way of managing its cost is to raise the entitlement age.

Health services for the elderly is but one aspect of a crisis in health care. Collectively the country underspends on health - other developed countries spend more. The problem is that the bulk of the cost comes through the NHS, paid for through taxation. Which means that tackling expanding demand means putting up taxes, introducing fees or allowing a larger private sector to flourish. The NHS can doubtless be made more efficient, but don’t let anybody persuade you that this can be more than a small part of the answer. The last government tried to ignore the problem; this one is devoting far too little resource to it. We can expect the NHS to deteriorate steadily, alongside a growing private sector. The alternatives of raising taxes, or changing the fundamentals of the NHS (e.g. by moving to an insurance model) are too politically toxic.

Which takes us to social care: the provision of care services in people’s homes and at specialist institutions. The last person to make a serious bid to solve it was Theresa May, the Conservative prime minister who served from 2016 to 2019, who made it part of her policy manifesto in the 2017 general election. It is widely credited with turning a near-certain landslide victory into lost majority, leading to the slow and painful death of Mrs May’s career. Killing this policy, which involved taxing gains on people’s homes (“dementia tax” as its opponents called it) is probably the then Labour leader Jeremy Corbyn’s biggest contribution to British public policy. Nobody has been prepared to take it on since - including the current government, who seem to be on a mission to raise the costs of providing social care while providing token extra funding. The rich will be OK, and quite few others who are able to tap into the unearned capital gains from their homes, but misery beckons for many others.

Funnily enough, I think most of the public sense all this. Populist politicians from right (“abandon net-zero”) and left (“tax the rich”) peddle fantasy solutions, but I don’t think more than a few will be taken in. Which won’t stop people from voting for them anyway to give the established parties a kicking. Meanwhile those established parties cling to their own fantasy solution: raising economic growth through productivity improvements, alongside procrastination. How I wish for a bit more political courage.