The Long View: Demographics may show the consolations of old age

By Chris Brown-Humes

Populations in many parts of the developed world are shrinking. The ratio of pensioners to workers is rising. Economic and corporate profits growth must slow and financial markets sell off.
That is one view of how demographic change will play out in the next few decades. While a number of trends counter the economic impact of ageing, things do not seem particularly encouraging. Baby boomers are starting to retire in the developed world at a time when many families are having fewer children.
According to the UN, in the US, Japan and Europe – 70 per cent of the world economy – there will be as many people over 60 as of working age in 20 years’ time. In other words the ratio will shift to 50:50 from 30:70 at the start of this decade.
In certain parts of the globe the trend is particularly bad. Japan, Italy and Germany are well known for their adverse demographic profiles – Japan’s population is set to shrink from about 127m last year to 100m in 2050. Compare also China’s demographic profile with that of India. In the former, thanks to its one-child policy, population growth will be 6 per cent by 2050, while India’s is expected be 44 per cent.
As for emerging markets, while the populations of the Asia Pacific region and Latin America are set to grow robustly up to 2050, those of nearly all of central and eastern Europe will shrink – the notable exception being Turkey. Countries with high dependency ratios and falling populations could experience weaker economic growth and poorer investment returns. Lombard Street Research noted in a report last year: “In any economy, output growth can be treated as a function of changes to the labour force and of productivity growth. Further, the returns on financial assets over the long term tend to be related to output growth. Demographics can play a vital role in affecting a country’s output growth and so indirectly the return on financial assets.”
But the issue isn’t clear cut. Russia’s population may be shrinking, but in recent years its enormous resources and wealth along with the rising affluence of its middle class have made it an attractive investment destination rather than a place to avoid.
There is another aspect to the debate, which is the link between demographics and savings. This is based on the life-cycle theory that young people borrow, the middle-aged save and the elderly run down their savings. When a large proportion of the population is middle-aged, savings are high as people prepare for retirement. Equally, when the supply of savings is high, their price falls. In bond markets, this should mean lower yields. But the opposite is also the case: when the supply of savings is low – which could be the case when the number of retirees is high – yields should go up. So a rising dependency ratio could mean higher global bond yields.
As for equity markets, the price of shares should fall as baby boomers retire and cash in their savings. That process is exacerbated if there are fewer people of working age to buy them.
Things may not turn out so badly. According to Standard Life Investments, there are at least three reasons for economic growth not to be hit as badly by demographic change as pessimists fear. The first is the rapid growth of the developing economies, led by Brazil, Russia, India and China. The so-called Bric economies could be bigger than the G6 by 2035 in dollar terms, and 50 per cent bigger than them by 2050.
Second is migration. The US has relied on net immigration for many years to lift economic growth. More recently, UK economic performance seems to have benefited from an influx of workers from eastern Europe. Of course migration is a zero sum game: one country’s gain is another country’s loss in pure numerical terms. But that does not mean the net economic effect of migration is zero: it has the potential to lift the growth rate in some economies, just as it can improve labour market efficiency and cut unemployment.
Third is the increased willingness of retirees to work. A recent survey showed that 63 per cent of Japanese retirees planned to work at least part time. In any case, people are having to work longer as retirement ages are increased to offset burdens on state pension systems.
One final factor to consider is the accuracy of demographic projections. The UN sometimes changes its forecasts. For example, in 2000 it projected Spain’s population would be 31.3m in 2050. By 2004, its forecast for that year had climbed to 42.5m.
In spite of such positives, Richard Batty, global investment strategist at Standard Life Investments, says: “We would still expect global GDP growth to slow,” he says. “Specific examples include the US, where commentators are talking about trend growth rates slowing from 3-3.5 per cent to 2.5-3 per cent in, say, the next two decades. Similarly, the EU Commission has warned of slower trend growth ahead – around 0.5 per cent less than the current 1.5-2 per cent trend growth rates assumed.”
The basic message seems to be: do not exaggerate the impact of demographic change. Instead, look closely at regional and country allocations while not forgetting the positive impact that many (high-spending) retirees will have on sectors such as travel and leisure and healthcare.
chris.brown-humes@ft.com
Copyright The Financial Times Limited 2007