Introduction:
The aging population structure in many developed countries has set the stage
for an enormous increase in the old-age dependency ratio. Looking towards
the future, with this extraordinary demographic shift in mind, it is important
to ask whether or not population aging will drive up labor costs. The cost
of labor is determined by several of factors with countless variables, but
overall trends can be drawn from both theory and empirical sources to answer
this question. For a number of reasons, the aging population of developed
countries will drive labor costs up, but many factors will mitigate this
effect, and the wage rate will not rise much in the long run.
This paper is divided into five sections, the first of which will introduce the population dynamics that are behind the question at hand. The second section discusses factors that will increase labor costs, and is further divided into four subsections relating to the effect of aging on labor force reduction, tax rates, and productivity rates. The third section pertains to those factors that will mitigate the increase in labor costs while the fourth examines potential flaws and ambiguities in the arguments presented. The fifth and final section will briefly discuss policy initiatives and finish with concluding remarks.
Population Dynamics of an Aging Population:
Various factors have combined over the last few decades to give rise to
a population in many developed countries that is on the verge of a major
demographic shift. The rectangular to urn-shaped population pyramid that
most western countries currently face is largely the result of declining
fertility rates (Spiezia, 2002). Overall, the growth of more developed countries
(MDCs) has dropped in recent years from 0.82 to 0.34% (Spiezia, 2002). Coupled
with decreasing mortality rates and increases in life expectancy, these
figures predict a rapidly aging population in the near future, especially
for Japan (Venne, 2001). The total number of young people expected to enter
the labor force is going to decline somewhat while the number of people
older than 65 will increase dramatically; the net result of this situation
will be a more than doubling of the old-age dependency ratio (Spiezia, 2002).
This increasing ratio, as well as issues raised by the increase in age-related
needs such as healthcare and pensions, will be important in determining
why labor costs will rise, and to what extent they will remain high.
Factors That Will Increase Labor Costs:
Labor Force Reduction
In the short run, the retirement of the elderly will create an employment
vacuum that cannot be filled by an influx of new workers that do not exist.
In basic terms, the consequent shift in the labor supply would force companies
to pay a higher wage to maintain the retain number of employees. Firms can
choose to react by paying this higher labor cost, reducing the amount of
employment they require, or some combination of the two. In the short run,
wages will likely increase the most before these additional funds induce
many of the mitigating factors I will discuss later.
Taxes and Social Contributions
Perhaps the biggest threat to long term increase in labor costs comes from
the increasing pension and healthcare costs of retirees. The possibility
that these costs may increase taxation rates has led to the supposition
that a demand for higher wages will result (Venne, 2001). This increase
in the wage demanded will drive labor prices up by shifting the labor supply
of labor curve up in order to maintain the same level of real income (Spiezia,
2002).
Productivity of the Labor Force
The amount of resources that workers can transfer to dependents is dependent
upon the productivity of the labor force (Spiezia, 2002). If the future
workforce is to support the increasing dependent population they must become
more efficient. Spiezia claims "if productivity grows faster than the
dependent ratio, ageing will not have any negative impact on demand for
labour or on employment" (Spiezia, 2002). If, however, the dependency
ratio outpaces productivity growth, then an increase in taxes will likely
be necessary to finance the pension of the elderly. Given the fact that
the dependency ratio is expected to increase from 0.21 to 0.45, it seems
unlikely that increases in productivity will be able to account for the
entirety of the increase in total payments to dependents (Spiezia, 2002).
If one assumes that the elderly will remain in the workforce longer than they normally would, in order to compensate for the lack of newcomers filling the positions they would leave behind, then there are several arguments as to why productivity will fall with population aging. As noted by Spiezia, several authors have proposed reasons why productivity would likely decrease as a result of an aging working force. Flabbi part hereOthers take an opposite view though, and the arguments for this potential increase in productivity will be discussed in the following section.
Factors That Will Mitigate the Increase in Labor Costs:
Effects of Aging on Savings
The life-cycle hypothesis of spending indicates suggests that during the
retirement years, net savings rates decrease because employment-derived
income is no longer offsetting spending or enabling saving. The decrease
in savings that will result from an aging population will stunt capital
accumulation, resulting in diminished output and therefore a decrease in
the labor demanded.