The Demographic Transition - A Dynamic Process

I don't know whether you have noticed this but Ben Bernanke Chairman of the Fed just made a very important speech about the coming demographic transition and its economic and fiscal implications. The speech has been duly noted by Mark Thoma and also Edward Hugh from Demography.Matters.

Now of course Bernanke talks a lot about the US perspective which is only natural and also as Edward points out;

Of course, it is not hard to see that Bernanke still casts the problem in terms of the traditional compositional (dependency ratio) impact, without getting into either the ageing and productivity, or the life cycle saving and consumption issues.

However, in a general perspective I believe it is time to acknowledge a very important point here. Bernanke's speech shows that this point is beginning to emerge as a consensual view but still let me be quite clear here ...

The Demographic Transition is Not Over

The discussion of the sustainability of the US' health care and pension system notwithstanding Bernanke's speech serves as an entry point to the puncturing of a (widespread) myth. Namely the myth that the developed worldhas already gone through the demographic transition. As you will see from the Wikipedia link the consensus has slowly moved away from the static view of the DT. So the first thing we need to take away from Bernanke's speech and from the surrounding world in general is that the DT is not over. In fact, we are in the midst of a process none of us can claim to fully understand. The 'old' theory DT assumed that fertility rates would stabilize close to replacement levels as the country ventured into the last stages of the transition. A simple glance into the statistical data firmly rejects this claim. Actually the OECD fertility average in terms of TFR rates is hovering at about 1.6 well below replacement levels. Let me even ask a very simple question; what is in fact the floor for falling fertility and ceiling for rising life expectancy? No-one knows for certain which is also why the idea and perception of the DT as static is well ... nonsense on stilts.

This was the easy part because if we now know that the DT is not static we also know that how a country develops during the DT is extremely important. Let us for example take the idea of the demographic dividend (DD) and assume that we adhere to the traditional view of the DT. If we stick to the now mainstream idea of the dependancy ratio we can easily see that the DD becomes a free lunch. If fertility levels indeed stabilized at replacement levels the DD would just become an extra spike in economic growth driven by a more favorable dependancy ratio. However, what we see now in the developed world is the exact opposite of the DD namely that the dependancy ratios are becoming un-favorable as a function of falling fertility and rising life expectancy. So what does this mean?

Here we simply need to remember that the DT is not in the same stages all around the world. Following this it becomes very interesting to watch India for example, a country currenty passing through its DD phase. How India wields its relative population advantage today will consequently have major importance on how it weatheres the storm when birth replacement sets in and fertility begins to drop. This is obviously very long term but still important to be aware of. In terms of public economic policy it therefore becomes clear that reforms must reflect this and governments in many OECD countries are beginning to act accordingly in terms of pushing retirement age and thinking of clever ways to maintain the current level of welfare. What we obviously need to ask ourselves is whether it is enough or too late?

The short synopsis above pretty well sums up how the discourse on changing demographic realities is currently packaged and how I believe it should be packaged in the future. Consequently, it is very important to underline that the DT in whatever way we are going to conceptualize it cannot be seen as a static phenomen but in stead it must be seen as a dynamic process which exhibits a direct and important feedback mechanism with economic growth and public economic policy. Particularly, my description above of the DD and how it is not a free lunch constitutes an important aspect here in terms of the overall argument of the demographic transition.