Monday, February 13, 2012

Aging, Workers and Deflation

This article is really fascinating, even if it is about Canada.

In actual practice, it is about a global phenomenon - lower population - which is going to transform how the world works, plays and above all, retires, over the next several decades.  The short synopsis is that declining family size is shrinking the pool of workers.  This is going to either a) drive up wages b) drive down consumption, c) encourage labor substitution with increasing automation, or d) a combination of all three.

Output looks set to slow its rate of increase, if not to stagnate altogether.  Output is a product of output per hour worked x number of hours worked.  This second factor is itself a product of hours per worker and number of workers.  Thus, output can be thought of as

Output per hour X hours per worker X workers.  If the number of workers declines, then either hours per worker must increase (Stakhanovite sweatshops, anyone?) or output per hour must increase, or output stagnates (one or both of the first two terms must increase just to prevent a decline!)  Since output per hour (productivity) has been increasing smartly over the past several decades, one might think humanity "in the clear".  In fact, rates of productivity growth have generally been declining (prior to the recession anyway) as more and more work moves to services, which are harder to automate and generally less productive anyway.

The effect of this may be to generate a rather extended and continuous DEFLATION.  If demand declines (older folks don't buy as much) increases in purchasing power will come in the form of productivity enhancements driving down prices, a cycle which encourages deferring consumption in favor of lower prices tomorrow.

Wages, of course, may rise to reflect the need for additional workers, but higher wage demands may only accelerate the use of labor saving capital, as prices of finished goods can still decline, compressing margins (and profits).

With more retirees, social insurance programs will also put pressure on worker's wages, as governments look to raise revenue to meet promises to the most reliable voters.

When looking very long term, indeed, even medium term now, that the question of the "new normal" in terms of growth is the biggest question facing investors.  It is by no means certain that the world will return to anything like the rates of growth it has experienced since the Industrial Revolution.  At the end of industrialization may be only modest growth with limited productivity enhancements that can only be generated through massive education investments - and then only pay off decades down the line.

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