The developed world faces a big demographic challenge. There can be no doubt that demographic t...
The developed world faces a big demographic challenge.
There can be no doubt that demographic trends lie at the heart of the global socio-economic system, given that economic growth is determined largely by the size and productivity of a country's labour force.
With this information in hand, predictions can be made about growth in individual economies. The outcome of this analysis is startling. Whilst there should be around three billion more of us on the planet by 2050, the population of the developed world looks certain to fall. In this article, we outline some trends and assess the likely impact on global demand.
A clear relationship between demographics and demand
The chart for consumer spending and demographics compares the youth dependency ratio (the number of children relative to the number of people in work) with consumption growth. Each of the countries shown fits the line well and in economic terms this is a remarkably close fit. Analysis indicates that this relationship holds true over a number of earlier periods. For example, if you go back to 1980, Germany and Japan had very vigorous economies. Why? Because the demographic situation was better. Consumer spending and demographics
The developed world is shrinking
This high degree of correlation demonstrates that we should be interested in trends in population growth as we seek to predict the future economic prosperity of individual countries. Research conducted by Deutsche Bank ('The Demographic Challenge' September 2002) highlights a number of important trends, a few of which are outlined below.
• Birth rates are falling, people are living longer.
The population of many developed economies is both ageing (as life expectancy increases) and shrinking (as birth rates fall). This adds to the pressure on social security systems, creates a shortage of skilled workers and a likely reduction in both entrepreneurial activity and innovation. In a few years there will be as many pensioners as there are people of working age in some countries. This particular trend is not just a problem for the developed world.
• The populations of Europe and Japan are shrinking.
Enlargement of the EU to include ten countries from Eastern Europe will exacerbate the trend towards an ageing population.
Indeed, the total population of the EU is expected to fall by around 125 million by 2050 based on current United Nations estimates. In Japan, economic problems have undoubtedly contributed to a sharp fall in the birth rate whilst life expectancy is on an upward trend.
• The US looks set to remain the centre of gravity within the global economy.
The US population has historically expanded through immigration and is forecast to continue to do so. This should support economic growth. What is debatable is whether the productivity miracle is sustainable, given that the impetus provided by the technology revolution of the 1990's may provide less support going forward.
• Emerging economies will benefit from better demographics.
These include parts of Latin America and the younger Asian emerging economies. Using some of the larger Asian economies as an example, the ratio of the number of retired people to those of working age will only rise slightly in Indonesia (0.39), India and Malaysia (0.35). Compare this with a worrying 0.75 in Eastern Europe and just 0.1 in parts of Africa.
• The changing role of the state.
It is increasingly widely recognised that the social security systems of most developed economies are under pressure. This is because the number of working age contributors to taxes is declining, whilst the number of people of pensionable age (and therefore the size of the liability) is increasing. The solution seems to be tight control of public finances, which means restricting government budgets and increasing individual responsibility for retirement provision.
Politicians must both recognise the problem and act to increase awareness that a labour shortage is looming and the likely impact of this on economic prosperity. Sentiment currently seems to be driven by a lack of understanding and a degree of Xenophobia.
Whilst it is clear that the economic impact of a population that is both shrinking and ageing must be tackled, there are concerns that governments have a much shorter time horizon in mind than that required to implement necessary reforms.
• Labour markets must become more flexible
The labour market needs to modernise if it is to adjust to population decline. Governments can engage in several activities in order to stem the decline in the labour force of working age. Policies can be directed at increasing the total pool of eligible and skilled workers in the domestic economy, by encouraging immigration from areas where population growth is strong (Middle East and North Africa).
However, when faced with competition for skilled workers, countries in a favourable position will likely step up activity to protect their domestic workplace.
In addition, plans can be put in place to improve 'participation rates' i.e. the percentage of the population seeking work or in work as a proportion of the total population of working age. This can be done through incentives such as encouraging parents with children to return to work by improving childcare facilities.
Training initiatives aimed at increasing the size of the skilled workforce can also help.
• Capital movements must become more flexible
The adjustment associated with demographic trends will lead to massive cross border movements of capital. There is no doubt that the greater the international mobility of capital, the more likely it will be that the impacts of demographic change can be mitigated.
Studies show that countries with a higher average age are net exporters to countries with strong investment demand and low savings ratios. However, most studies conclude that developing countries (even assuming supply side and corporate governance reforms) are less able to absorb capital effectively. As a result, capital movements within OECD countries are expected to remain massive over the next few decades. The relative attractiveness of US investments should remain high and the associated capital movement is a trend likely to support the US dollar versus the euro. This is because although the US old-age dependency ratio is likely to rise, the trend is likely to be less pronounced and should emerge later than in Europe and Japan.
• The industrial landscape is set to shift
The shrinking population and associated drag on economic growth in industrialised countries implies a demand shortfall compared with earlier decades. From a demographic perspective, consumption depends upon four factors, the distribution of income, the size of households, the propensity to consume and tastes and preferences.
A higher proportion of consumption will occur in retirement whilst the actively employed will save more. Some industries are well placed to take advantage of a trend towards an ageing population. Healthcare will benefit through areas such as genetic engineering and increasing demand for treatments for age related illnesses.
Leisure is another winner, as consumption within older households increases. The trend towards private pension provision also supports the need for financial advice and asset management.
It follows that others are likely to suffer from a reduction in demand. These include construction, where demand for residential property in Germany is likely to decline with the total population after 2010. However, higher incomes among the working population could lead to a shift towards higher quality housing.
Industries that produce internationally tradable goods are likely to be less sensitive to demographic change than suppliers of goods and services reliant upon domestic demand, such as transport and retailers.
• Profits growth is likely to fall.
Demographic trends lead us to predict weaker economic growth overall going forward. This is based on the prediction that labour costs are likely to rise as the pool of skilled workers reduces. At the same time, an older society is likely to be an increasingly risk averse one.
Whilst equities should be higher on a 12-24 month horizon, the absence of impetus from falling inflation (from already low levels) and lack of dividend growth indicates that we should not expect similar returns from financial assets to those of the bull run during the 1980's/90's. However, we believe that shares should still command a risk and reward premium over other assets, which makes them an attractive long-term investment.
• Population decline in the developed world is unstoppable and likely to be led by falls in Europe and Japan by 2020
Governments must prepare now to ease the adjustment
• The US is likely to remain the centre of gravity in the global economy
• Ageing trend will affect demand and create winners and losers among industries
• The returns from all financial assets are likely to fall going forward, but we expect equities to maintain a suitable risk reward premium over bonds and cash
The Information contained in this article was produced by Deutsche Asset Management Investment Services based on research and analysis carried out as part of the normal investment management process. It is provided to the recipient, an existing or prospective client of Deutsche as a person having professional experience in matters relating to investments or who otherwise falls within one of the exemptions (to the financial promotion restriction in section 21 of the Financial Services and Markets Act 2000) contained in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. Its wider dissemination is incidental to this process and the information provided may have formed the basis for decisions already taken. Any investment activity to which this article may relate is available only to persons within the exemptions mentioned above and must not be acted or relied upon by any other person for any purpose. The information in the article was prepared as at 6 September 2002 and may no longer reflect Deutsche's views as of the current date.
Copyright Deutsche Asset Management Investment Services Limited 2002 where the work represents Deutsche Asset Management's original work.
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