The world’s three biggest economies are all facing a huge problem. We can see it looming over the horizon, but it’s hard to fully calculate the impact.
We know the United States, China and Japan are confronting population challenges. In Japan, the population has been shrinking since 2010 and China experienced its first population drop in 60 years in 2022. In the U.S., population growth is projected to level off over the coming years. How can we start to understand the economic and market implications of this massive shift?
The dependency ratio is the comparison of a working-aged population to the young and elderly among them. This metric is predictive of the shape of the global workforce, measuring which countries are poised to grow economically on the world stage and which ones may suffer economically if actions are not taken to adapt to an aging population and lower birth rates.
This is important because, despite increased automation, the number-one driver of economic output is labor. An aging population with low fertility rates means the workforce of a population will decline as retirees stop working and there are not enough young people around to replace them.
The top three countries by GDP (gross domestic profit) are the U.S., China and Japan. All three are wrestling with an aging population and low birth rates, meaning fewer people will be entering the workforce and more will be leaving it via retirement or health reasons for at least the next 25 years.
Demographics are destiny
The dependency ratio is rising in the three largest economies by GDP.
The dependency ratio is calculated by defining which ages make up the working population and comparing this total with the remaining population (youth and elderly) who do not work. It’s used to determine the demographic dividend — the economic growth potential of a population. The lower the ratio (i.e. 50 dependents for every 100 workers vs. 95 dependents for every 100 workers) the fewer non-workers a country needs to support.
This metric can be used to inform public policy decisions. So can the principles related to it, like who can work and how much a working population can support a country’s dependents through taxes and reallocation of its national budget.
Twenty five years ago, in 1998, the dependency ratio of the U.S., based on United Nations definitions, was 0.55, or 55 dependents for every 100 workers. The ratio continued to fall to as low as 52 dependents per 100 workers in 2011. As baby boomers began to retire more rapidly, however, the ratio began rising and it’s projected to keep climbing for the next decade until retirements slow down and the population continues to age. In 2048, 25 years in the future, the U.S. dependency ratio is projected to hit 67 dependents for every 100 workers.
A similar but more dramatic reversal has happened in China. From 1998 to 2011, China’s dependency ratio fell from 52 dependents for every 100 workers to 40 dependents per 100 workers. But the low birth rate from China’s one-child policy, which ended in 2015, now means there are currently fewer people entering the workforce to replace retirees. In 2048, the dependency ratio in China is expected to reach 70 dependents for every 100 workers.
Japan’s demographic challenge, of course, is on a whole other level. Its dependency ratio began its trip upward in 1993 from 46 dependents for 100 workers to 73 dependents per 100 workers in 2023. The life expectancy in Japan is the highest of any country and the fertility rate is 1.3 births for every woman, according to the World Bank. These factors will push the dependency ratio as high as 96 dependents for every 100 workers 25 years from now, an almost 1-to-1 split between its working age and dependents.
Read: Retiring in Japan: Seniors greatly outnumber younger workers — and that’s a big problem for everyone
The dependency ratio is not only an important factor for Wall Street and investors. It’s an important tool that can help direct all sorts of public policy decisions impacting an economy.
On a global scale, the indicator is used to mark where a country is in terms of its demographic transition, or changes in its age structure. One important stage of transition occurs when fertility rates decrease and the working-aged population grows. Two Harvard economists, David E. Bloom and David Canning, coined the potential economic growth resulting from this period of transition as the “demographic dividend.”
Qingfing Li is a statistician at Johns Hopkins University who develops models to present to decision makers of countries in sub-Saharan Africa and southeast Asia. Many countries in these two regions are entering their demographic-dividend stage and can grow economically if certain policy changes are made. A paper co-authored by Li outlines these areas of policy-specific change, like improving the quality of education, promoting a culture of savings through policy and improving healthcare.
Li talked to MarketWatch specifically about his work in Uganda, focusing on a model that measures the impact of a publicly funded healthcare program. Right now, most healthcare costs in Uganda are paid out of pocket, but having a social insurance program could improve the health of the population based on evidence from other countries. His model can help policy makers better understand the ins-and-outs of what a social policy program could look like.
“The country is actually making a cost effective investment if they invest in policies and education to capitalize on the demographic dividend, ” Li emphasized.
On a national level in the United States, the relationship between labor and dependents impacts the composition of the federal budget, specifically when it comes to spending on Social Security.
The Congressional Budget Office released its latest outlook for Social Security spending and revenue in December. It showed that the rapid increase in retirees from the baby-boom generation in the next decade, coupled with an increase in life expectancy as the century rolls on, will result in spending for the program exceeding revenue set at the current percentage of GDP.
According to Louise Sheiner, an economist fellow at the Brookings Institute think tank who researches the effect policy changes have on Social Security, there will be a rapid rise in the dependency ratio that comes from the retirement of the baby boom generation. It will level off as people live longer, Sheiner added. As a result, a key policy issue stemming from this change in the dependency ratio will be whether or not to raise the retirement age from 65 to 70.
Read: Opinion: We should fight inflation by adopting supply-side labor reforms that would encourage work
But Sheiner warns there are limits in using the metric for these types of decisions. While wealthier people are living longer, those at the bottom of the income distribution are not. Sheiner said it’s important to take such facts into account when making decisions that may take away benefits from those who need it.
“The increase in life expectancy that we’ve seen has been really uneven,” Sheiner said. “People at the top of the income distribution have seen large increases in life expectancy, but people at the bottom have not.”
Another solution for a declining workforce is to change U.S. immigration policy, as U.C. Davis economist Giovanni Peri points out.
While Peri can’t say what the results of a specific policy would be, his research shows the effects of doing nothing. He mentions Japan and China as two countries where productivity has dropped and no new immigration policy has been introduced to stem the tide.
Read: The solution to construction’s labor shortage? Women and immigrants, says Harvard researcher
He noted that the most likely immigration-policy response in the U.S. would be to expand the H1-B visa program, which would allow immigrants who have a college degree to enter the workforce without making them citizens. Amid the current political climate, Peri thinks it’s extremely unlikely that the U.S. will implement a policy change that would see more lower-educated immigrants allowed into the country.
“I don’t think immigrants will come in to fill those jobs. Not because we wouldn’t need them, not because there is not demand, not because this would not be economically efficient, but because the policy does not exist,” Peri said.
Read also: Is it time to take another look at legal immigration?
A Competitive Disadvantage
The U.S., China and Japan are seeing their dependency ratios soar, lowering their dependency-ratio ranking among the world’s countries.