A young country's slim window of opportunity

India has become the most populous nation in the world, and will overtake China’s population by nearly three million more people by the middle of 2023. Will India’s surging population help or hinder future economic growth? The simple answer is that economic growth is not determined by the size of the population, but by the age structure of the population. India is well-positioned to sustain rapid economic growth, thanks to its large youth bulge in a rapidly ageing world.

Across the world, population ageing is the dominant demographic trend of the twenty-first century — a reflection of increasing longevity, declining fertility and the progression of large cohorts to older ages. An ageing population has already raised alarm bells for future economic growth in Europe, Japan and the US. However, India remains a young country, with the largest youth bulge in the world, its biggest asset.

The country has the potential to benefit from a demographic dividend to become the third-largest national economy. However, a demographic dividend is a time-limited opportunity, and so India will need to introduce a growth agenda tailored to benefit from it.

This gives policymakers a greater incentive to redouble their efforts to benefit from this demographic dividend.

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The link between demographic dividends and economic growth is well-established. China’s fast pace of economic growth in the past corresponds to its increasing ratio of working-age to non-working-age people. A demographic dividend promotes economic growth through several channels.

An expansion in working-age people has the potential to increase savings, as the working age happens to be the prime period for savings. A rise in savings can increase investments that sustain high economic growth. Demographic dividends can also reduce fiscal distress, unlike in Europe and the US, where rising pension liabilities and costs of long-term care associated with an ageing population have generated fiscal stress. However, the benefit of a demographic dividend is not automatic.

Shaping the future

India’s demographic shift provides a narrow window of opportunity to stimulate economic growth and sustain a sizeable middle-class workforce. Nearly one million new workers will join the labour force every month in India for the next two decades. The pace at which India creates new jobs will determine whether its demographic trend turns into a dividend or a disaster.

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How will more jobs be created? There is a strong link between the formation of new enterprises and job growth. Empirical evidence from 600 districts in India has shown that a faster pace of creation of new enterprises is associated with a faster pace of job growth. High rates of entrepreneurship are also linked to subsequent job growth.

Unfortunately, entrepreneurship rates in India remain too low to capture the demographic dividend. Unlike in other countries, where it has matured, India’s entrepreneurship is still evolving. Entrepreneurship has grown rapidly in India’s mega cities, but remains weak in tier-two and tier-three cities. There are also too few women entrepreneurs which has hampered jobs for women.

There are several policy levers that can be used to promote start-ups and entrepreneurial growth. Instead of being preoccupied with firm chasing — attracting large firms from other locations — policymakers should shift their focus to improving physical and human infrastructure and encouraging entrepreneurship within local communities. ‘New’ and ‘small’ are beautiful in job creation.

The two most consistent factors that promote entrepreneurship and job creation are investments in human infrastructure and physical infrastructure. These patterns are true for both manufacturing and services. This relationship is much stronger in India than that found in the US.

Investment in people is an easy call for policymakers. Likewise, local areas must provide adequate electricity, roads, telecom, water and sanitation facilities. Entrepreneurs are especially dependent upon these public goods. Identifying these attributes and acting upon them is essential to accelerate the pace of job creation. More entrepreneurs will not only create more jobs, but also sustain high growth, as this helps allocate resources more efficiently and reduce productivity gaps that currently exist.

Enabling policy environment

The most likely major effect of policy inaction will be that many young working-age people will be unemployed or underemployed. This is already the case, but the situation could easily become much worse than it is now. Large numbers of unemployed workers, especially of relatively young working-age people, can lead to increased internal conflict. In addition, unemployed young people will effectively increase the share of the population that is dependent on workers, slowing economic growth. The economic insecurity of the elderly will increase because there will be fewer productively employed workers to generate the wealth on which both government and families rely to support the elderly.

India is at a point in its demographic transition where a policy environment needs to be created to maximise the chance of capturing the demographic dividend. It is important to recognise that the benefits of demographic dividends do not arise automatically, and the policies chosen can have a large effect on the outcome. The ‘low road’ for achieving high employment, characterised by a focus on expanding low-wage jobs, has not worked in all countries and often led to continued poverty traps. A ‘high road’ approach, characterised by seeking to build up types of employment that reward workers’ skills with higher wages is attractive, but it has also proven difficult for many countries.

As there is no single pathway that works, India needs to explore different options to strengthen the role of labour in growth. As industry and services have come to play considerably larger roles in the economy, the need for an educated workforce has grown. In a wide range of services and industries that do not rely on cutting-edge technologies, having well-educated workers who are easy to train for ever-evolving positions is important to benefit from the demographic transition. The efforts to capture the potential of the demographic transition will need to be supported by appropriate policies, and a stable macroeconomic environment will need to be supported by smart trade policies.

(Ejaz Ghani is a senior fellow at Pune International Centre. He has also worked for the World Bank and taught at Oxford University.)