Why Demographics Sway Emerging Markets

Favourable demographics can buoy economic growth

By James McCormack

November 2015

Between 2015 and 2050, the world’s population is projected to grow by one-third, to 9.3 billion people, with emerging market (EM) economies accounting for 99% of the increase. In absolute and percentage terms, the forecast growth is lower than the period from 1950 to 2015, when population jumped from 2.5 billion to 7.3 billion people, but the concentration in EMs (91% in 1950–2015) is greater. Over the last several decades, a number of EM economies have benefitted from favourable demographic conditions, growing quickly and reducing poverty. The decades ahead offer similar opportunities for another set of EMs.

The Economics of Demographics

This leads to the question: “Why are favourable demographics a critical ingredient in the pursuit of stronger economic growth?” If productively employed, a growing labour force contributes to the accumulation of wealth that should, in turn, lead to higher investment. Ideally, a virtuous cycle takes hold, in which the stocks of capital and labour expand while productivity improves, all leading to higher GDP growth.

There are several phases through which countries pass with respect to the relationship between demographics and potential income growth. An oversimplified multi-decade timeline might run as follows. Prior to urbanisation, low-income EM countries that are largely based on agriculture tend to have relatively high fertility and mortality rates. As large numbers of young people eventually reach working age, urbanisation increases along with industrialisation and incomes. This positive phase is typically associated with lower fertility rates, leading to the labour force growing quickly relative to younger dependents, allowing for faster economic growth and a greater accumulation of wealth. Mortality rates fall as incomes rise, meaning that as the population ages and begins to retire, the number of older dependents ultimately grows relative to the labour force. Over time the country’s dependency ratio (people of nonworking age relative to those of working age) increases, leading to a greater share of income being devoted to care of the elderly, and lower economic growth. Weaker growth and the increased dependency ratio then reinforce the trend of lower fertility rates, pushing GDP growth prospects even lower.

Chart 1: Dependency Ratios by Region

The Department of Economic and Social Affairs of the United Nations defines the “demographic window” most favourable for economic growth as the period when the share of the population younger than 15 years drops below 30%, and the share of the population older than 64 years remains below 15%. While in the demographic window, which typically lasts 30–40 years, the potential labour force is — by definition — at least 55% of the total population.

East Asia and Eastern Europe: Similar Demographics, Not So Similar Growth

The two EM regions that have largely gone through their respective demographic windows are East Asia (including Japan) and Central and Eastern Europe (CEE). In East Asia, the window spans 1985 to 2020, while in CEE it was from 1950 to 2015.

The modern history of economic success in Asia — characterised by sustained high GDP growth — is well known. The largest economies of China, Japan and Korea all had periods when the 20-year trailing average GDP growth rate was about 10 %. In the 1950s and 1960s, it was Japan that grew most quickly. Korea grew fastest in the 1970s and 1980s, and China took over in the 1990s and 2000s. The periods when countries led the region in growth correspond with their respective demographic windows, and falling dependency ratios.

Eastern European economic growth numbers have been impressive when countries were in their demographic windows, but not as strong as those in Asia. Czech Republic (and Czechoslovakia), Poland and Romania are the region’s largest economies for which comparable historical data are available. Their demographic windows typically started before those in Asia and lasted longer. Growth rates peaked closer to 7% in the 1950s in the Czech Republic, the 1960s in Romania and the 1970s in Poland.

There are at least three reasons why Asian economic growth rates were higher than those of Eastern Europe when countries went through their demographic windows. First, GDP per capita (on a purchasing power parity basis) was higher to start in Eastern Europe, so the demographics-induced surge in growth may have been less pronounced. Second, dependency ratios did not decline as much or as quickly in Eastern Europe (see chart 2), meaning the boost to growth from the increase in the relative size of the labour force was less dramatic. Third, the economic policy mix in Asia was much more successful, with state-led industrialisation initiatives creating globally competitive, labour-intensive manufacturing enterprises. Supported by high domestic savings rates that financed the needed investment, this model was critically important in effectively absorbing new entrants in the labour force into high value-added sectors that lifted overall growth.

Chart 2: Dependency Ratios: East Asia and Eastern Europe

The Next Demographic Frontiers

The most populous countries in Latin America (Brazil, Mexico, Colombia and Argentina) are mid-way through their demographic windows, with the exception of Mexico, where the window opened in 2010. Compared with Asia’s experience, economic growth rates in Latin America have been markedly lower. Labour force participation rates in the two regions are broadly similar, but the manufacturing share of GDP in Latin America’s biggest economies is still consistently less than 20 %, compared to 30% or more in China and Korea.

This is a lesson that Indian policymakers appear to have drawn in introducing the “Make in India” campaign last year to support the development of manufacturing as the country enters its demographic window (2015 to 2050). India’s working-age population will be larger than China’s by 2025, and will continue to expand until 2050. If the very large addition to India’s labour force is productively employed, economic growth could easily accelerate beyond current — already impressive — rates.

Twenty-three of the 25 youngest countries are in Africa, where the median age is 19 years, 10 years below the world median and 20 years below the developed-country median. Of the four most populous countries (Nigeria, Ethiopia, Egypt and the Democratic Republic of the Congo, (DRC)), none will enter its demographic window before 2030. Nigeria and the DRC enter their windows in 2070, thus extending the potential economic benefits into the next century. It would appear that educations should be a policy priority in the meantime to ensure the burgeoning labour force is as well-equipped as possible when the demographics are most favourable for growth.