After decades of expansion, David Skilling points out the global labour force will contract as demographics turn & frictions on global flows strengthen

By David Skilling*

A regular theme of these notes is the regime change underway in geopolitics, globalisation, and economic policy.  Another regime change is a global demographic transition: the great contraction of the global labour supply.

Global labour markets are tightening structurally, with implications for wages, the income distribution, and business/growth models.  Firms, investors, and policy-makers need to adapt to a new world, very different from the era of low cost, abundant labour supply that has prevailed over much of the past few decades. 

Labour markets are already tight across advanced economies.  Unemployment rates sit close to record lows in the US, the UK, the EU, as well as in Australia, New Zealand, and beyond.  Some of this is due to reduced participation rates after Covid, notably in the UK and the US, as some people withdrew from the labour force, voluntarily or because of sickness.  There were also substantial numbers of excess deaths, although on a smaller scale than in previous pandemics.  And some countries have seen reduced migration inflows.

Higher wages and flexible working arrangements will pull people back into the labour force over time. But a structural change is underway in global labour markets. 

A global labour market

A big driver of disinflationary growth across advanced economies over the past few decades has been growth in the effective global labour supply: strong demographics, the integration of multiple large emerging markets (notably in Asia) into the global labour force, and rising participation rates.  The headline global labour force has grown by >50% since 1990, from 2.3 billion people to ~3.5 billion today. 

But this understates the effective growth rate in the global labour supply; intense globalisation has supported the integration of domestic labour forces into the global economy. As a rough proxy for this, I scale the labour supply for various countries and regions by their export shares.  This gives an approximate sense of the extent to which workers were engaged in global activity.  Between 1990 and 2008 the internationally-engaged global workforce more than doubled: from ~600 million to ~1.4 billion. 

This growth was dominated by China and other East Asian countries, where strong working age population growth was combined with aggressive integration into the global economy: China’s globally engaged workforce increased by 3.6x, from ~95 million to ~340 million.  Asia became the manufacturing powerhouse of the world, with workers moving out of low productivity agriculture into higher productivity manufacturing.

The unit labour costs of this ‘new’ workforce were much lower than in most advanced economies.  Coupled with changes to labour market institutions (such as reduced unionisation), this expansion of global labour supply had big effects on wages and income distribution around the world.  And these dynamics had a substantial political impact across advanced economies: exposure to import competition in the US and elsewhere has been shown to influence voting patterns (particularly in economies that haven’t managed exposure to globalisation well). 

However, growth in the effective global labour force has slowed since the global financial crisis.  The intensity of globalisation (world trade/GDP) has levelled off , although the share of exports from emerging markets has continued to increase.  And demographic growth has slowed in some key economies.

A new (old?) world

Looking forward, global labour force dynamics will change structurally over the next few decades and beyond.  Demographics across many key parts of the global economy are reversing very quickly.  This astonishing demographic reversal is particularly evident in Asia, a region at the centre of globalisation.  The working age populations in China, Japan, and South Korea are projected to halve or more by 2100. 

And by 2050, just over 25 years into the future, China’s working age population is projected to contract by >20%, Japan’s by >25%, and South Korea’s by ~35%. In absolute terms, China’s working age population is forecast to shrink from ~980 million people in 2022 to ~770 million in 2050, a reduction of ~210 million people (about the current combined total populations of Japan, the UK, and the Netherlands!). And these projections use the UN’s ‘medium fertility’ assumption, which are likely to be optimistic: fertility rates are dropping very quickly across Asia. 

Europe is also aging, but at a slower pace: a forecast ~15% contraction in working age population by 2050 and ~30% by 2100. This may be partly offset by stronger migration inflows than in many Asian countries.

Population contractions of this scale are unprecedented, except following war, natural catastrophe, or pandemic.  And the change is happening very quickly, providing less time for adjustment.  These global demographic dynamics will have profound economic, social, and political consequences. Japan’s PM Kishida warned recently that Japan was ‘on the brink of social dysfunction’.

There are other parts of the world where labour supply will continue to grow strongly: parts of South East Asia, India and Bangladesh, as well as Africa.  Some global economic activity will relocate to these areas with positive demographics.

However, the ability to fully relocate export-oriented production to geographies with stronger demographics is constrained in a world of reshoring and nearshoring: firms are organising supply chains closer to end consumers, many of whom are in advanced economies, both to better manage supply chains as well as to respond to political pressures.  The US and the EU (as well as China and others) are setting policy to strengthen their industrial bases in a world of strategic geopolitical competition.

This means that there will be some ongoing bias towards production in countries with labour constraints on production. Even the US, which has the most positive demographics of the large advanced economies, is struggling to secure the labour needed to strengthen its industrial base (semiconductor plants, green energy).  These structurally tight labour markets will continue for both demographic and political reasons.

The productivity imperative

This persistent, material tightness in global labour markets means that firms and countries will need to find ways of raising labour productivity to compensate.

Technologies like automation and AI will provide a partial offset. It is no coincidence that rates of industrial automation are highest in countries that have rapidly aging populations; most notably in East Asia.  South Korea, Singapore, Japan, and China have particularly high rates of automation – and some of this is moving beyond industrial uses into other domains, such as healthcare.  This process is likely to accelerate. And Goldman Sachs analysis out this week estimated that 18% of global work could be automated by AI, with ~15% in China and ~25% in Japan and Singapore.

There are some lessons from small advanced economies in terms of how to mange tight labour markets: combining high levels of capital intensity and innovation with heavy investment in skills and active labour market policy. This supports high employment rates in these economies. 

Migration at scale is another possible response.  If there are constraints on production moving to countries with more labour, then labour may move to economies with excess demand for labour, such as the US and Europe.  Indeed, Japan has become (slightly) more liberal in its approach to migration as it faces a contracting working age population.  However, the challenging politics of migration will mean that this is only a partial solution. And what is likely to be an intense global ‘war for talent’ means that not every country will be able to attract the labour it wants.

Demography as destiny?

The increase in the effective global labour supply that has supported deflationary global growth over the past few decades will weaken and unwind over the coming several decades.  The materiality of these global dynamics will have disruptive effects: on wages and the income distribution, on growth and inflation, and on the ability of countries to compete effectively. It will also shape geopolitical competition, with US demographics much stronger than those in China.

However, some of these effects may be counter-intuitive. For example, the disruptive labour-saving properties of new technologies may advantage some economies with contracting working age populations: they are under less economic and political pressure to structure their growth models to generate substantial numbers of new jobs. Indeed, the traditional jobs generating sectors (export oriented manufacturing) will likely be able to create fewer jobs in the future (‘premature deindustrialisation’), creating challenges for countries in South Asia and Africa with strong forecast demographics.

These are multi-decade dynamics, but demographic effects are already in evidence: wages are increasing, there is increasing demand for automation, and firms are relocating supply chains in response to expected changes in labour availability. Indeed, working age populations are already contracting in China, Japan, and South Korea. 

Countries and firms that can position themselves for this environment will prosper – just as those firms and economies that established growth models that leveraged the globalisation of labour markets did from the 1990s.

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*David Skilling ((@dskilling) is director at economic advisory firm Landfall Strategy Group. The original is here. You can subscribe to receive David Skilling’s notes by email here.