Quantitative easing and low interest rates may have helped restore economic stability, but they have failed to deliver meaningful growth. A growing number of economists and policymakers are blaming demographics — we are having too few babies and living too long.
Alex Clay, Investment Director, Rathbones
On 18 June 1945 the process of demobilising nearly 4.5 million British servicemen and women began. Nine months later maternity wards around the country started to get much busier.
After a short baby boom immediately following the war, the UK saw a second surge in the 1960s. This peaked in 1964, when the total fertility rate reached 2.93 births per woman.
The resulting increase in the number of young families fuelled consumer demand and generated wealth, which boosted consumption further. Economically, it was a virtuous circle for which policymakers took the credit, as is their wont.
However, in economics, as in Newton’s third law of motion, everything has an equal and opposite reaction. George Magnus, author of The Age of Ageing: demography and its influence on markets and geopolitics, believes what he calls “the fingerprints of demographics” can be seen on many of today’s economic and political challenges. The baby boomers are retiring and the consequences are significant.
The UK’s last census showed that between 2001 and 2011 the number of over-65s passed 10 million. The Office for National Statistics (ONS) has predicted this number will reach 16 million by 2032.
Economists and policymakers trying to explain the failure of quantitative easing and low interest rates to kick-start global growth in the wake of the economic crisis have begun joining the dots.
In October 2016, the Federal Reserve in Washington published Understanding the New Normal: The role of demographics, which concluded that demographic factors alone could have impacted real GDP growth in the US by as much as 1.25% per annum since 1980, primarily through lower growth in the labour supply.
The same month, the Federal Reserve Bank of San Francisco issued What is the new normal for US growth?, arguing that demographic pressures mean the US can now expect growth rates of between 1.5% and 1.75% per annum (“noticeably slower than the typical post-war pace” and far short of President Trump’s 4% target).
In the UK, Andy Haldane, chief economist at the Bank of England, earlier this year acknowledged that demographics in mainstream economics has been underemphasised for too long.
Recognising some of the causes of a problem is important, but being able to do something about them is another matter altogether. The challenges presented by these demographic shifts are daunting.
One issue is lower levels of consumption. Research from the UK’s International Longevity Centre shows that the over-80s spend on average 43% less than households headed by 50-year-olds. The Centre claims its research “busts the myth of a hedonistic retiree population… spending their kids’ inheritance on holidays and leisure”. Many pensioners — often anxious about longevity and unknown care costs — are actually saving. “We calculate total annual savings made by those in retirement in the UK today of around £48.7 billion,” says Ben Franklin, the Centre’s Head of Economics of Ageing. “This equates to 2.8% of GDP.”
With the proportion of the population in retirement rising, this is a serious issue as household expenditure accounts for about 60% of the UK’s economy.
One way to counteract the problem would be to raise the wages of those in work. Some believe wage inflation may occur naturally — as more people retire, there could be a labour shortage and more competition for workers. But there is little evidence of that happening yet. Laura Gardiner, Senior Research and Policy Analyst at the Resolution Foundation, authored a report last year, The Stagnation Generation, looking at the plight of the generation reaching adulthood at the turn of the millennium.
She concluded: “Millennials are at risk of becoming the first ever generation to record lower lifetime earnings than their predecessors — in contrast to the taken-for-granted promise that each generation will do better than the last.”
They were also faced with higher rents, debts and living costs. “A baby boomer at age 30 was 50 per cent more likely to own their own home than a millennial at the same age,” says Gardiner.
Tax revenue and expenditure
Lower lifetime earnings also mean reduced long-term tax revenues. The government’s attempts to balance the books will be made harder by the financial burden of caring for
an ageing population.
While acknowledging that longevity should be a cause for celebration, the Office for Budget Responsibility argues that by 2060 ageing will lead to an increase of up to £80 billion a year in public spending — most of it needed to cover increased health and care costs and state pensions.
One way to keep tax revenues flowing and reduce state pension costs would be to increase the statutory retirement age. That is already happening; the state pension age will reach 66 for women as well as men by October 2020, and further increases are planned.
University College London’s Centre for Research and Analysis of Migration concluded in a 2014 paper that immigrants from the European Economic Area were less likely than UK nationals to receive state benefits. They were also less likely to receive tax credits or to live in social housing. Between 2001 and 2011 they contributed £20 billion in taxes. In the same period recent non-European immigrants contributed £5 billion.
As always, these figures are contested. The anti-immigration sentiment in the Brexit vote suggests this is not an argument that will be accepted or an option that will be readily welcomed.
Britain’s leaving of the European Union may actually reduce the number of skilled and unskilled immigrants arriving on these shores, exacerbating the nation’s demographic challenges.
Part of the answer over the longer term may lie in encouraging people to have more children. The current fertility rate is 1.82 children per woman — significantly below the UK replacement rate of 2.1.
People are waiting longer to start families — the fertility rate is now higher among over-40s than under-20s for the first time since 1947. The ONS points to “increased female participation in higher education and the labour force, the increasing importance of a career, the rising costs of childbearing, labour market uncertainty and housing factors”.
“Rapid ageing is unique in human history,” argues Magnus. “This problem is not specifically about rising life expectancy, but the combination of rising life expectancy and weak or falling fertility. There aren’t going to be enough children growing up to become productive workers to support the expansion of older and retired citizens.
“The economic problem with ageing societies is about the stagnation or decline of the working age population — the part of the population that drives economic growth, productivity, tax revenues and wealth creation.”
And that leads neatly to another concern. Many of those at the centre of the demographics debate worry about the potential for increasing inter-generational tension. A shrinking working population might resent having to take on a greater fiscal burden as older generations fight to defend the wealth and privileges they earned through hard work and sacrifice. For decades politicians have ducked the issue, continuing to make promises they cannot afford.
Magnus argues: “In the West rapidly ageing societies were predicted plainly enough 30 years ago. Now they’ve arrived and present us with an existential threat to the social and economic model we built after World War Two. We are having to redraw the lines separating the entitlement rights and obligations between states and citizens.”
In other words, we face some difficult decisions. Immigration? Pushing back the retirement age more dramatically? Or, transferring wealth from older generations to younger through taxation?
In last year’s Autumn Statement, the Chancellor of the Exchequer, Philip Hammond, made a promise to pensioners that also sounded rather like a threat. He said: “We will meet our pledge to our country’s pensioners through the triple lock. But as we look ahead to the next Parliament, we will need to ensure we tackle the challenges of rising longevity and fiscal sustainability." ...We have all been warned!