Demographics Help Squeeze Labor Supply 

The inflationary pressures now roiling the economy and markets will probably fade once the economy has fully reopened and the pandemic is in remission.

Yet beneath the surface, some of the forces that have long kept inflation in check are starting to turn. Most important: demographics.

The world’s two largest economies have just reported that their population growth in the past decade was the slowest in generations, as people aged and birthrates plunged.

Lower fertility initially boosts the labor supply by enabling more women to enter the workforce. But fertility has been falling for so long in the U.S. and China that those demographic dividends were spent long ago, and now come the consequences: a diminished supply of workers.

The U.S. population grew 7% between 2010 and 2020, according to census results. The age breakdown isn’t yet available, but a smaller sample by the Census Bureau and the Bureau of Labor Statistics shows that the working-age population—those 16 to 64— grew just 3.3%. Because the share of those people working or looking for work has shrunk, the working-age labor force grew only 2%, and actually shrank last year. Some of those missing workers will return when the virus recedes. But many won’t: Baby boomer retirements have soared.

Reversing this move would require either a dramatic increase in births, which has eluded countries with more-family friendly policies, or immigration, which is politically hard.

The demographic squeeze is far more severe in China, which admits almost no immigrants and for years limited families to one child. Tuesday, authorities said the population in China had grown just 5.4% in the past decade. The working-age population— those 15 to 59—shrank 5%, or roughly 45 million people. When worker shortages began emerging over a decade ago, factories began moving to poorer inland provinces and then cheaper countries including Vietnam. In recent years some indicators suggest jobs are getting harder to fill, though the data might not be nationally representative.

Workers produce more than they consume while dependents— children and retirees— consume more than they produce, economists Charles Goodhart and Manoj Pradhan argue in their book, “The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival,” published last year. Over the past three decades, the integration of China and Eastern Europe into the global economy, the entry of baby boomers into the workforce and rising women’s participation effectively doubled the labor supply of advanced economies, putting downward pressure on costs and workers’ bargaining power.

That is now reversing as dependents grow much more quickly than workers, and “dependents are inflationary,” Messrs. Goodhart and Pradhan write.

Aging creates numerous problems for economies. The elderly’s political clout makes it hard to raise the retirement age or trim pensions. President Biden has proposed lowering the Medicare retirement age to 60 and pouring more money into elder care. Such a move enhances quality of life but adds to cost pressures because healthcare is notoriously resistant to labor-saving efficiency.

Workers nearing retirement are in their highest-saving years. As they retire, they draw down those savings. Young adults marry later, leaving fewer years to save. Corporations might have to invest more to compensate for shrinking workforces. All of this will chip away at the “global saving glut” that has held interest rates down, Messrs. Goodhart and Pradhan argue.

Whether inflation accelerates is largely up to central banks. But shifting demographics could change their challenge, from fighting to keep inflation up in the face of deflationary forces, to keeping it down in the midst of inflationary forces.

Of course, numerous other factors are at work. Indeed, the world, in particular Japan, has been aging for a while without any obvious effect on inflation and interest rates. Some studies have found low-wage competition from China did hold down U.S. inflation, but outsourcing had basically peaked by the 2008-09 financial crisis. Even steep tariffs that the U.S. imposed on Chinese imports didn’t raise prices much.

One reason might be that private investment sank in the aftermath of the financial crisis, which was only partially offset by government borrowing. By contrast, investment has remained steady throughout the pandemic, and government borrowing has soared.

China itself doesn’t plan to let aging change its high-saving, high-investment model, notes Andrew Batson of Gavekal Dragonomics, a research service. Yet what matters for the world is whether Chinese saving and investment depress global inflation and interest rates. China is directing more of its investment inward while facing rising barriers to its exports as Western voters sour on globalization and China.

After decades of declining power, “labor has retaliated, not at the wage bargaining table, but in the voting booth,” write Messrs. Goodhart and Pradhan, adding that globalization “has been checked by populism, just at the time that demographic factors are swinging back to labor’s advantage.”