How Population Decline Affects Productivity

Tim Lloyd: Welcome to the Timely Topics podcast from the Saint Louis Fed. I'm your host, Tim Lloyd, and with me today is Juan Sanchez, a senior economic policy adviser at the Federal Reserve Bank of Saint Louis.

Juan, thanks for joining us.

Juan Sanchez: Thanks for having me.

Lloyd: You've got some really interesting research out right now on population decline and how it affects productivity, but, before we get into some of you and your coauthor’s, Hiroshi Inokuma’s, findings, I want to take a step back and start by asking, why is it so important, from an economics perspective, to study this topic?

Sanchez: Well, there are two trends that are important. And our paper, we study them. So, the first one is the growth rate in productivity. It has been shown that productivity growth is the main driver of economic growth over the last 100 or 150 years. So, studying productivity growth, I think is one of the more exciting topics. The second trend is the growth rate in this size of population. For us, that means the size of the labor force, the number of workers in the economy.

In developed countries, during the last 20 or 30 years, the recent slowdown in the growth rate of population. So, there is a concern among developed countries that this may have an impact on productivity, but there is no not a lot of research on that. And in particular, the forecast for the growth of the labor force during the last 50 or 60 years, it shows that the decline will continue in the future.

So, given the importance of productivity and this forecast, we think that is a very exciting topic for research.

Lloyd: You note in the paper that there is a large body of research on how population decline affects dynamism. What does dynamism mean in economics and how is it affected by population decline?

Sanchez: Yes, dynamism means how dynamic is a market. Some statistics that capture this is the entry rate of businesses. How many young businesses are in the economy? What is the growth rate of businesses? How fast they are growing, and also the exit rate of businesses that is connected to the entry rate of businesses. A more dynamic market would mean that there is a higher entry rate, a higher exit rate and businesses grow faster.So that's business dynamism.

What has been observed that in the US, I think since probably 2000, there is a decline in this statistic. There is a decline in business dynamism. So, there were questions about where is this coming from? And this recent paper connects this with population growth? The key there to understand the mechanism is to notice that the growth rate of the number of workers affect the growth rate of the number of firms or the number of businesses.

So, if there are more workers then there will be more businesses. So, when there is a slowdown in population growth, or if the growth of the labor force, we notice that there is a decline in the entry rate of new businesses. As a consequence of that, the share of young businesses in the economy decline since young businesses are more dynamic than older businesses.

Their exit rate is higher. They grow faster than other businesses. This implies that on average, the economy is less dynamic when there is a decline in the labor, the size of the labor force, in the growth rate of labor force. And as a consequence, a decline in entry rate.

Lloyd: You and your coauthor, though, specifically decided to study productivity instead of dynamism. Why did you make that decision?

Sanchez: When we read those papers, we were very excited. We think it's a very interesting, interesting topic. But for us, we were wondering, okay, but what is the effect on the productivity growth? It seemed that something was missing given the importance of productivity growth. We decided to say, okay, let's analyze the impact on productivity growth. Our first result is very connected to this previous result that I mentioned. And our research has to do with the effect in the long run. What we noticed is that when there is a decline in the growth rate of the labor force, and a consequence a decline in the entry rate of businesses in the economy. And as a consequence, then again, a decline in the share of young, younger businesses. What we needed to know is like, what is the contribution of those younger business to productivity growth relative to the overall contribution of other business? Because this driving force will imply that there will be more older businesses in the economy. We show actually that there is a crucial statistic. What we call a sufficient statistic that will tell us how large is effect and in which direction the effect goes from population growth to aggregate productivity growth? That statistic is the growth rate of surviving old businesses. So, we can go to the data, measure that growth rate of surviving old businesses. If the growth rate implies that these businesses are shrinking in size it means that the productivity is growing less than aggregate productivity growth. So, in some sense these businesses are the drag for the economy. So, when there is a large share of them we will see a decline in aggregate productivity. So, that's our first result and it has to do with the long run effect of the growth rate of population growth on the growth rate of productivity .

Lloyd: Is there a difference, when it comes to productivity, in the short term versus the long term. So, when you look at the numbers, do you have one finding for sure short term as it relates to productivity in the context of population decline. And then maybe even a different result for long term effects?

Sanchez: Yes. I find this is one of the most interesting parts of our research. After we characterized it said for the long run, we go to study what we call transitional dynamics. That means what is the effect on impact? What is the effect on 5 or 10 years after the change in the growth rate of the of the labor force?

What we find that on impact the effect actually goes in the opposite day. So we went to try to study. Okay. Why is that happening? In the long run what model is the growth rate of businesses versus younger businesses, in the short run is the level of productivity. So, although younger businesses grow more over time. their level of growth, initially, when they enter the economy, is relatively small. So that's why they are relatively small. So, on impact, when we see a decline in the share of young businesses, that will mean that there are fewer businesses with a low level of growth. And as a consequence aggregate productivity will increase.

So, this is what we call the level effect. that is good for aggregate productivity for a few years. Eventually this effect vanishes and what matters is the growth effect I mentioned earlier and in the long run, the effect is negative.

Lloyd: In the paper, one of the things I found really interesting is that you compare and contrast the U.S. economy and the economy of Japan as it relates to population decline. What did you find?

Sanchez: Yes, my co-author Hiroshi Inokuma is from Japan. So, we thought, okay, let's study these two economies and let's see what difference we would find. Fine. So, the key as I mentioned earlier is this statistic that is the growth rate of surviving old businesses. So, when we went to calibrate our model we got this statistic what we find is that in both countries surviving old businesses shrink over time. But, that that is more important in Japan than in the U.S. That means that in the U.S. older business are relatively more dynamic. Thos is important because then when we do all our exercises, the effect of the growth rate of the labor force is going to be more important for productivity in Japan than in the U.S.

Lloyd:And so why is that? Why did the U.S for, so why is that, why did the U.S firms perform better?

Sanchez: That's something very interesting for me. We don't get there in the paper. I have a few ideas because I have studied this in other papers. I have paper when I study venture capital. And when I study that I noticed that something that exists in the US, for instance, is corporate venture capital. That is a way for all business to acquire young businesses. So that's the way that in which older businesses learn or can adopt productivity from younger businesses, and that will make, older business relatively more dynamic. I think that's a market that works very well in the U.S. We haven't done research about that in Japan, but one conjecture is that that may be behind the differences between the U.S. and Japan.

Lloyd:That's really fascinating. And I want to close out by asking you somewhat of a tricky question, which is, when you look at the numbers is there an ideal mix of young and older firms within the context of population decline?

Sanchez: That's a very interesting question. Our next paper is probably going be over that. As I mentioned, it's important, the the share of young and old businesses in our set up, our model for aggregate productivity growth, so this is a very natural question. And also there are many policies that countries take that would affect that share. So we are looking forward to doing more research on that and I’m sure we talk

Lloyd:We'll have to have you back. Well, Juan, thank you so much. This has been fantastic.

Sanchez: Thank you.

Lloyd: For more from our Timely Topics podcasts and to read Juan’s analysis, visit the Saint Louis Fed's website, stlouisfed.org. You can also stream and subscribe to all of our episodes on Apple Podcasts, Spotify or your favorite podcast app.