Since the Industrial Revolution, human society has undergone tremendous economic and social change. Economically, average per capita income grew more than 10 times, and people in developed countries are 100 times wealthier than they were 200 years ago. Historically, innovation has always been the driving force for economic development, but it is only recently that technology companies have become the main engine of wealth generation. In 2011, Apple overtook Exxon, an oil producer, to become the most valuable company in the world. In 2015, five of the top 10 most valuable companies were technology companies founded in the last 40 years. The Chinese Internet giant Alibaba.com is now the most valuable company in China, with over US$250 billion in market capitalization, and is ranked only after the big five U.S. technology companies.

Equally dramatic has been the rise of China over the last 40 years. China has transformed from a backward country to the second largest economy and the largest exporter in the world. Much more significantly, China is catching up as a hotbed of innovation, even more quickly than its near miraculous emergence as a dominant exporter a few decades ago. China's overall spending on research and development is growing at 15% a year (Figure I.1). This is much faster than its GDP growth. China already spends more on research and development than all the European countries combined, and will outspend the United States by 2020 on a purchasing power parity (PPP) basis. Wealthy, developed nations such as the United States, Japan, as well as many of the European countries are naturally concerned whether they can continue to reign supreme in the race of innovation that is set to shape the twenty-first century. These established players are all striving to uncover what the best strategies for competing with emerging innovation powerhouses like China and India are. For technology companies, the key success factor is human resources; analogously, it is the view of this book that demographics, more than any other factor, is the ultimate determinant of success in innovation. This view has huge policy implications in areas such as education, immigration, as well as social policies such as, for example, support offered to growing families.

The largest social change of the last 100 years is in demographics. First, people today live longer lives. In the last 200 years, life expectancy in developed countries has doubled from 40 to 80 years and is still increasing. A more recent and abrupt social change is the dramatic reduction in family size over the last 50-year period. The world's average fertility rate has dropped from 4.9 in the 1950s to around 2.5 in the 2010s.

As shown in Figure I.2, fertility rates dropped not just in high-income countries, but also in middle-income and low-income countries. The replacement total fertility rate, defined as the fertility rate required in order for each generation to remain the same size, is 2.1 children per woman (this figure is slightly more than 2, because a small fraction of children die before adulthood). For the first time in human history, the fertility rates in most developed countries as well as in East Asia have fallen below the replacement level. The fertility rates in many developing countries have also been declining rapidly, although they are still above the replacement level. Fertility rates have remained high only in some of the poorest countries, particularly in Africa. Despite the fact that people are living longer, the world's population growth rate has dropped sharply from 1.92% (1960–1965) to 1.18% (2010–2015).

The first country to experience this dramatic social change was Japan. The fertility rate in Japan has been below the replacement level for the last 40 years, and currently is only around 1.4. In 2005, Japan became the first country in the modern era to experience natural negative population growth. In Europe, the total fertility rate is about 1.6, slightly higher than in Japan. In China, the fertility rate dropped below the replacement level in the 1990s and is now only 1.4. Over the next 20 years, China will experience negative population growth and a rapidly aging population. It is estimated that in 10 years' time, India will replace China as the world's largest country in terms of population, but India's fertility rate is also decreasing. The country's total fertility rate has dropped from 5.49 in 1970 to 2.48 in 2013. In some cities in India, such as Delhi, the fertility rate has already fallen below the replacement level. Overall, therefore, the world's population will continue to age rapidly, and many countries will experience negative population growth in the near future. This is a new problem confronting the world, and will have profound implications economically, but particularly in the race of innovation, which is the subject of this book.

This reversal of population growth is unexpected. Two hundred years ago, Thomas Robert Malthus published his influential book An Essay on the Principle of Population (Malthus, 1798), in which he argued that productivity improvements always lead to an exponential growth in population size, simply because people have more children when they have more food available to them. A period of plenty results in unchecked growth, and the resulting overpopulation will wipe out the productivity gain by way of famine, war, and other manmade disasters. The net result is that productivity improvement will only lead to growth in population but not in per capita income. Malthus' ideas have very stubbornly retained currency, perhaps because examples of population fluctuation have been so well documented in the natural world. In 1972, for example, a report entitled The Limits to Growth by the Club of Rome predicted that a population explosion would lead to energy depletion and resource exhaustion in the subsequent decades.

These predictions have all been proven wrong. Over the last 200 years, both human productivity and population growth have increased. At the same time, natural resources have not run out, as alternative resources and energy sources have been developed. In fact, the price of natural resources has remained relatively stable, and the value of natural resources relative to other assets has declined rapidly. In addition, most developed countries, following the initial stage of swift industrial development, have solved or made significant steps in solving the problems of environmental pollution—once thought to be another potentially disastrous outcome of industrial growth.

Surprisingly, human society has encountered a situation that seems to be completely opposite to what Malthusian economists predicted. In recent decades, as a result of increased urbanization, industrialization, and resulting affluence, people have started to have fewer children. This new demographic scenario has created a different set of social problems, such as labor shortages, aging populations, and a decline of economic dynamism.

There are, of course, many reasons why people choose to have fewer children. The main ones seem to be: a significant increase in the level of women's education, as well as their labor participation; the rising cost of raising children; the reduction in the need for children to directly support their parents in old age; and a modern lifestyle that focuses on individual fulfillment, which itself often competes with the time and effort required to raise children. These topics will be elaborated on in Chapter 1.

How will this unprecedented demographic development affect the global economy (or economies) and society as a whole? Research on the impact of depopulation and aging is very limited, partly because this is a very new phenomenon. The mainstream economic view is that aging is mostly a public finance problem, as the aging population will impose a heavy burden on the public pension system. First, in an aging society, there will be more retirees relative to the working population and expenditure on old age support per worker will increase. The increased expenditure will have to be financed by higher taxes on the current workforce, or simply by postponing retirement. Moreover, consumption among the elderly is different from that of younger people. Older people spend less on houses and cars, but more on medical services and travel. Consequently, a change in the overall industry and economic structure is inevitable. Finally, because an older population has lower income levels, but a higher consumption rate (i.e. a net negative savings rate), capital markets are significantly impacted. Overall, therefore, an aging population will have a profound impact on many industries and the macroeconomy as a whole.

It is the view of the author that many negative aspects of an aging population will be mild and manageable. For example, extending the retirement age can largely alleviate the problem of the burden on public pensions in a country where a large segment of the population is older but healthier and more active than it would have been in the past. People today are not only living longer but they remain, for the most part, willing participants in and contributors to the economy. As the majority of jobs in the present day are not physically intensive, it becomes far less challenging to raise the retirement age by a few years.

I will argue in this book that the most fundamental and irreparable problem of aging is the weakening of entrepreneurship and innovation, and a sort of degradation in the vitality of the human population taken as a whole. A 50-year-old may be just as productive as a 30-year-old, particularly when it comes to non-physical labor, but in terms of the ability to learn new skills, or the willingness to take risks such as starting a new venture, the 30-year-old is a much more productive individual. Although medical advancements have allowed people to live longer, humans are still physically most capable in their 20s, and mentally most innovative and energetic in their 30s. More importantly, as Chapter 2 will show, inventors and scientists are most productive in their 30s; most entrepreneurs start their firms at this age.

My research shows that the negative effect of aging on innovation and entrepreneurship can be dramatic. In an aging society, not only is the number of young people reduced, but their vitality itself is diminished. This is mostly because, in an aging society, the opportunities for promotion are blocked by those who are older. In an aging society, because young workers occupy relatively lower-level positions in organizations, they have lower social and political power, fewer skills, and more limited access to financial resources. I will show, consequently, that their entrepreneurship vitality suffers. By analyzing data from Japan and other developed economies, I have found that entrepreneurial activity is much lower in countries with an aging population. For example, in Japan, where the population has been aging rapidly since the 1990s, entrepreneurship and innovation have declined dramatically. This has been, in my view, a contributing factor to a prolonged economic recession experienced by that country over the past 25 years.

In the future, economic competition among the leading countries will mostly be in the fiercely competitive field of innovation. How to boost innovation and entrepreneurship will become the most important problem facing every country. The purpose of this book is to share with the reader my findings regarding the impact of demographic change on innovation and the economy. Furthermore, to help the reader, whether they be a policy maker or simply someone wishing to better prepare themselves for the future, to make good decisions in the present.

The first half of the book (Part I, from Chapter 1 to Chapter 5) will analyze the theories and evidence on the impact of demographics on innovations, as well as their policy implications. After a short overview of global demographic trends in Chapter 1, Chapter 2 strives to demonstrate that demographic factors are the most important drivers fueling innovation capability. The three most important demographic factors affecting innovation are analyzed in this chapter. In addition to aging, the size of the population and the geographical concentration of the population also have a fundamental impact on innovation. Large countries and cities, with easy access to a large consumer market as well as a talent pool, have decisive advantages in innovation.

Chapter 3 discusses how demographics will impact other aspects of the economy, such as public finances, unemployment, and inflation. Chapter 4 clarifies many misconceptions regarding the effects of demographics on various aspects of the economy, including the availability and consumption of resources, as well as the impact on the environment. Chapter 5 discusses the policies that need to be implemented in order to maintain a growing innovative and young workforce. Such policy choices include a pro-fertility policy, an education policy, and an open immigration policy.

The second half of the book (Part II, from Chapter 6 to Chapter 10) will discuss the prospect of future economic competition among the major economic powers, including Japan, China, the United States, Europe, and India. For the major economic powers, demographics and related policy choices are the critical success factors to win the race of innovation.