The Link between Falling Population and Productivity

Juan Sánchez, senior economic policy advisor at the Federal Reserve Bank of St. Louis, discusses his research on how population decline affects productivity.

Productivity growth has been the main driver of economic growth for more than a century. How might a slowdown in population growth—or more specifically, the size of the labor force—impact productivity?

In a May 2024 Timely Topics Podcast episode, St. Louis Fed Senior Economic Policy Advisor Juan Sánchez discussed his recent research on population decline among developed countries and how it may affect productivity and economic growth—in the short and long run.

During the episode, Sánchez described how he and working paper co-author Hiroshi Inokuma found that when the growth rate of the labor force declines, the share of newer or younger businesses also declines. The authors studied the contribution of younger businesses to the economy relative to other (older) businesses. The implication being that with a decline in labor force growth, there will be more older businesses in the economy.

“If the growth rate implies that these [older] businesses are shrinking in size, it means that the productivity is growing less than aggregate productivity growth,” Sánchez said. “So, in some sense, these businesses are a drag for the economy. When there is a large share of them, we will see a decline in aggregate productivity growth.”

The authors also found that having fewer new businesses has a different effect on productivity in the short term than it does in the long run.

“Although younger businesses grow more over time, their level of productivity initially when they enter the economy is relatively small,” Sánchez said. “So, on impact, when we see a decline in the share of young businesses, that will mean there are fewer businesses with a low level of productivity. And as a consequence, aggregate productivity will increase.”

This is what Sánchez and Inokuma call “the level effect.”

Sánchez explained how that effect is good for aggregate productivity for a few years. Eventually, this effect disappears and what matters is the long-run effect, which is negative, he noted.

Sánchez added that he and Inokuma, who is from Japan, compared the U.S. economy with the Japanese economy in terms of population decline. Using their model, they found both countries’ surviving older businesses shrink over time, though this was more important for Japan. “That means that in the U.S., older businesses are relatively more dynamic,” Sánchez said.

He suggested the existence of corporate venture capital in the U.S. may be a reason: “That is a way for older businesses to acquire young businesses. That’s the way in which older businesses learn or can adopt productivity from younger businesses.”

During the episode, Sánchez also fielded the question of whether there’s an ideal mix of young and older firms within the context of population decline.

For more of Sánchez’s insights on this topic, listen to the episode.

A transcript of the podcast episode is available at How Population Decline Affects Productivity.