The size and age structure of a population can play an outsize role in any country’s economic development in numerous ways, including international competitiveness. Population composition affects competitiveness via propensities to save and consume, companies’ investment behavior, capital intensity of production, and global and regional labor supply.

Determinants of price competitiveness

If production costs are relatively low by international standards, a country’s products can be highly price-competitive. Numerous causes influence production costs. The most important are:

  • Production factors: The greater the supply of labor and capital, the lower the prices of these two central production factors: wages and interest rates.
  • Propensity to consume: A high demand for goods and services. By itself, this means an increase in the overall economic price level and, thus, also in production costs. In addition, a high propensity to consume means manufacturing consumer goods uses a significant proportion of production factors. This leaves fewer resources for capital goods production ( a relative shortage of capital with a high price for this production factor.)
  • Technological progress: Technological progress results in increased productivity and thus lower production costs.

Competitiveness of an aging society

An aging society is characterized above all by the fact that the working-age proportion in the total population is relatively high. Examples of such countries are currently Germany and Italy. Japan also still has a relatively high proportion in this age group. However, the share is already declining relatively sharply. Even China is currently entering a phase in which the proportion of working-age people is declining (see Fig.1).

This population structure gives rise to several economic developments that have an overall positive impact on the country’s international competitiveness:

  • The relatively large number of workers has a dampening effect on wages.
  • Employees build up savings to provide for their retirement. The high propensity to save means an increased supply of capital, which in itself leads to low-interest rates (the price for capital as a production factor.)
  • High savings in the past usually lead to the accumulation of capital stock. In addition, high savings allow large investments to promote technical progress. Both have a positive effect on productivity and international competitiveness.
  • A low propensity to consume, which is the reflection of a high propensity to save, results in a low demand for goods, which has a dampening effect on inflation.

An aging society is a relatively competitive economy. The combination of high competitiveness and low consumer spending means that the country exports more than it imports. The economy generates a trade balance surplus or current account surplus – just as Germany and Japan have for many years.

Competitiveness of an old society

In an old society, the proportion of people of retirement age in the total population is high, and the proportion of young people is low. The percent of the working-age population is lower than in an aging society. Today, without immigration, in an aging society, the population will shrink as the large baby boomer generation reaches an increasingly higher age, and more people die than are born. Japan currently comes closest to this type of society (see Fig. 1).

In an old society, the outlined effects that characterize an aging society are reversed (see Fig. 2):

  • A declining labor supply causes wages to rise.
  • An aging workforce results in a decline in labor productivity, which increases costs.
  • When many pensioners dissolve their savings, this reduces the supply of capital and increases interest rates. Rising interest rates mean higher production costs.
  • A decreasing number of employed persons means in itself a lower supply of goods. The number of consumers is still high because of the many pensioners. On the goods market, this causes a tendency for demand overhang, which causes prices to rise.

So an old society tends to have higher production costs and less competitiveness than an aging society. However, because of the international interdependence of national economies, global economic developments also influence countries’ production costs. For the economic development of an open economy, not only is its own demographic development relevant, but also global demographic development.

The role of the global labor market

As the number of working-age people grows worldwide, there is a surplus of labor in the global labor market, which in itself has a wage-reducing effect. This wage pressure also affects economies whose working population is small and shrinking in relation to the total population. There are two channels of action for this:

  • For an old society, the immigration of labor from labor-rich countries provides an additional supply of labor that has a wage-reducing effect.
  • The import of labor-intensive manufactured products reduces the demand for labor in the importing country and depresses wages via a falling demand for labor.

The role of Asia

How strongly the demography-induced increase in production costs asserts itself in a society also depends on global demographic development. If an old society finds itself in an environment where the proportion of working-age people worldwide is still growing, the resulting global wage pressure also affects the old society – either through migration movements or through the import of goods and services.

The impact of demographic developments on the global economy shows that the world as a whole is currently in an aging society phase. Although the proportion of working-age people will decline slightly in the coming years, it will remain relatively high, mainly due to labor supply in Asia (see Fig. 3).

Asia’s high labor supply is having a price-reducing effect worldwide: through the wage-dampening effect and the increased savings that the global aging society is creating. As a result, there is an increased supply of capital on the global capital markets, which has the effect of lowering interest rates.

Outlook

The central challenge of social aging is the declining international competitiveness of old societies. The demand for products in those economies is declining, resulting in a drop in production, leading to a loss of income.

This puts pressure on real material prosperity per capita. To prevent this, a road to action would be an increase in labor productivity. The levers for productivity increases are higher capital input in production, technological progress, and increased labor productivity through improved education and qualification measures. Immigration of working-age people and their integration into the economy and society can also increase labor supply.

If the aging of the population increases the incentive to use more capital in production and to excel in labor-saving technological progress, there will be repercussions on economic globalization and the international division of labor. This is especially true when worldwide the proportion of people of working age is declining.

Therefore, if there is a global incentive to use more capital and technology in production, the importance of labor costs for the location decision of companies decreases.  The previous strategy of offshoring (relocation of production steps from labor-poor high-wage countries to labor-rich low-wage countries) is then replaced by the strategy of reshoring (relocation of production steps back to high-wage countries). This could signal a significant change international trade.

Note: This paper is based on a GED discussion paper which is only available in German: “Alterung, Inflation and International Competitiveness“

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