Is Economic Implosion Inevitable?

The last three centuries have been a period of unprecedented economic growth. The world's GDP doubled in the 18th century, increased six times in the 19th and then shot up 40 times in the 20th. Understandably, the public now considers growth to be the natural state of economy, while periods of recession are viewed as temporary aberrations.

Unfortunately, the recent recession is qualitatively different. Consider the basic economic equation:

Size of economy (GDP) = Individual productivity x Working age population x Employment rate

The economic expansion in recent centuries was due to two factors: a) exponential population growth that followed advances in public sanitation and medical science; b) technological revolutions in industry and agriculture which have drastically increased individual productivity. Occasionally, one-time events, such as a burst of speculative bubble or rising commodity prices, could produce a sudden drop in the employment rate and plunge economy into recession. However, all past recessions were bound to be temporary thanks to the long-term demographic and technological trends.

These trends have now been reversed:

1) Fertility rate fell below replacement level in nearly all developed countries. As a result, the labor force stopped growing, while the dependent elderly population is still increasing. In addition, natural growth is lowest in the most productive social groups and highest among groups that receive public assistance.

2) The past growth in individual productivity was largely driven by mechanization. Machines, which could cheaply perform simple repetitive tasks, have drastically reduced the need for human labor in agriculture and manufacturing sectors. As a result, the labor force is now concentrated in the service sector jobs that cannot be easily replaced by machines. Unlike industry and agriculture, where the output per worker has increased by at least two orders of magnitude, the productivity of hairdressers, teachers, or lawyers has not improved compared to preindustrial society.

Some countries experienced the trend reversals earlier than others. In Japan, fertility fell below replacement level in the 1970s and the economic recession began in 1989. Just like in the U.S., economic problems were initially blamed on speculative bubbles, failures of the banking sector and low consumer demand. Just like in the U.S., the Japanese government responded by making changes in financial regulations and pumping money into the economy. A quarter century later, the Japanese government debt exceeds 200% of GDP and the economy is still in recession.

Politicians regularly talk about "restarting" the economy, by which they mean inducing companies to expand production and hire more employees. Some hope to achieve this by raising taxes and spending, others by doing exactly the opposite. However, whatever the advantages of each strategy, neither can by itself restore long-term growth. Even if unemployment is somehow magically eliminated, a declining labor force and stagnant productivity will continue to drag the economy down.

Restoring long-term growth requires either solving the demographic problem (through immigration, increased birth rate or decreased death rates) or boosting the productivity of the service sector which now employs most of the workforce. Let's examine each of these options:

1) Raising individual productivity

Past growth in individual productivity was largely driven by mechanization of agriculture and industry. Continuing this process in the service sector requires overcoming two major obstacles:

I) Machines vastly outperform humans at simple and repetitive physical tasks. By contrast, many mental tasks that people find elementary remain impossible for machines. Therefore, most jobs in the service sector might not be replaceable without a new revolution in the field of artificial intelligence.

II) In the past, mechanization moved most of the workforce from agriculture to industry and later from industry into the service sector. However, in the current recession, automation of the service sector would eliminate jobs without immediately producing an alternative source of employment. Electoral pressures are then likely to force governments to create a large number of artificial jobs which would offset productivity gains made in the private sector.

2) Immigration.

Singapore, which now has the world lowest fertility rate, demonstrates that economic growth can be sustained by massive influx of foreign workers. However, this solution is economically unfeasible for Western countries where social expenses (minimum wage, social security, medical care etc.) outweigh the economic benefits of predominantly low-skilled immigrants. Importing exclusively high-skilled professionals can be economically sensible, but the potential supply of such immigrants is too small to solve the demographic problem in all the developed countries.

3) Raising birth rates.

So far, there is no proven way to raise birth rates across the whole population. Various non-financial incentives that has been tried (the ancient Romans went as far as to prohibit the use of cosmetics for women with less than three children) failed to make a significant difference. Financial incentives proved effective only in families where child benefits are one of the principal sources of income. For middle-class families, raising children requires a very large financial investment. The incentives that would induce middle-class parents to "fulfill their duty to the party" need to be correspondingly large and therefore politically impossible.

4) Lowering death rates

In the past, remarkable success in reducing mortality rates was achieved thanks to near elimination of malnutrition and infectious disease-related deaths. Achieving further significant progress requires breaking a biological limit on human longevity (i.e., slowing or reversing the aging process).

Based on the above, it appears that there are two ways to restore economic growth. One is through technological revolutions whichat present sound almost like science fiction. Another is through radical social reforms which, in the present political climate, sound even more fantastic. Therefore, it seems most likely that the current trend - stagnant economy kept afloat by government stimulus -- will continue until G7 governments exhaust their credit.

The last three centuries have been a period of unprecedented economic growth. The world's GDP doubled in the 18th century, increased six times in the 19th and then shot up 40 times in the 20th. Understandably, the public now considers growth to be the natural state of economy, while periods of recession are viewed as temporary aberrations.

Unfortunately, the recent recession is qualitatively different. Consider the basic economic equation:

Size of economy (GDP) = Individual productivity x Working age population x Employment rate

The economic expansion in recent centuries was due to two factors: a) exponential population growth that followed advances in public sanitation and medical science; b) technological revolutions in industry and agriculture which have drastically increased individual productivity. Occasionally, one-time events, such as a burst of speculative bubble or rising commodity prices, could produce a sudden drop in the employment rate and plunge economy into recession. However, all past recessions were bound to be temporary thanks to the long-term demographic and technological trends.

These trends have now been reversed:

1) Fertility rate fell below replacement level in nearly all developed countries. As a result, the labor force stopped growing, while the dependent elderly population is still increasing. In addition, natural growth is lowest in the most productive social groups and highest among groups that receive public assistance.

2) The past growth in individual productivity was largely driven by mechanization. Machines, which could cheaply perform simple repetitive tasks, have drastically reduced the need for human labor in agriculture and manufacturing sectors. As a result, the labor force is now concentrated in the service sector jobs that cannot be easily replaced by machines. Unlike industry and agriculture, where the output per worker has increased by at least two orders of magnitude, the productivity of hairdressers, teachers, or lawyers has not improved compared to preindustrial society.

Some countries experienced the trend reversals earlier than others. In Japan, fertility fell below replacement level in the 1970s and the economic recession began in 1989. Just like in the U.S., economic problems were initially blamed on speculative bubbles, failures of the banking sector and low consumer demand. Just like in the U.S., the Japanese government responded by making changes in financial regulations and pumping money into the economy. A quarter century later, the Japanese government debt exceeds 200% of GDP and the economy is still in recession.

Politicians regularly talk about "restarting" the economy, by which they mean inducing companies to expand production and hire more employees. Some hope to achieve this by raising taxes and spending, others by doing exactly the opposite. However, whatever the advantages of each strategy, neither can by itself restore long-term growth. Even if unemployment is somehow magically eliminated, a declining labor force and stagnant productivity will continue to drag the economy down.

Restoring long-term growth requires either solving the demographic problem (through immigration, increased birth rate or decreased death rates) or boosting the productivity of the service sector which now employs most of the workforce. Let's examine each of these options:

1) Raising individual productivity

Past growth in individual productivity was largely driven by mechanization of agriculture and industry. Continuing this process in the service sector requires overcoming two major obstacles:

I) Machines vastly outperform humans at simple and repetitive physical tasks. By contrast, many mental tasks that people find elementary remain impossible for machines. Therefore, most jobs in the service sector might not be replaceable without a new revolution in the field of artificial intelligence.

II) In the past, mechanization moved most of the workforce from agriculture to industry and later from industry into the service sector. However, in the current recession, automation of the service sector would eliminate jobs without immediately producing an alternative source of employment. Electoral pressures are then likely to force governments to create a large number of artificial jobs which would offset productivity gains made in the private sector.

2) Immigration.

Singapore, which now has the world lowest fertility rate, demonstrates that economic growth can be sustained by massive influx of foreign workers. However, this solution is economically unfeasible for Western countries where social expenses (minimum wage, social security, medical care etc.) outweigh the economic benefits of predominantly low-skilled immigrants. Importing exclusively high-skilled professionals can be economically sensible, but the potential supply of such immigrants is too small to solve the demographic problem in all the developed countries.

3) Raising birth rates.

So far, there is no proven way to raise birth rates across the whole population. Various non-financial incentives that has been tried (the ancient Romans went as far as to prohibit the use of cosmetics for women with less than three children) failed to make a significant difference. Financial incentives proved effective only in families where child benefits are one of the principal sources of income. For middle-class families, raising children requires a very large financial investment. The incentives that would induce middle-class parents to "fulfill their duty to the party" need to be correspondingly large and therefore politically impossible.

4) Lowering death rates

In the past, remarkable success in reducing mortality rates was achieved thanks to near elimination of malnutrition and infectious disease-related deaths. Achieving further significant progress requires breaking a biological limit on human longevity (i.e., slowing or reversing the aging process).

Based on the above, it appears that there are two ways to restore economic growth. One is through technological revolutions whichat present sound almost like science fiction. Another is through radical social reforms which, in the present political climate, sound even more fantastic. Therefore, it seems most likely that the current trend - stagnant economy kept afloat by government stimulus -- will continue until G7 governments exhaust their credit.