Emerging economies’ demographic challenge

By Martin Neil Baily and Jaana Remes

Population aging is often cited as a major economic challenge for the developed world. But shifting demographics pose an even greater threat to the growth prospects of many emerging economies, write Martin Neil Baily and Jaana Remes on Project Syndicate.

Population aging is often cited as a major economic challenge for the developed world. But a new report from the McKinsey Global Institute (MGI) shows that shifting demographics pose an even greater threat to the growth prospects of many emerging economies.

Over the last 50 years, the world's 1.6% annual population growth fueled a surging labor force and a rapid increase in GDP in many emerging economies. Employment more than doubled in China and South Africa, and at least tripled in Brazil, India, Indonesia, Mexico, and Nigeria. In Saudi Arabia, employment increased almost nine-fold.

But, with population growth slowing, average annual employment growth in emerging economies is expected to drop from 1.9% to 0.4%. In absolute terms, the decline will exceed that of developed economies, where annual employment growth is expected to fall from 0.9% to 0.1% the coming years. In most economies, employment is expected to reach its peak within the next half-century; in China, the labor force could shrink by 20% over this period.

Of course, there are exceptions to this trend. Indonesia and South Africa are projected to continue to experience rising employment (albeit at slower rates). Nigeria's labor force is expected to triple from 2014 to 2064, and many other economies in Sub-Saharan Africa will experience similar levels of growth.

But, overall, economies' demographic tailwinds will wane, with serious consequences for GDP growth. With no other change in current trends, emerging economies' rates of GDP growth would fall by one-third, from 4.8% to 3.1% annually, by 2064. More problematic, the declining share of the working-age population is set to cause per capita GDP to decline by more than 30% in some countries—most notably, Brazil, Mexico, and Saudi Arabia.

The good news is that emerging economies have at their disposal a powerful means to offset these trends: productivity growth. To be sure, annual productivity growth in emerging economies would need to accelerate by 57%, from 2.8% to 4.4%, to compensate fully for the demographic shift. But, even if that ambitious goal is not achievable everywhere, emerging economies have considerable scope for catch-up productivity growth. After all, over the last 50 years, the productivity gap between emerging and developed economies has barely narrowed; in absolute terms, it has more than doubled.

Indeed, though average productivity growth in emerging economies has accelerated in every decade since the 1970s, this largely reflects rapid productivity growth in just one country: China, where the annual average has been 5.7% since 1964. Elsewhere, the record has been patchy. Mexico and Saudi Arabia improved their productivity by less than 1% per year over this period; Argentina, Brazil, Russia, and South Africa managed productivity growth of 1.2-1.5%.

There is reason to believe that these economies can do much better. With a comprehensive approach, 11 emerging economies (Argentina, Brazil, China, India, Indonesia, Mexico, Nigeria, Russia, Saudi Arabia, South Africa, and Turkey) could, on average, boost their annual productivity growth to as much as 6% by 2025. Four-fifths of that growth would be achieved through the adoption of approaches that have already been successful elsewhere, with new technological, operational, and business innovations covering the rest.

Opportunities to catch up to developed-country productivity levels abound across key sectors. In retail, emerging economies could double their productivity by 2025, largely by adopting modern store formats, such as supermarkets and hypermarkets, which are at least three times more productive than traditional small shops. In Mexico, boosting the share of modern retailers by 10% would yield a 25% increase in the sector's total productivity.

Similarly, if China's huge automotive industry consolidated operations into a smaller number of larger plants operating close to capacity, the sector's productivity—which is well below the developed-country average—could rise by up to 50%. And many countries can improve the efficiency of food value chains considerably, such as by mechanizing agriculture.

There is also enormous scope for productivity-enhancing innovation, particularly in health care, a sector that is just evolving in most emerging countries. Digitization of health records enabled India's Bhorugram Rural Dispensary nearly to double the number of immunizations it provided in just four years. Likewise, it allowed clerks at western Kenya's Mosoriot Rural Health Center to spend two-thirds less time interacting with other staff on administrative tasks, and almost twice as much time registering patients.

In terms of operational innovations, there is the example of India's Aravind Eye Care System, which, by applying principles of industrial engineering to its work flow, has become the world's largest eye-care provider. Aravind can carry out two-thirds the number of operations conducted by the United Kingdom's entire National Health Service at one-sixth the cost—and with a lower infection rate.

Governments can play an important role in promoting such innovation. Brazil's deregulation of agriculture and encouragement of R&D enabled the Brazilian Agriculture Research Corporation to pioneer more than 9,000 technology projects, including the design of a tropical soybean strain that can thrive in Brazil's climate. Efficiency soared, placing Brazil's crop yields on par with those of developed economies.

The era of “easy" GDP growth driven by a massive army of young workers is ending. Emerging economies must face the resulting growth challenge head-on, by pursuing sweeping changes in policies, incentives, and established practices to boost productivity. Recognizing this imperative is the first step. Now the hard work must begin.

This article originally ran in Project Syndicate

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