A pensioner argues with an official as he tries to enter a National Bank branch to receive part of his pension in Athens, Greece, July 6, 2015.
A pensioner argues with an official as he tries to enter a National Bank branch to receive part of his pension in Athens, Greece, July 6, 2015.
Christian Hartmann / Reuters

It is well known that Western societies are aging and that the relative paucity of young workers will come with all sorts of budgetary challenges. But the real problem is worse than most people imagine: Grey societies are intrinsically less productive than green ones. What’s now at stake is the economic prosperity of the West and the ability of governments to provide for a growing share of inactive people. 

For years, a productivity slowdown has haunted the advanced economies. In the 1960s and 1970s, the G-7 economies saw, on average, a 4.4 percent increase in output per hour worked every year. Between the fall of the Berlin Wall and the 2008 financial crisis, productivity growth decelerated to 1.8 percent. And now its pace of expansion is a mere 0.4 percent. It might be time to start worrying, as Angel Gurria, head of the Organization for Economic Cooperation and Development, said, “We are now entering a period of poor growth and low job creation.”

Economists have looked to structural and cyclical factors to explain the mystery. Some, such as Federal Reserve Chair Janet Yellen, blame the dearth of private investment. Others, such as Robert Gordon of Northwestern University, point out that current innovations are less transformative than any of the major technologies of the second Industrial Revolution such as electrification, cars, and wireless communications. Still others, such as Erik Brynjolfsson and Andrew McAfee from MIT, argue that standard productivity statistics do not capture changes in the quality of new products and so the productivity slowdown might just be a measurement error. Few, such as James Feyrer of Dartmouth College, look to aging populations. The greying of many developed societies is almost irreversible in the medium term, which makes it the factor that, more than anything else, could permanently drag down productivity. 

Retiree Madeline Barcelo swims at the beach with her granddaughter in Varadero, Cuba, August 26, 2015.
Retiree Madeline Barcelo swims at the beach with her granddaughter in Varadero, Cuba, August 26, 2015.
Alexandre Meneghini / Reuters

Demographic changes are slow to play out. For example, it took more than 60 years for declining fertility and rising longevity in rich countries to push the world average old-age dependency ratio—the ratio of older people to those of working age—from around 20 percent in 1960 to 33 percent today. But once the changes start to become noticeable, they accelerate fast. The United Nations expects the old-age dependency ratio to jump to 47 percent by 2050. It will reach 71 percent in Japan.

The changes in the structure of the population are mirrored in the structure of the workforce. With fewer young workers entering the job market, the base of the pyramid erodes, increasing the relative weight of the age groups at the top. Meanwhile, with retiring workers outnumbering incoming ones, the overall size of the pyramid shrinks. As a result, the workforce grows both small and old. This transformation is especially acute in continental Europe and Japan. In the United States and the United Kingdom, it is mitigated by still decent demographic growth.     

Women look at an electronic board showing the stock prices of Japanese companies in Tokyo, July 3, 2008.
Women look at an electronic board showing the stock prices of Japanese companies in Tokyo, July 3, 2008.
Kim Kyung-Hoon / Reuters
Economists have typically been concerned with the overall decline in size of the labor force because fewer workers imply a smaller GDP, unless a major technological revolution comes along. (To fully compensate for the projected GDP decline caused by a shrinking workforce, the McKinsey Global Institute, for instance, has estimated that productivity growth would have to rise 80 percent faster.) But changes in the shape of the labor force matter just as much as its absolute size. Age affects the productivity of labor and, ultimately, what the economy churns out.

Several studies have shown that productivity increases with age, reaching a peak at 45–50 before declining, especially for problem solving, learning, and speed. It is true that the older members of today’s workforce are more educated than past generations, and better education might support higher productivity. But recent major technological disruptions may cut the other way: they dilute the value of skills acquired long ago.

For decades, advanced countries have addressed the problem of declining productivity through generous retirement policies that removed old, potentially unproductive workers from the labor force. In the eurozone, for instance, thelabor force participation employment rate for people aged 60–64 is around 30 percent (almost 20 percentage points below the rate in the United States) and it drops to less than five percent for people older than 65. But fiscal constraints have made retirement policies tougher. When an economy sharply contracts as during the recent crisis, the resources available to a government to honor its retirement promises shrinks, making retirement less appealing. And so, even though the tougher policies that Italy, Spain, Greece, and Germany adopted in the last few years might relieve public finances and beef up the workforce, they could also keep less productive workers at their desks.

Outside the workplace, older people can drag down productivity as well. Greying societies must allocate an increasing amount of resources, labor included, to care for the elderly. In 1980, old age-related spending—both private and public—absorbed about six percent of French, German, Italian, and Japanese GDP. The figure now stands at 11 percent, and is slated to increase by at least five additional percentage points of GDP over the next three decades. Activities such as nursing and elderly entertainment, for instance, display stagnating productivity. So, if the GDP share of such old-age related services increases, then more and more workers will be stuck in jobs that contribute little to expand the size of the economic pie.

In addition, as countries age, the availability of aggregate savings decreases. People save while working and deplete their savings once retired. As the number of pensioners increases, savings begin to evaporate, which erodes the resources available for investment purposes unless money from abroad pours into the system. This puts pressure on the stock of capital, which along with technology, determines the productivity of workers. In Italy, for example, the gross savings rate dropped from around 30 percent of disposable income in the eighties to around 11 percent today partly as a result of the steep reduction in the ratio of prime savers to elderly. Although the level of investment in Italy has remained unchanged since 2001, the country turned into a net lender to the rest of the world to a net borrower over that period.

Seventy-six-year-old Minekatsu Kinugasa (R) and his seventy-four-year old wife Kiyoko make "imagawayaki' buns with sweet fillings at their shop in central Tokyo's Azabu-juban district, February 8, 2013.
Seventy-six-year-old Minekatsu Kinugasa (R) and his seventy-four-year old wife Kiyoko make "imagawayaki' buns with sweet fillings at their shop in central Tokyo's Azabu-juban district, February 8, 2013.
Issei Kato / Reuters

The relationship between population aging and the productivity slowdown will intensify as aging increases. And slightly diverging demographic pressures might radically remake the economic geography of the advanced world, widening the growth gap between continental Europe and Japan on one side and the United States and the United Kingdom on the other. The most vulnerable countries, such as Italy and Germany, will then be faced with a herculean challenge: using a shrinking pool of increasingly less productive workers to create enough resources for a larger share of inactive people. 

Beefing up the workforce by raising participation rates or boosting productivity through investments in innovation will not be enough. For example, encouraging older people to work might negatively weigh on productivity, and introducing sophisticated technologies that they are ill-equipped to use will hardly increase their efficiency. Rather, policymakers should couple such initiatives with measures aimed at breaking the ties between demographic forces and productivity dynamics.

Addressing age-related human capital differentials should be a top priority. Governments cannot ask people to work longer if they lack the skills necessary to thrive in today’s job market. Life-long learning programs should become more widespread and should be designed in ways that leverage the cognitive abilities of older workers. A few years ago, the United Kingdom launched, with mixed results, the New Deal 50+, the goal of which was to reduce long-term unemployment by providing training to people older than 50. But usually the commitment of Western governments to such kinds of programs is limited both in terms of funding and in terms of cooperation with private companies and trade unions. 

In addition, firms should be offered tax incentives to retain or hire older workers or they should be allowed to let wages decline after a certain age to reflect the deterioration of old workers’ skills. With even the most traditional industries being disrupted by the latest innovations, employers prefer to give jobs to young workers, who have a stronger grip on new technologies, and place little value on the experience acquired throughout a long career. In 2006, for instance, Sweden introduced tax credits for older workers, reducing employers’ contribution for people aged 65 and over. At the same time, firms should approach in a more constructive way the problem of the employability of older workers. BMW, for example, has adopted several organizational measures to transform its aging workforce into an asset, including inexpensive tweaks to make workplaces more comfortable for older employees such as wooden assembly-line floors and easier-to-read computer screens. These changes have contributed to reduced absenteeism and lessened the chance of errors and physical strain.

As a final step, high-income economies should invest more in technologies such as robotics and the Internet of Things to replace workers in low-productivity, old-age related jobs. Japanese Prime Minister Shinzo Abe put such technology at the heart of the Japan Revitalization Strategy, for instance, with the goal of developing care robots and driverless cars for the elderly. These technologies may push many potential nurses into higher productivity jobs outside the elderly care sector. At the same time, governments should forcefully push forward their digital agendas. More digitalized economies requires less physical capital, and so less savings, than old fashioned ones. After all, WhatsApp has greater market value than Sony with next to no capital investment required to achieve it. 

The world ignores the link between productivity and aging at its peril. If the challenge is not met head-on now, over the next 50 years, the West will go through an unprecedented demographic and economic reversal: its population will not only grow small and old, but also significantly poorer. 

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  • EDOARDO CAMPANELLA is a Eurozone economist at UniCredit Bank and a shortlisted author for the 2015 Bracken Bower Prize, awarded by the Financial Times and McKinsey. The views expressed are his own.
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