(An abbreviated and edited version of a speech given at the ZfU International Business School, 21st May 2013)
23rd January 2014
Demography covers many disciplines. Most people try to focus on only one, mine is economics, but this evening, I’ve been asked also to talk not only about how demographics affects market, but also geopolitical trends. To get things going then, here’s the cover of a book you might find interesting….
It came out at the end of 2008, and it looks at the economics of ageing, as well as the social implications, consequences for the children of the baby boomers, for emerging markets, globalisation, immigration and even for religious movements. Five years on, some its numbers are a bit dated but otherwise I’m still very happy with what it conveys about the demographic challenges we face.
I always stress that it’s as hard to see the consequences of demographic change as it is to see a glacier move. But we know that glaciers do move, and also that demographics have significant effects over time. These words, supposedly hung up on a wall in Albert Einstein’s office at Princeton, capture the subject of demographics well:
This play on the English word ‘counts’, is apt. There’s a lot in demography that can be counted like population, age structure, dependency ratios and so on, but also much that can’t like attitudes, public opinion, and incremental changes that eventually have a tipping point effect.
In the Age of Ageing, I said that the demographic shifts we are seeing are
– unique in human history,
- universal, and
- divisive in three important ways.
First, ageing is forcing us to make decisions about the sensitive issue of the entitlement rights and obligations of citizens versus the state at a difficult time because of the consequences of the financial crisis.
Second, it is making us confront important intergenerational issues about equity, fairness, taxes and benefits at time when our children face high rates of unemployment and considerable economic uncertainty.
And, third, and for the time being, it is driving a wedge between mostly fast ageing developed countries, and younger and more populous emerging countries over matters ranging from security, access to resources including energy, climate change, and immigration, to international financial and monetary policies.
Demography and markets
The main market we have to start with is the labour market, because ageing will cause the size of the working age population to slow down, stagnate or decline. And because of that and the significant increase in the over-65s, the old age dependency ratio is predicted to rise sharply for many years to come.
The inverse of the dependency ratio is the support ratio, or the number of workers per dependent. I’m going to show you next how the support ratio has risen in a number of countries over time, and when they started to fall or are expected to fall.
So in the 1960s to the 1990s, when child dependency ratios fell significantly but before old age dependency started to rise, support ratios rose significantly. This period was associated with rising levels of discretionary income, consumption, savings, living standards – and equity markets.
But as you can see, the support ratio peaked, and then started to fall first in Japan, and next in the US and Europe. Rising old age dependency we think will bring precisely the opposite. So, is it an accident that the support ratio peaked in Japan in 1989-90 coinciding with the onset of a crisis, and again in the US and Europe in 2007-08 at the same sort of time? And look at China, where the support ratio peak is fairly imminent. You can draw your own conclusions, but the fact that China’s economy and credit system are in some trouble at the present time is rather spooky.
In the next slide, you can see old age dependency ratios for faster and slower ageing advanced economies, or what we can call hares and tortoises.
By and large, the hares are Japan and European countries such as Germany, Italy and Spain, whose old age dependency ratios will rise from 20-35% to 60-70%. That’s a change in workers per older citizen from about 3-5 to about 1.5. The tortoises are the Anglo-Saxon economies plus Sweden and France. In this group, the support ratio will fall from 4-5 workers to about 2-2.5.
The interesting thing about the hares and tortoises is that the tortoises all tend to have higher fertility rates and better child care facilities, higher levels of female and older worker labour force participation, and higher immigration rates.
These distinguishing characteristics are by no means exploited as fully as they might be even in the US, UK and Scandinavia, but they do point to the coping mechanisms that we have to build or refine in order to offset the economic consequences of ageing.
Think about three likely consequences of rising old age dependency ratios, that is rising cohort numbers of over-65s, and a stagnant or declining working age population.
1. Potential economic growth will be lower because of the weakness in the working age population, as shown here as share of total population.
2. Real interest rates are likely to permanently lower, perhaps by around 0.5-1.5% compared with the decades before 2007
The textbook reason is the rise in the ratio of capital, which will become relatively abundant, to labour, which will become relatively scarce. Since capitalism rewards scarcity, labour returns (wages) should rise relative to capital returns (interest rates).
Real interest rates should also remain lower than they were because of higher savings. This is a bit controversial, because the so-called lifecycle hypothesis of consumption has taught us that savings fall as we get older. However, higher life expectancy may cause more people to work for longer, and therefore to save for longer. Savings could also rise as the structure of pension system funding changes further towards funded schemes.
And we shouldn’t forget that governments will be looking to save more too as they seek to close their structural budget deficits, not only as a response to the recent crisis, but because of the unaffordability of the predicted rise in age-related spending. This chart from the IMF shows by how much countries would have to improve their cyclically adjusted primary balances in order to get public debt down to 60% of GDP, for example, by 2030. We all know the numbers look bad…
Of course, the actual situation for governments is changing all the time as new policies are introduced, and with varying degrees of success.
3. Ageing will probably have disinflationary consequences as a rule.
Although labour and skill shortages are already pushing up wages and incomes for some people, what’s happening is a relative shift, not a significant acceleration in wages and salaries. Japan’s experience suggests that deflation can easily become embedded, and nowadays, investors are having to think about similar risks in the US and Europe, but especially in the Euro Area. I’m not saying we can pin this all on demography, but ageing provides a significant disinflationary headwind.
So as investors, we face an environment of weaker growth, lower real rates, higher savings and low inflation. This doesn’t mean that asset prices are doomed to fall, but it does suggest over time, we should expect lower asset returns than those to which we have been accustomed.
The equity market environment is unlikely to be as buoyant as it has been in the last year and until the early part of 2014 at least. The outlook for bonds as an asset class, as we know, is not good – but we must also remember that unless there is a major debt or currency crisis, bond yields are unlikely to rise too far as long as policy rates don’t rise that much. And even if central banks raise them this year or in 2015, it seems very unlikely at this juncture that they’ll be raised far or fast.
What about house prices?
This shows the percentage change in the number of 25-40 year olds, who I’ve labelled prime age, first time home buyers. At first sight, the place you want to buy residential real estate is in Nigeria and sell it in most other places. Reality, of course, is more complex.
But the suggestion is that the backdrop to house prices in advanced economies is not good, especially as baby boomers sell their houses to downsize, go into care or to the great retirement home in the sky. To whom will they sell, and what if the buyer universe shrinks as shown? Clearly we have to know a lot more about home building, household formation, mortgage lending, immigration and so on.
Before I move on to look at emerging markets, let me summarise how we might change the outlook for our demographics and therefore also for economic performance and markets. It could all look so different if we are able to deploy new coping mechanisms.
For example, the economics of ageing could look quite different if we could
- raise the employment rates of workers aged 55-64 and of women
- continue to raise the retirement or pensionable age, and eligibility to healthcare benefits
- introduce phased retirement schemes, and new occupational and compensation structures to suit older workers
- and boost productivity growth. Would that it were so easy, but it isn’t unreasonable to think that at some point, new technologies will augment productivity growth, even if we can’t see such a moment in current circumstances
There are two things to say about emerging markets at the outset
- All but the least developed economies in the world will be in the same boat as we are regarding rapid ageing, but not for some time yet – around the 2030s for many countries and even later for nations in Sub Sahara Africa
- Emerging markets and developing countries will mostly have to adapt to ageing much faster than we have in the West, as you can see from the following chart
If you consider how long it took countries to double the share of their over-60s in their population from 7% to 14%, you get some startlingly different results.
In France, it took over a century. In most other developed countries it has taken or is taking between 40-80 years. In the US, over 60 years. But as your eyes drift to the right side of the chart, you can see almost only emerging countries in which the process is occurring in roughly 20 years, give or take, with China blazing the trail. China’s over-60s population, for example, will grow from 144 million or 11% of the population, to 438 million or 31% by 2050. Some Chinese cities, for example, Shanghai, already have an age structure similar to that of Japan. And it is this that really gives rise to the now common mantra about growing old before you get rich.
So you can see the problem. Rapid ageing is a difficult enough economic issue. But having to build the social and income security infrastructure to deal with it in a third of the time it took in Western countries and at significantly lower levels of income per head makes it much harder.
I showed earlier old age dependency ratios for advanced economy hares and tortoises. here is the the same chart for emerging countries.
The tortoises in the top chart show a relatively concentrated and low old age dependency ratio currently, which translates into 10-20 workers per older citizen, and gradually a rise to where we are today in the West, though Nigeria, S Africa and Saudi Arabia are ageing even more slowly than Indonesia, Turkey, Mex and Brazil.
The hares are China, Russia, and Korea. Another tortoise India, included for comparison, is the so-called demographic darling,
What most emerging countries have in common is the opportunity to exploit what we call the ‘demographic dividend’. This is a phase during which child dependency is declining, and the working age population is expanding, but before the old age dependency ratio has really begun to shift. The ‘dividend’ is associated with strong trends in income and consumption growth, savings and investment, and technical progress. It’s where the West and China were from the 1980s until now, and, as I have pointed out, now that the dividend has been banked, we have to consider how to offset or live with weaker economic growth and other effects.
But for the majority of emerging markets, this dividend phase still lies ahead. It has given rise to colourful stories about a surge in prosperity and economic power. But I would caution that there is nothing inevitable or even probable about this, and no investment strategy should take it for granted.
At the very least, think about SE Asia and Latin America in the 1970s. They both had comparable demographic and age structures, and if that were all that mattered, you’d have predicted they’d be on the same economic level today. The reality could not be more different. Or more dramatically, look at the young and populous countries that experienced the Arab Spring a couple of years ago. You can see that far from being a source of prosperity, the demographic dividend can also go to waste – or worse – without appropriate intervention to exploit it. And this means resilient institutions, a strong investment climate, good infrastructure policies, and an aptitude for innovation and high educational attainment.
Demographics and Geopolitics
Let’s look now at some of the ways in which demographic changes are affecting geopolitical trends. Let’s start with some facts.
First, because of the combination of low fertility and rising life expectancy, some countries face the prospect of absolute population decline, ie for reasons other than war or disease. Today there are 18, and by 2050, there will nearly 40.
Second, the oldest median age in 1950 in the world was 36. Today there are 31 countries with a median age over 40, and by 2050, it’s predicted that there will be 84 plus 15 where it’ll be over 50. This group of 100 countries includes half of Western Europe, Russia and all of Eastern Europe, Japan, Korea, and Taiwan. The US will remain relatively young with median age rising from just under 38 to just over 40.
Third, the big picture change in world population is that the Western world now accounts for 17%, way off the peak of nearly 25% in 1930, and below the level in 1800. The decline from 1930 didn’t of course affect rising prosperity, so we should be careful not to be overly pessimistic, but as I have already said, it’s the ageing that’s new… and that’s important
Last but not least, as the world’s population continues to grow – even though growth is slowing down a lot – more and more emerging markets will account for what I’ve chosen as an arbitrary 60% of world population. In 1950, there were five Western countries in the top 10. Today there are 2 in the top 12. By 2050, there will be only 1 – the US – in the top 15.
From these facts I’d like to draw out some observations
Emerging markets are muscling the developed countries out of the way in terms of share of world population, and the question is whether this marks a major shift in the distribution and exercise of global power.
People assume that populous emerging markets will get a lot richer as well, that is the march of the middle class. If this happens as predicted in the next 20-30 years, the current distinction between developed and emerging markets may become irrelevant. The BRICS have been the focus of much attention for over 10 years, and now the MINTS are being hailed as the next group of wannabes.
But just because people talk about global geopolitics this way, and assume that large populations become rich and powerful, doesn’t mean that it’s correct. Countries with large populations don’t become wealthy because they have a lot of people, any more than countries like Switzerland and those in Scandinavia with small populations are condemned to poverty or stagnation.
The reasons why countries with large or small populations are able to escape poverty are pretty well understood. And basically this comes down to what a rising middle class comes to expect, which is more accountable government, and importantly, better and improved governance. The bigger your population, the more important this is.
The reasons why only about 35 countries, excluding small population oil producers, have been able to become high income nations, i.e. with income per head greater than $30000, are more complex and have a lot to do with your economic model, how you sustain total factor productivity at a certain stage in development, and the role played by robust and inclusive institutions in harnessing and organising physical and human capital. Some of you may be familiar with the book Why Nations Fail by Darren Acemoglu and James Robinson, which is a good insight to this important topic.
Unlike small countries, those with large populations carry significant political and geopolitical weight, regardless of whether they are rich enough to join the OECD, so to speak. And this matters enormously at a time when the Western world is in some disarray, and the US seems to be in retreat from its global role. So how will China exercise power, in the future, for example, and in whose interests? A more truculent China in its relations with a more nationalistic Japan, and with Vietnam and other countries in Asia, does not fill us with cheery optimism. With whom will the BRICS and the MINTS form alliances and on what basis? How does the world work if it becomes multipolar, as many argue it is or should?
These are complicated questions because without a benign global hegemony, how do we resolve the tensions between globalisation, which leads to progressive integration, and geopolitics, which lead to nationalism and security concerns?
I think everyone acknowledges that the G20 had to be created to speak for more of the world than the old G7. It’s got all the BRICS, all the MINTS except Nigeria, and it has Saudi Arabia. But its track record as an agent of change and coordination is not that good. The main thing that the ten emerging markets in the G20 have in common is that they’re not in the Western camp, and don’t feel subservient to the US – even though several depend on and identify with the US more than they might admit publicly.
So while global demographics are driving us towards a multipolar world, I’d argue that it has very little to do with the common interests of populous emerging markets and much to do with the weakening of America’s relative global position reflecting a rising China and the political consequences at home of the financial crisis. The blow to US economic prestige, especially, alongside the eruption of strong political divisions in the US, has in many respects taken America out of the game of global leadership – for now at least.
In a more recent book I wrote, called Uprising, I talked about this new world order, or disorder, and discussed what I called America RIP, where the RIP stands nor Rest in peace, but for Renaissance in Progress. The essence of this was that for all its faults and frailties, the US has some important and enduring advantages.
US population is predicted to keep growing from 320 to about 400 million by mid-century. The pace of population ageing will be slower than in most other developed markets, and also in due course than in China. Its share of population in the developed world is predicted to rise from a quarter to about a third, its share of GDP from 37% to 54%.
Most of these gains are coming of course at Europe’s expense. Here we face demographic decline or stagnation, austerity politics can be expected to linger for many years to come, and there is still the unresolved existential matter of how European countries will be organised in the future, i.e. in a supercharged monetary union, or not – and if not, what? Europe’s difficulties are not principally demographic in origin, but the footprints of rapid ageing and demographic change can be found in many of our economic and social issues.
Importantly, as you know, the US, despite all the political and healthcare chicanery which is fixable, is starting to extract competitiveness gains from its lead in advanced manufacturing and from the shale energy revolution, which, by the way, is on track to make the US the largest oil producer in the world in the next few years. According to recent reports from the Energy Information Administration, the net import share of consumption of liquid fuels is predicted to decline from 60% in 2005 to 24% by 2015. This is a huge benefit to the US trade balance, if nothing else. And that’s before any relaxation of curbs on oil and gas exports.
The energy focus, where I’d like to conclude, is really important in a demographic context – a point that came across well in Ian Morris’ super book Why The West Rules (For Now). In contemporary terms, we can see that population growth and its handmaiden, urbanisation – which are overwhelmingly emerging market phenomena – are leading to sustained demand for energy, water, and other raw materials for food processing and transportation, fertilisers, urban refrigeration, irrigation, heating, and so on.
So – with the bulk of the world’s population in Asia, and as global population rises from 7 to 9.5 billion over the next 30-40 years, mostly in S. Asia, the Middle East and Africa – having access to energy is going to be of utmost importance. So-called ‘geo-energy’ gas become a subset of geopolitics, fusing politics, geography and new energy technologies and capabilities. While some of the hotspots in future will continue to erupt within national boundaries, e.g. in Thailand or Turkey, the geopolitical hotspots, I imagine are likely to be focused on the countries bordering the Straits of Hormuz, the Caspian Basin, the East and South China Seas and the energy-rich, and warming Arctic – where the strategic interests of the US, EU, China, and Russia all meet.
Finally, let me say that I don’t think anyone would argue that demographic change alone is going to be the principal mover of markets and geopolitical outcomes. At the same though, it would be short-sighted, perhaps even negligent, to think about either markets or geopolitics without considering the ubiquitous and universal effects of demographics.