Falling population will hurt economic recovery

When the going is good, time flows.
“So why are we going to Delhi?” she asked.
“Well just like that. Mumbai gets claustrophobic after a point,” I said.
“Oh, really?”
“Another way to look at it is that we are helping the Indian gross domestic product (GDP).”
“And can you tell me how?”
“Well, the GDP of a country can be expressed using the equation: Y = C + I + G + NX.”
“I don’t remember that,” she said.
“Okay. Y stands for GDP. C stands for consumption at both the individual and business level, I represents investment by private businesses, G stands for government spending and NX is the difference between exports and imports. The total is the value of the total output of a country.”
“But that doesn’t answer my question,” she said.
“When we buy air tickets we spend money. That is an airline’s income. The airline pays its employees and meets other expenditure from the money we spend. The employees in turn can spend that money or save it in a bank, which can lend that money to someone, who in turn can spend that money. And so the cycle continues and all this spending gets captured in the GDP at some level.”
“So when economies go into a recession, the C part — consumption — falls, as there is a lot of uncertainty around. And does this in turn pull down the overall GDP?” she asked confidently.
“Yes. When economies go into a recession, governments boost spending to balance for the fall in consumption. And that is what has happened across many countries in the last two years. And once demand rises, governments can slow their spending spree.” 
“But has that happened?” she interrupted.
“Not really. The US has gradually started to withdraw the fiscal stimulus 1and that is already showing in the GDP growth figures. The US GDP for April-June grew 1.6%, as against 3.7% in the quarter before that. So the slowdown in government spending has started to impact the GDP growth, as consumption hasn’t picked up. Japan is another case, where the economy is trying to come out of a recession for the last 20 years.”
“Why is that happening?”
“Sustained GDP growth happens in two ways. Either the productivity has to rise or the population has to go up.”
“And what does that mean?” she asked.
“Let me simplify. Let us say before the recession struck, a country was producing ten million cars every year. Now it is producing nine million cars. Or lower productivity because of lower demand. Now, flip this argument around. Why are governments spending so much money? So that consumer demand picks up, people start buying things again and GDP growth picks up. But it is not as simple as that. Primarily because the money spent by the government is always less productive and creates lesser jobs than when it is spent by the private sector. As John Mauldin, an investment newsletter writer, states in a recent column, “While a government can invest in industries in ways that are productive, empirical evidence and the preponderance of academic studies suggest that private companies are better at increasing productivity and producing long-term job growth.”
“So where does that lead us?”
“Well, the answer is that maximum jobs are created by start-ups and not big behemoths. As Mauldin writes, “Without start-ups, there would be no net job growth in the US. From 1977 to 2005, existing companies were net job destroyers, losing 1 million net jobs per year. In contrast, new businesses in their first year added an average of 3 million jobs.”
“So all that is needed is to encourage start-ups,” she remarked.
“Ah… but start-ups are a risky business. Nearly half of them are out of business within five years. Also, with the losses that all banks have faced, the last thing they will want to do is to take on more risky lending.”
“Makes sense.”
“But that is a minor point. The major point is population growth. William Gross, who manages money for Pimco, the biggest mutual fund in the world, wrote in  a recent column, “Demographics — or population growth is so long-term in its influence that economists and observers are inclined to explain the functioning of economic society without factoring in the essential part that it plays in growth. Production depends upon people, not only in the actual process, but because of the final demand that justifies its existence. The more the consumers, the more the need for things to be produced.”
“Simplify,” she said.
“Well, let me continue with Gross to explain my point. “Our modern era of capitalism over the past several centuries has never known a period of time in which population declined or grew less than 1% a year. Currently, the world is adding over 77 million people a year at a pace of 1.15% annually, but slowing. Still, that’s 77 million more mouths to feed.” All this consumption adds to the GDP. Things are good when the population is going up at a significant rate as that adds to the GDP. In Japan, however, the population has been falling. In 2010, it estimatedly fell by 0.22%. Same is the case with bigger countries in the West where population growth rate is low and if it is positive, it is because of poor immigrants coming in, who do not have the ability to spend like residents do.”
“So what are you hinting at?”
“Population growth has been slowing from the 1970s. But countries made up for it by running easy money policies, letting their citizens borrow and hence consume more and increasing consumption per capita. Now that has ended. Over and above that, several western economies are rapidly ageing, and older people spend less than younger ones.”
“Can governments do anything about it?”
“Well, nothing that I can think of. Unless of course they force citizens to produce more children,” I said.

(The example is hypothetical)
References: The Last Chapter, John Mauldin, www.safehaven.com
Private Eyes, Bill Gross, www.pimco.com