The demographic question, the issue that is of just how important demographic processes actually are in the emergent evolution of economic and social phenomena, is one which has enjoyed a long and complex history. It has been one of the most hotly contested social science topics since it seems time immemorial, or at least this is how it feels. Protaganists of now this, now that point of view have each argued their point of view with equal fervour and conviction.
Back in the 18th century, for example, mercantilists and physiocrats held that having a large population was a good thing, something to be encouraged, since, in addition to enhancing national security, it was thought to be a major stimulus to economic growth. This argument has long enjoyed a certain popularity, and has continued to rear its head now here, now there across the span of the years in the form of either pro-natalist public policies or economic priorities which could possibly be best be described as 'immigration friendly'. On the other hand there have always been those who have seen in growing populations a threat and a menace. Thomas Malthus would be the name which first comes to mind here, but there have been plenty of others, whether these have been at the end of the 19th century (with the densely overcrowded cities of Western and Northern Europe) or in the second half of the twentieth century (with the population explosion which followed the mortality decline in the third world).
It is though, undoubtedly, the arrival of below replacement fertility in most of the societies which have achieved maturity in their economic systems which has lead produced the deepest, and possibly the most critical, episode in this long series of heart-searching debates. Actually the current debate is in many ways a revival of one which originated in the back in 1930s - when the prospect of generalised below replacement fertility first began to be glimpsed by the most far-sighted theorists . At the time writers and theorists began to forsee important negative (even cataclysmic) consequences - both socially and economically - for those countries who were expected to experience population decline. (Redaway, 1939, Myrdal, 1940, Spengler, 1938). Of course the decline never happened, war came and was followed by a generalised baby boom, and demographers, not for the first or for the last time, were felt to be hopelessly incapable of predicting anything. However, as we can now see, these early theorists were not wrong, but simply out of time.
In economic theory, the question of population change has had a complex history. Following the early lead of the mercantilists many have considered it to be a positive influence on economic performance due to its impact on aggregate demand and investment. In the context of development theory population growth has often been argued to stimulate development through its effect on the investment share in GNP.
This type of argument has come and gone over the years as it has come under contsant and sustained attack from neo-Malthusians who have argued that excessive population growth has been one of the decisive factors maintaining countries in povery. The origins of this argument can, of course, be traced back to the early 19th century, with Malthus himself arguing that population growth, by producing decreasing returns in agriculture, leads directly to lower per capita income.
This decreasing returns argument itself has in its turn been countered by those who have tried to suggest that in the industrialisation process - whether in the original industrial revolution in the UK, or in the modern 'development process' in third world countries - scale effects may well be important, but this time with the effects working in the opposite direction: ie the increasing returns on investment produced by growing domestic demand being thought to be one of the decisive 'trigger' elements in the take-off process (Kuznets, 1960).
More recently there have been those working within what could broadly speaking be termed the 'new growth theory' tradition who have argued that it is precisely the increasing returns effect produced by the non-rivaly properties of ideas which may be the best argument of all in favour of population growth (Kremer, 1993, Jones, 2001).
Over the years versions of both these classes of arguments have tended to come and go, with the pendulum swinging now this way, now that.
In general, neo-malthusians (like the Swede Knut Wicksell at the end of the 19th century) have continued to argue the view that population growth is harmful, while Keynesians, for example, have generally tended to see population growth as a stimulus for investment demand and, thus, for income growth (Perlman 1975). A third, more neutralist view, has, however, come to occupy the position of 'paradigmatic view' from the early 1970s onwards. This view holds that population growth rates are not an economically decisive factor, one way or the other, and that they do not constitute a significant variable when it comes to understanding differences in per capita income growth across countries. This is essentially the view taken in the standard accounts of neo-classical growth theory. (Mankiw et al, 1992, Jones, 2001, Barro and Sala i Martin, 2003).
This view could fairly be said to have constituted itself as the dominant academic consensus in the area of growth theory since the early 1980s, with the neutrality of population change for per-capita income being treated as being a theoretically well-founded result. This state of affairs has, of course, not been without its critics, with the claim being made that this finding has in and of itself had a negative impact on the development debate since it has lead to the marginalization of population and reproductive health questions as instruments of economic development policy within key agencies like the World Bank (Birdsall 2003, Kelley 2003).
The heyday of the neutralist view, however, was in many ways the 1990s, as throughout the decade growth study after growth study seemed to reveal little in the way of cross-country evidence to justify thinking there was any significant demographic effect on growth, either in the form of a dividend or in that of a penalty. However, it is important to stress right from the outset that much of the work which belonged to this generation of population 'neutralist' growth research had one obvious limitation: virtually every other factor which could conceivably infuence growth was held constant in order to test exclusively for correlations between rates of population growth and rates of per capita income growth.
Now whether results obtained in this way truly reflect the unimportance of population growth, or, as some have argued, they simply reveal the summative outcome of the impact of diffent, and mutually offsetting, negative and positive influences of population on economic growth is a question which is still, obviously, being debated.
Be this as it may, in recent years the 'neutralist' view has been coming under increasing criticism. On the technical level, critics of the neutralist studies tend to cite the existence of inadequate control variables or other such model specification errors, or the relatively poor quality of the available data, or the presence of reverse causality, or all of these combined.
At the same time, from the late 1980s onwards another tradition of growth research has increasingly come to cast doubt on the idea that population dynamics don't matter for economic theory, and it has done so by emphasising that it is not population growth per se which is important, but the impact of changes in the rate of population growth on the age structure of a population. This increased interest in age structure coincided, not co-incidentally, with the arrival of South Korea, Taiwan, Hong Kong and Singapore on the scene as newly developed economies, an arrival which has often been termed the Asian Tigers phenomenon.
The arrival of this change in attitudes can be traced to new evidence coming in three principal forms.
In the first place a series of empirical studies based on aggregate-level panel data have concluded that demographic factors do in fact have a strong, and statistically significant effect on aggregate saving rates (Bloom at al, 2003; Deaton and Paxson, 2000; Kelley and Schmidt, 1996; Kinugasa, 2004; Williamson, 2001) and on economic growth (Bloom et al, 2001; Bloom and Williamson, 1998; Kelley and Schmidt, 1995).
Secondly, detailed case studies of the East Asian miracle have provided compelling and consistent evidence that what has come to be known as the "demographic dividend" was an important element in facilitating the economic success of the countries concerned (Bloom and Williamson, 1998; Mason, 2001b; Mason et al, 1999). In particular, and in a study which really made it impossible to continue to simply ignore the relevance of demographic changes, Bloom and Williamson (1998), using standard and even rudimentary econometric techniques, found that approximately one-third of East Asia’s increase in per capita income was due one way or another to the impact of the demographic dividend. In a corpus of work which very much parallels that of the above mentioned Harvard economists, Andrew Mason (Mason, 2001a), using growth accounting rather than econometric methods, estimated that the 'demographic dividend' which Bloom and Williamson had identified accounted for about a quarter of the Asian Tiger’s economic growth during their 'growth spurt'. While not everyone has accepted these conclusions at face value (see eg Schultz, 2005), there is little doubt that an increase in the proportion of the population of working age, and an accompanying increase in 'prime age' workers, must have been a significant factor in the growth transition evidenced by these countries. There are sound and elementary (econ 101) type reasons for thinking that this ought to be the case, and there is growing empirical evidence that it was.
In the third place evidence of the importance of population change on growth performance has been coming from a new and unexpected source: the ageing developed economies. A growing number of developed countries now find themselves with a rapidly increasing proportion of their population over retirement age, lowest-low levels of fertility and continuing and unprecedently (for mature economies) low levels of economic growth sustained over a considerable period of time. The combination in time of these two processes ( falling fertility and increasing life expectancy) with the 'low growth impact' has meant that economists have started to 'prick up their ears' on the 'population topic' as never before.
While it should be obvious, it is perhaps worth noting here that all the above-cited authors when they argue that age-structure variables do have predictive power and can 'explain' a significant portion of economic growth during the development transition, continually stress that the relationship between demographic variables and economic development is not a deterministic one. Population matters, but policy matters to, and whether or not governments put in place an appropriate package of policies, or whether or not a country enters an adequate 'mindset' makes a big difference in deciding whether the opportunity offered by the demographic dividend is put to productive use or simply frittered. The difference between the experiences of some Latin American countries and some Asian ones is clearly salutory here.
It is also perhaps worth pointing out at this stage that a further possibility does, in fact, exist: that movements in the key policy variables like democracy, openness, defence of private property rights etc etc, may turn out to be endogenous to the transition process which the changing age structure sets in motion (in particular here see Chapter Two on Malmberg's idea of four phases in the age structure transition). This possibility will be discussed more fully later in this book.
The Coale Hoover Hypothesis
The recent blossoming of interest in the demographic and age-structure related components of growth in fact dates-back to 1958 and to the publication of what was at the time a highly influential book by Ansley J. Coale and Edgar Hoover: Population Growth and Economic Development in Low-Income Countries.
In their book Coale and Hoover advance what has subsequently come to be known as the Coale-Hoover hypothesis. This hypothesis is based on a simple but powerful intuition: rapid population growth arising from falling infant and child mortality swells the ranks of dependent young, and this single demographic event, in and of itself, increases the consumption share in national income at the expense of the saving one. Despite all the comings and goings around their hypothesis over the years, this single insight has survived more or less intact, and will surely form one of the core building blocks of all subsequent development theory.
By analysing simulation results derived from an econometric model which had been calibrated using Indian data, Coale and Hoover concluded that India's development would be substantially enhanced if there were lower rates of population growth. Their analysis here rested on two premises. Firstly, that in post initial-mortality-decline 'child-heavy' societies household and aggregate saving is reduced by the generalised presence of large families. And secondly, that the existence of such high ratios of dependent children skews aggregate investment away from the more self-evidently economically productive activities, since there is a continuous pressure for resources to be transferred towards so-called 'unproductive' population-sensitive social expenditures (like health and education).
The key novelty in the Coale Hoover model was the linking of this 'crowding out' process to the age composition of a high-fertility population, and not simply to its size, density, or growth, per se.
A pioneering work in many ways, their book:
1) identified several possible theoretical linkages between population growth and economic growth which were in perfectly compatible with the general of the time about the economic-growth process (which tended, for example, to place considerable emphasis on physical capital formation);
2) formalized these linkages into a generalised model that was parameterized and simulated to generate forecasts of alternative fertility scenarios over the intermediate-run;
3) offered an enlightening case study of a major developing country country whose short to mid term economic prospects prospects were considered to be far from good. The Coale-Hoover framework was transparent and easy to understand, the assumptions were explicit and qualified, and the findings were clearly expounded and accessible to a wide readership.
The model identified, and the simulations quantified, three adverse impacts of population growth:
1) A capital-shallowing impact: a rapidly growing working age population produces a reduction in the ratio of capital to labour since population growth per se does not increase saving rates, and a rapid increase in the proportion of young people tends to lower the aggregate savings ratio;
2) An age-dependency impact: an increase in youth-dependency raises the requirements for household consumption at the expense of saving, thus diminishing the savings rate;
3) An investment diversion impact: a shift of (mainly government) spending into areas such as health and education at the expense of (assumed-to-be) more productive, growth-oriented investments.
In particular, as has been suggested, the hypothesis attracted a good deal of attention from growth economists due to its emphasis on the role of physical capital (as distinct from the earlier Malthusian focus which was on land as a scarce resource). At the time physical capital accumulation was considered by many to be 'the' key to economic development.
Hoover and Coale's work, which had a substantial impact on U.S. population policy and thinking at the time of publication, did not however go unchallenged, even at the time of publication, and its influence was subsequently to wane rapidly as empirical research failed to uncover the strong and consistent impacts of population movements on saving in the developing and less developed world which the Coale Hoover hypothesis was interpreted as anticipating.
Initial research results did however seem be favourable. Nathaniel Leff, for example, in an early study based on a sample of 74 countries, found the log of gross savings rates to be inversely related to the proportion of the population either under 15 or over 64 (Leff, 1969), a finding which appeared to place the youth dependency hypothesis on a solid empirical footing. Subsequent research, however, (Goldberger,1973, Ram, 1982) failed to find confirmation of the dependency hypothesis and some researchers even cast doubt on the validity of econometric procedures employed in the initial Leff study.
Subsequent developments in growth theory also seemed to undermine the foundations of the dependency hypothesis. The principal rival to the hypothesis, Tobin’s life-cycle model (Tobin, 1967), took it as axiomatic that savings rates should increase as population growth did. The reason Tobin thought this is not difficult to comprehend, at least in the original version of his model which worked with a typology of only two population groups (workers and a retired population): faster population growth tilts the age distribution toward young, saving, households and away from older, dissaving ones. This way of looking at the process, which contains the germ of a very interesting idea in the 'tilt effect' it proposes, was, however, seriously misleading as it rested on a considerable over-simplification of the life cycle process.
The representative agent version of Robert Solow’s neoclassical growth model also lead thinking in a similar direction, with faster population growth being thought to result in higher savings rates, savings rates which go up as interest rates raise in response to heightened investment demand (Cass 1965, Phelps 1968, and Solow 1956). However, neither class of model explicitly addressed the dynamics of the dividend which Hoover and Coale had considered to form part and parcel of the ongoing impact of the demographic transition.
In Tobin’s steady-state model the "age tilt" factor, whose presence is interesting and insightful in and of itself, arises as a result of an initial modelling decision which described a world where there were only two groups of partyicipants, active adults and retired dependents. Had the model also incorporated the idea of youth dependency a very different tilt-effect would in all likelihood have been produced.
In similar fashion, the standard neoclassical growth models assume exogenously fixed labor participation rates, and, by implication, assume no endogenously driven changes in the dependency ratio. Clearly this kind of assumption is - strictly speaking - 'necessary' if one's objective is the conceptualisation of "steady-state" behaviour, but this precisely begs the question as to whether, in the light of the impact of key "transitional dynamics" during a continuing process of demographic change, the postulation of even a hypothetical 'steady state' economy is a useful and valid procedure. Certainly as we shall see later it is hard to find many examples (by 'many' I mean here enough to count on the fingers of one hand) of the kind of constant 'mature trend' which Kaldor presented as one of the core stylised facts typifying modern economic growth (Kaldor, 1961).
In effect it could be argued that by working backwards from the steady state idea the whole neoclassical school of models gain in modelling simplicity precisely at the expense of sacrificing the rich and complex population dynamics which were implicit in Coale and Hoover’s early theorising and which were to become so blatantly empirically evident in the course of East-Asian demographic transition.
That subsequent empirical findings were to go against Coale and Hoover was not perhaps entirely surprising in the context of the times. At the household level, the saving impacts they attempt to describe are fundamentally based on a 'life-cycle' conceptualization of behaviour, and such a conceptualisation requires a substantial 'forward looking' planning horizon. The behavioural transition which is required for this to occur also involves a considerable evolution in institutional structure (developed capital markets, reliable pension options etc) in order to make the implementation of such lifetime plans feasible. At the time Coale and Hoover were writing these conditions simply did not exist in the vast majority of the then third world countries. For many families living in an agricultural context spending on children represents an investment in a cheap ongoing stream of willing or unwilling labour (Kramer and Boone etc Edward, and Kaplans comparisons with different levels of skill formation in foraging societies) as well as a form of saving for an uncertain future (e.g., parents may expect transfers from their children in old age - think institutional structures, Lee etc : Edward) and, children, as many studies reveal, can be viewed as a productive asset both in the household and on the farm (Doepke 2004, Doepke and Zilibotti 2005, Kramer and Boone, 2002).
The research climate at the end of the 80s, and the evaluation of Coale and Hoover which this produced is perhaps well summed-up in a single observation from Angus Deaton (1992): "Although there are some studies that find ... demographic effects, the results are typically not robust, and there is no consensus on the direction of the effect on saving."
New-Wave Age Structure Theory
As has been said above, the revival of interest in the Coale-Hoover model which has taken place in recent years has been considerable , and this despite its known limitations (see eg Williamson 2001). In fact it would be no exaggeration to say that a revised form of their dependency hypothesis is now enjoying something of a renaissance. The original Coale-Hoover insight has been developed into a class of explicit economic models that, suitably calibrated, account tolerably well for the cross-country savings variations which are to be found in macro time-series for many developing countries. Almost all the recent analyses of developing countries macro data which have tested explicitly for age structure impacts find the presence of Coale-Hoover effects to a greater or lesser degree (Collins 1991; Harrigan 1996; Higgins 1994, 1998a; Kang 1994; Kelley and Schmidt 1995, 1996; Lee, Mason, and Miller 1997; Masson 1990; Taylor 1995; Taylor and Williamson 1994; Webb and Zia 1990; and Williamson 1993).
This renaissance of the Coale Hoover hypothesis has in large measure been possible due to the work of a fairly limited number of researchers. What might be reasonably be termed the 'new wave' era of age-structure research probably has its begining with an early paper by Mason and Fry (Mason and Fry, 1982). As subsequently elaborated-on by Mason (Mason 1987,Mason 1988), this work develops what Mason and Fry called a 'variable rate-of-growth effect' model which tries to establish a link between youth dependency ratios and national saving rates. The model relies principally on the insight that given the existence of positive labor productivity growth, younger cohorts enjoy the prospect of continually higher permanent incomes and as a consequence higher consumption than their parents did. If at the same time consumption is shifted from child-rearing to the later, non-childrearing stages of the life cycle, aggregate savings rise with a momentum that depends directly on the growth rate of national income. In their work the dependency and lifecyle perspectives are unified through a full blooded incorporation of the effect of changes in the youth dependency ratio on the timing of life-cycle consumption.
A decline in the youth dependency ratio, for example, should cause consumption to be shifted from the childrearing years to later, non-childrearing, stages of the lifecycle. As a result, following the Mason and Fry model, the saving rate depends on the product of the youth dependency ratio and the growth rate of national income ( ie they explicitly incorporate the Tobin 'growth-tilt 'effect), as well as on the dependency ratio itself (the 'composition effect').
This result had an important qualitative implication for the "classic" dependency model: the demographic "center of gravity" for investment demand is located earlier in the age distribution than the centre of gravity for savings supply. In particular, investment demand should be more closely related to the share of young people in a population (through its connection with labor-force growth), while savings supply should be more closely related to share of mature adults (through its connection with retirement preparations). The divergence between these centers of gravity also has the interesting implication that the effects of demographic change on savings and net capital flows will depend on the economy's degree of openness to capital flows (Higgins, 1994, 1998).
Simply put, in an open economy, a population with a heavily child-centred age distribution should exhibit a tendency towards current account deficits: savings are low due to the high youth dependency burden. Later as increasing numbers of young people enter the labour market investment rises in response to higher labour-force growth. Then as the age distribution shifts steadily upwards, the savings supply should increase pushing the current account into surplus (Cutler et al, 1990). Of course all such schematic ideas need to be subject to important qualifications. As Bo Malmberg argues, child dominated societies also tend to be heavily dependent on primary extractive industries, and hence on the price of raw materials, like say energy, or precious metals (Malmberg, 2000). Thus not all 'child rich' societies will experience current account deficits ( a fact which Brad Setser, for example, is only too happy to draw to our attention). Countries like Saudi Arabia, and other oil-rich 'young' states, may demonstrate a capacity for significant and sustained long term current account surpluses. Interestingly, in a global-macro context, these surpluses may be related to high demographic-dividend-driven growth in other parts of the global economy.
It is also important to note that the negative saving impacts found to be associated with increases in the share of the elderly population need not indicate that they themselves are actually drawing down their stocks of assets. The burden of supporting the elderly (either directly or through transfer payments) might lead to lower saving by younger households. Alternatively, prime-age households with elderly parents might save less in anticipation of bequest receipts (Weil, 1994). The age coefficients here are not then simple behavioural parameters which describe the actions of agents belonging to different age groups, but instead attempt to capture the relationship between age distribution and the behaviour of economic agents of all ages.
The Demographic Dividend
Recent use of the expression demographic dividend to describe the positive feedback mechanism associated with the fertility decline component of the demographic transition dates back, as we have seen, to the East Asian growth study of David Bloom and Jeffrey Williamson (Bloom and Williamson 1998). According to their argument as advanced in that study the "demographic dividend" leads to opportunities for growth of output per capita for two principal reasons.
In the first place there is an impact on total GDP due to a "growth accounting effect". A rising share of the total population in the working-age group increases the ratio of 'producers' to 'consumers'. Obviously this situation contributes directly and positively to a growth in output per capita.
Secondly, they conjecture that age-distributions might also be associated with what they call 'behavioral effects' (a growing proportion of prime age workers enhancing overall productivity, for example, and more people in the prime age group means a potentially higher personal savings rate and hence, potentially, lower interest rates) and these behavioural effects in their turn have a favourable influence on the growth of output per capita.
Formally the the accounting effect and the behavioral effect can be broken down in a fairly straightforward fashion between growth in the proportion of the population of working age and growth in the level of productivity per worker, although the former does not always and everywhere imply the latter since in part this depends on the educational and skill level of the new labour market entrants.
Simply stated, then, the demographic dividend occurs when a fall in the birth rate following an initial mortality decline produces changes in the age distribution of a society, and when these changes have the result that fewer investments are required to meet the needs of the youngest age groups. In this way resources are released which may be used for investment in economic development and for improved family welfare. That is, a falling birth rate makes for a smaller population at the young, dependent, ages and implies the presence of a relatively larger share of those in the adult age groups who comprise the productive labor force. It improves the ratio of productive workers to child dependents in the population. This situation generally makes for faster economic growth and fewer burdens on families.
In addition, the decline in fertility which accompanies the transition is also normally accompanied by an increase in female education levels and, concommitently, with an increasing level of female participation in the labour force (Lutz and Scherbov, 2004).
This demographic dividend, however, is not available forever. It operates through a limited time window. As the demographic transition continues its course, the age distribution changes again, and the large adult cohorts move inexorably into the older, less-productive age groups being followed in turn into the more productive ages by the smaller cohorts that were born later in the fertility decline. When this occurs, the dependency ratio rises again, but this time it is a question of growing care and support needs for the elderly, rather than the demands of child rearing and the economic consequences that these demands have.
It should also be stressed that the dividend itself is in no way automatic. While demographic pressures are normally eased when fertility initially falls, some countries will take better advantage of this easing than others. Some countries will act to capitalize on resources released and will use them effectively, while others will not. As, in the course of time, the favourable window once more closes, those that who have not found the way to take ample advantage of the demographic dividend may well face renewed resource pressures at a time when their ability to respond is weaker than ever. The current situation of the Eastern and Central European economies may well furnish one example of a flawed dividend situation, for while many of these economies are now, thanks to their recent incorporation in the European Union, belatedly closing the living standards gap which had opened up, they are also ageing very rapidly (and of course not all these countries by any means are in the EU: the Russian Federation, Belorussia, Ukraine, Moldava, Georgia etc remain outside, and will almost certainly grow old before they grow rich, if that is, they many to avoid that worst of all eventualities - population meltdown - on the way). Other examples of countries with below replacement populations which have yet to achieve economic development would be Cuba, North Korea and Iran. It may well be that in all these cases the earlier failure to capitalise will truly mean that many of these countries will grow but never grow rich, and the fact they missed the dividend boat may well mean they pay a high price for this in the form of a difficult and uncertain future.
The demographic dividend itself works through the combined operation of several interconnected mechanisms.
Labor Supply
As the demographic transition follows its course the generations of children born during the high fertility years enter adult life and become workers. Women who are now having fewer children than before are released from childrearing responsibilities and are able to take jobs outside of the home; also, as the transition moves forward, and years of compulsory education increase, younger women tend to become better educated than those to be found in the older cohorts, and are thus more productive once inside the labor force.
Savings
Mature working-age adults tend to earn more and thus are potentially bigger savers than are new labour market entrants, or those setting up an independent home for the first time. Thus the larger generations who work their way through the labour force as the age pyramid changes favour greater personal and national saving. This ability to save becomes even greater as the 'thick cohorts' move into their 40s, especially as in the first instance the generation-span is smaller, and their own children rapidly become wage-earners themselves and hence soon require less support. Thus personal savings continue to grow and are able to serve as a source of investment funds. Countries steadily move from being heavily dependent on external finance, to a position of relative financial self-sufficiency (the contemporary Chinese example, of course, immediately springs to mind here).
Human Capital
Having fewer children normally enhances the health of both mother and child. Female participation in the labor force, in turn, enhances the social status and personal and financial independence of women. Also fewer children normally means fewer and better educated ones. More investment is allocated to each individual child.
Theory and Modeling
The beginings of a more general awareness among economists of the possibility that such demographically related processes might have more importance for understanding economic growth than had been traditionally attributed to them coincided with the emergence in the 1990s of the empirical 'convergence' growth research. Pioneered by Robert Barro, this work postulates the existence of either a universal, or a country-specific, long-run steady state growth-rate for economies. In the former case economists tended to talk of absolute long run convergence, while in the latter they tended to talk about 'conditional convergence'. Based on this strong initial assumption researchers proceeded in an attempt to identify the factors (economic, political, social, institutional, geographic etc) that determine both the long-run steady state growth rate for individual countries, and, in the shorter-to-intermediate-run, the transition dynamics of each country towards this longer-run state. Conveniently the models lend themselves fairly readily to certain types of demographic testing due to in part to this very differentiation between short- and long-run impacts.
Three approaches have tended to characterise the now extensive literature on economic-demographic modeling: simple correlations, production functions, and convergence patterns (Kelley and Schmidt, 2005).
Simple-correlation studies normally hypothesize that per capita output growth is influenced by a variety of demographic dimensions in the following fashion: Y/Ngr = f(D), where Y is national income, Ngr is the rate of growth in labour supply, and D is normally some kind of proxy for demographic components, like Total Fertility Rates.
Production-function studies are based on estimating variants of a model which takes some variant of the form
Y = g (K, L, H, R, T), where K is capital, L is labour, H is human capital, T is technology etc
Convergence-pattern studies, are rooted in neoclassical growth theory, and explore the relationships between economic growth and the level of economic development. They focus on the pace at which countries move from their current level of labour productivity to their long-run, or steady-state equilibrium level of labour productivity.
One revealing feature of the convergence-pattern models can be clearly illustrated by taking a closer look at some of the variables which have been omitted by those working in the Barro tradition. In the majority of papers authors emphasize variables that determine longrun, or 'potential' labour productivity, and downplay variables that might be instrumental in bringing about the 'adjustment', or transition, to long-run equilibrium. An example of one such omitted variable would be the investment share of GDP.
Indeed investment might be considered to be the first variable one would think to include in a model which focuses on labour productivity since Levine and Renelt (1992) in an influential study surveyed a wide variety of empirical growth research in an attempt to identify a common set of influential variables and found, somewhat unsurprisingly, that investment rates constituted the single most robust variable. Rather than implying that the investment rate is a viable variable in-and-of itself to use in determining long-run capital-to-output ratios and through these long run trend growth potential, the significance of this finding is most probably that it suggests an incomplete set of variables are being tested. If the convergence hypothesis were correct and the list of Barro variables were complete, the investment coefficient should in theory be insignificant (see Bloom, Canning, and Malaney 2001, Higgins and Williamson 1994, and Kelley and Schmidt 1994).
One way of looking at this issue is to start from the proposition that the gap between current and long-run labor force productivity largely dictates the return to investment. According to standard theory investment should flow to those countries which exhibit the highest returns, so, rather than investment accounting for growth per se, it could be argued that the it is the 'structural' features of a country (among which one would evidently incorporate demographic structure) that either impede or facilitate investment, and thus that ultimately determine growth.
Attempts to incorporate demography into convergence models have been few, and in general relatively ad hoc. The demographic variables that normally qualify for inclusion are those that affect long run labour productivity, and those that condition the transition to it.
Barro himself seems to have been aware of the problem of neglecting demographic dynamics and did subsequently attempt to incorporate some element of demography into his use of the standard convergence models (Barro 1991). In a first pass at the problem he and his co-workers concluded that high fertility, strong population growth, and high mortality all exert negative impacts on per capita output growth. In 1994 Kelley and Schmidt extended the list of variables to include population density and size, which in fact revealed positive impacts, although the net assessment for the complete set of demographic variables tested was negative. The density finding is interesting, however, since it raises the question as to whether density itself serves as a proxy for some other 'hidden' variable which is not itself being tested for. This interest is only heightened by the recent finding of Wolfgang Lutz and his co-workers that human fertility declines as population density rises (Lutz et al 2005), and by applying to this the thought that both of these may be a reflection of changing female labour force availability and education levels.
As indicated above, Barro focuses on one single demographic variable, the Total Fertility Rate (Barro, 1997) . This variable captures both the adverse capital-shallowing impact of more rapid population growth, and the resource costs of raising children versus producing other goods and services. By its very nature the TFR exerts its impacts mainly on long-run population trends and on potential long run labour force growth, a focus which tends to understate the short- and mid-term transition dynamics (which may of course last for decades) en route to to the postulated equilibrium state. TFR is, it should always be remembered, a statistical construct that attempts to what population dynamics 'would be' if the current age-specific fertility rates were maintained over a long period of time. Measurement and interpretation issues abound here (Bongaarts and Feeney, 1998, Sobotka et al, 2005).
Rooted in neoclassical growth theory, the framework Barro uses explores the relationships between economic growth and the level of economic development of a country. It focuses on the pace at which countries move from their current output level to what is postulated as their long-run, or potential, or steady-state equilibrium level of output.
So the model from the outset contains a convergence assumption:
In Barro's model the rate of output growth per worker is proportional to the gap between the logs of the long-run, steady-state growth rate and the current one. The greater this gap, the greater are the gaps of physical capital, human capital, and/or technical efficiency from their potential levels. Large gaps allow for 'catching up' through (physical and human) capital accumulation and technology transfer across, and within, countries.
The rate of convergence is assumed to be independent of time and place. By contrast, potential steady-state output per worker is specific to country and time. This potential is, of course, unobservable and is simply a modelling heuristic. Its log is modeled as a linear function of a vector of country- and time-specific characteristics which normally take a form similar to:
ln(Y/Lit)* = a + b Zit.
The actual specification of the determinants of long-run labor productivity (i.e., the selection of of the variables which are included in Z ) varies considerably from one study to another, but the basic framework used is the same across a very large number of empirical studies:
What types of Z variables should be included as determinants of long-run output per worker, we may ask? Recognizing that a long-run, steady-state production function in principle lies behind the postulated steady state growth rate, factors which influence long-run physical and human capital stocks, technology, and natural resource stocks have been considered to be important. Also included among are factors like market structure, access to ports, climate, policies toward trade, education, health, etc.
However, not all countries finance investment with equal ease. Thus, a second category of variables has been added to the Z vector in order to 'condition' the convergence rate. These variables have included country- and time-specific factors which may be thought to either enhance or deter international capital flows, domestic saving, domestic investment, and/or migration. Included among these are, for example, restrictive licensing, the risk of expropriation, political conditions, the rule of law, migration regulations, and so forth.
In a number of works Barro has outlined a list of core economic Z variables (Barro, 1991, 1997). Growth in output per capita is held to be positively related to:
1/ A lower initial level of productivity. Convergence is posited as being more rapid the greater this difference and the the higher initial levels of schooling.
2/ Higher male secondary and tertiary schooling attainment, which facilitates the absorption of new technologies.
3/ Higher life expectancy, which is normally considered to be a proxy for better health and better quality of human capital in general.
4/. Movements in the terms of trade.
5/ Inflation levels, with lower inflation being thought to lead to better forecasting decisions based on more predictable price expectations.
6/ A lower government consumption share - net of education and defense spending - since this in theory releases resources for more productive private investment.
(7) The strength of democratic institutions, since these promote market activity by loosening 'rentier-type' controls, by facilitating more transparency, and generally weakening the hold of corruption. However this demographic component is normally conditioned according to the economic development of the country, since stronger democracies in weakly economically developed countries can dampen growth by exerting pressure for an increasingly active government role in redistributing income, and for higher spending on basic welfare services regardless of the capacity of the economy to support them (Viz, Bolivia at the present time).
7/ A stronger rule of law which stimulates investment by promoting the honouring of contracts, security of property rights, the presence of intellectual property rights etc, etc.
The Harvard School
As has already been intimated, the end of the 1990s saw a veritable boom in econometric testing of the 'demographic hypothesis' which built on the early example of Coale and Hoover. In the forefront of this boom were a number of prominent Harvard economists (among these David Bloom, David Canning, Jeffrey Sachs, and Jeffrey Williamson).
Building on the original Barro setup (albeit with a different choice of core variables), the Harvard researchers focused on the population impacts of the age-structure changes which are normally associated with the demographic transition. Their core model attempts to capture these impacts compactly by linking just two variables: population growth and working-age growth. Such a specification can be readily achieved by “translating” a traditional neoclassical growth model, which is formulated in output per worker terms, into an equivalent model formulated in output-per-capita growth terms. This translation has the virtue that it provides a straightforward way of highlighting some shorter-period “population impacts” within the usual long-run neoclassical framework. Numerous empirical papers by the Harvard economists have found significant demographic impacts, especially in the East Asian case. (more references)
Much of the Harvard work takes as its starting point the alternative methodology for exposing dynamic demographic relationships which was advanced in the original Bloom and Williamson paper (Bloom and Williamson, 1998, B&W hereafter).
In the Bloom and Williamson version of the demographic dividend thesis, as has been explained above, the accounting and behavioral effects of the age transition can be decomposed using fairly straightforward econometric techniques (ones which essentially involve the formulation of an identity function, the taking of natural logarithms of output per capita and the differentiation of the resulting expression with respect to time).
Starting with a definition of output per labour hour, B&W illustrate how the basic Barro model can be transformed into one which describes the growth process in per-capita terms. Now the impacts of working-hour growth and population growth just cancel each other out when they change at the same rate, something which would certainly occur in the hypothetical steady-state growth situation with a static age pyramid. This 'unworldy' assumption (unworldly since outside the rather unique case of the USA this phenomenon is virually unknown empirically) is normally - as has been indicated - imposed by fiat (it certainly cannot be induced empirically) in most standard convergence studies. B&W, on the other hand, take as their starting point the fact that in the developing world the demographic transition only really got started after WWI, and that the 1960s, 1970s, and 1980s continued to be decades of heavy demographic transition in most developing countries. As a result, the 'mutually cancelling' condition did not hold and differential growth rates should, in principal, be observed. This of course is presisely what in practice was found to be the case.
The basic B&W set-up does not model workforce-share and its relation to output growth. Quite the contrary, B&W replace labour force growth with a pure demographic proxy, the growth rate of the working-age population. They thus build their model as if the only determinant on hours worked were the age-distribution of the population, and hence the relative growth of the working-age versus the full population constitutes the sole impact of demography in their model. Following the B&W setup, sometimes the impact of demography will be positive, sometimes negative, and sometimes zero. The model thus highlights the reality that demographic impacts vary during the transition but is silent on the issue of possible demographic impacts on long-run labor productivity; i.e., demography does not affect the Barro convergence variables.
As a result, the BW model has a narrower interpretation than most other renderings in the more recent literature, which often admit both short- and long-run impacts of demographic change as a part of their theoretical structure. On the other hand, it has the desirable attribute of clarity in its interpretation. Thus the postulated relations between population growth and working age growth allow for a clear interpretation of the role of demography in the transition dynamics in that relatively rapid growth of the working-age population will speed the transition to long-run economic prosperity. At the same time two countries with the same convergence variables will ultimately arrive at the same level of labour productivity growth, irrespective of their demography. B&W acknowledge the possibility that the rates of growth of working age and total population might impact long run labour productivity, but at no point do they attempt to model this explicitly. To be continued.
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