An ageing population is no excuse for low growth despite fears of a labour shortage

The demographic warning is misguided. Land, capital and entrepreneurship can help boost the UK’S output

It is common to hear people say that for advanced societies such as the UK, the heyday of strong economic growth is over. Like it or not, we must come to terms with the fact that growth will continue to slow on trend as an ageing population causes everworsening labour shortages.

We can take little solace in the knowledge that other nations may be suffering more. According to the Office for National Statistics, the UK headcount is likely to keep growing well into the middle of the century, from 67m presently to a peak of around 72m. But even with a still-growing population, employment growth will slow as more people retire and new entrants to the labour market decline.

Fuelled by high net immigration, employment has risen by 9pc over the past decade. But in the decade ahead, employment may only rise by about 3pc. Further out, the negative impact on total employment of ever more grey-haired folk will grow.

Like many headline-grabbing claims, the underlying narrative to the demographic warning contains some truth. However, the hard-line view that demographic challenges put a ceiling on growth is misguided.

Although labour growth matters, there remain three other factors of production that the UK can use to increase its output: land, capital and entrepreneurship. Land is a special case. Of course, the UK is not getting any bigger, but even in England, by far the most populous part of the UK, the vast majority of land is still not built-up. In 2022, about 63pc of England’s area was used for agriculture and about 20pc for forest, open land and water. Only about 9pc was used for transport, residential, industry, commerce and other everyday economic activities. A range of small miscellaneous uses made up the remaining slice. How the UK’S land is and should be used makes for interesting politics, but from an economic perspective, it is a sideshow.

This leaves the two most important factors: capital and entrepreneurship. Taken together, they can lift productivity – which, in the final analysis, is the only real driver of rising living standards. Between 2000 and 2006, productivity measured by output per worker grew by an average of 1.8pc per year. After the global financial crisis (GFC), this rate more than halved to around 0.7pc. Unless productivity gains improve, the sustainable speed at which the UK can grow is no more than 1pc. That would be unprecedented in modern times. It would be well below the 2pc-3pc range the UK enjoyed for the 50 years up to the GFC and about half the rate managed between 2010 and 2019. Is such slow growth driven by ultra-weak productivity gains likely? For two reasons, probably not.

First, an ample supply of cheap labour at home and abroad had kept the cost of labour low relative to capital investment after the GFC.

Second, the rebuilding of balance sheets across the private sector to cleanse pre-gfc excesses weighed on demand and impaired normal risktaking. Cautious businesses opted for the cheaper, lower-risk option of hiring ever more workers to raise productive capacities. This came at the expense of investment and hence productivity suffered. Neither of these factors applies any longer, however. Persistent labour scarcities will keep labour costs relatively high compared with capital investment and the balance sheet repair is complete.

Since the middle of 2020, businesses have dramatically stepped up the pace of investment in response to labour shortages and reduced political uncertainty. As the economic recovery builds into next year, productivity gains should start to pick up. At what rate they will settle once the recent shocks have fully faded is unclear.

Average productivity gains of 1.2pc year on year, which is the average of the pre-gfc and post-gfc periods, may not be a bad guess – but with only modest gains in employment ahead, that would still only put potential growth at around 1.5pc.

Growth of 1.5pc is paltry by historical standards. During the 1980s and the 1990s, productivity growth averaged about 2pc per year. During the post-war boom years, gains of 2.5pc per year were standard.

It is an open question whether the UK may eventually return to more historically normal rates of productivity growth. However, as the sudden return of inflation has proven, recent history is not always a reliable guide to the future. Big productivity leaps do not occur as a result of incremental efficiency gains, but when revolutionary technologies provide businesses with the opportunity to substitute labour for capital.

The period of massive economic progress over the past three centuries has occurred mostly as a result of agriculture, industrial production and construction becoming ever more capital-intensive. This has led to a dramatic improvement in living standards and a mass migration of workers towards more labourintensive economic activities in services. Future improvements in productivity therefore hinge on our ability to substitute labour for capital in parts of the broad services sector. In the past, this has proven difficult.

Unlike mechanistic industry and farming, many services activities require a high degree of human discretion and hence are not easy to automate. But the advent of AI and other advancements in computing and robotics provides a genuine chance to overcome these challenges. So great is the opportunity that people are even growing concerned about the negative impact on jobs.

We now face an odd paradox. On the one hand, severe labour shortages as a result of ageing populations will hurt growth. On the other, the spread of innovations such as artificial intelligence and advanced robotics will apparently trigger widespread technological unemployment. Is this a serious double-problem or just double-think? History tells us it is the latter. One hand can wash the other.

Technology remains the only viable solution to the economic effects of ageing and, so long as policymakers do not try too hard to placate fears of mass unemployment by interfering with the diffusion process, offers real hope of economic growth returning to more desirable rates.