The demographic dividend

Tucked away on the last page of the latest Economist was a table on Old Age Dependency Ratios that caught my eye. I had been hearing about the “demographic dividend" and had never really understood it till I saw this little table.

This table showed the number of elderly people (65 and over) as a share of those of working age (15-64 years)- or the old age dependency ratio- in a country in 2010 and projected in 2050. “Continued increases in longevity” according to this European Commission report, “will ensure that the number of elderly people as a share of those of working age will rise sharply in most countries over the next forty years. The biggest absolute increase will be in Japan, where the ratios of 35.1% in 2010, already the world’s highest, will more than double, to 73.8% by 2050. At that point, the number of pensioners in China will be equivalent to 38.8% of its labor force, up from 11.6% in 2010.” In the same period, however, in India the number of old age pensioners will only be 21% up from about 9% in 2010.

How do these changes really affect anything?

The basic idea of a demographic dividend is straightforward enough. In the year 2004 India had a population of 1,080 million, of whom 672 million people were in the age-group 15 to 64 years which is called the "working age population". Since outside of this age group very few people work, it is reasonable to think of the remainder, that is, 408 million people, as the "dependent population". A nation's "age dependency ratio" is the ratio of the dependent population to the working-age population. In the case of India this turns out to be 0.6 or that there are 60 dependants for every 100 working age people. On the dependency ratios India does not look too different from many other developing countries. Bangladesh's dependency ratio is 0.7, Pakistan's 0.8, Brazil's 0.5.

What is different about India is the prediction that it will see a sharp decline in this ratio over the next 30 years or so. This is what constitutes the demographic dividend for India.

India's fertility rate - that is, the average number of children a woman expects to have in her life time - used to be 3.8 in 1990. This has fallen to 2.9 and is expected to fall further. Since women had high fertility earlier we now have a sizable number of people in the age-group 0-15 years. But since fertility is falling, some 10 or 15 years down the road, this bulge of young people would have moved into the working-age category. And, since, at that time, the relative number of children will be small (thanks to the lowered fertility), India's dependency ratio would be lower. It is expected that, in 2020, the average age of an Indian will be 29 years, compared to 37 for China and 48 for Japan; and, by 2030, India's dependency ratio should be just over 0.4.

This can potentially confer many benefits.

First is the direct benefit of there being a rise in the relative number of bread-winners. Moreover, with fewer children being born, more women can now join the work force; so this can give a further fillip to the bread-winner ratio.

A more indirect but vital benefit for the economy is the effect this can have on savings. Human beings save most during the working years of their lives. When they are children, they clearly consume more than they earn, and the situation is the same during old age. Hence, a decline in the nation's dependency ratio is usually associated with a rise in the average savings rate. India's savings rate as a percentage of GDP has been rising since 2003. It now stands at 33% which is comparable to the Asian super-performers, all of whom save at above 30%, with China saving at an astonishing near 40% rate. This savings growth is driven by improvements in the government's fiscal health and a sharp rise in corporate savings. But even if these factors disappear, the decline in the dependency ratio should enable India to hold its savings and investment rate above the 30% mark for the next 25 years.

Another factor is the number of dependents that the working people need to support in a country. The World Bank computes a metric called the “age dependency ratio” which is the ratio of dependents--people younger than 15 or older than 64--to the working-age population--those of age 15-64. For example, 0.7 means there are 70 dependents for every 100 working-age people. According to the Bank’s projection, in India in 2010, there will be 55 dependents/100 working age people but by 2050, the ratio will move to 49 ie the relative number of dependents will decrease. Compare this with say Japan where the figures in 2010 were the same as in India, 55, but by 2050 they are projected to rise to 91 dependents for every 100 working age people. Thus in Japan, the savings of a 100 working age people will need to provide for 91 dependents while in India they will need to provide for only about half of that number.

This theory of demographic advantage has been challenged by some as just that - theory. One way of evaluating this in reality is to look at the actual experience of other nations. The most striking example of economic growth being spurred by demography is the case of Ireland. Ireland's legalization of contraception in 1979 caused a decline in the birth rate, from 22 (per 1000 population) in 1980 to 13 in 1994. This caused a rapid decline in the dependency ratio. The phenomenal economic boom in Ireland thereafter, earning it the sobriquet "Celtic Tiger", is very likely founded in this fertility decline. As David Bloom explains “ in Ireland the ratio of workers to dependents improved due to lower fertility but was raised further by increased female labor market participation and a reversal from outward migration of working age population to a net inflow. Africa, on the other hand continues to have high fertility and youth dependency rates, which contribute to its economic stagnation”. “The magnitude of the demographic dividend appears to be dependent on the ability of the economy to absorb and productively employ the extra workers” he warns, “rather than be a pure demographic gift”. One has seen a similar sequence of changes in demographics and the economy in Japan in the 1950s and China in the 1980s.

But even if this happened in some places, will it happen in India? Will India get benefit from higher savings and investment rates will this continue to fire India's high growth rate? Will India be able to develop the primary and secondary education so as to make sure that the larger working-age population conferred by the demographic dividend is an educated lot? And will the manufacturing sector which is needed to create job opportunities for the larger labor force be able to absorb these skilled laborers?

What is important to remember is that the demographic dividend is a population bulge in the working-age category. Like a pig in a python's stomach it will eventually move up, causing a rise in the old-age dependency ratio some three to four decades from now. The doubling of the old age dependency ratio from 9 % to 20 % in 2050 is thus the obverse of the dependency ratio. That is, every demographic dividend comes with an accompanying "demographic echo".

It is in the nation's interest to reap as much as possible from the dividend so that it is robust enough and not stymied later by the echo.