Ageing populations: The demographic hit on growth and inflation1 August 2017
Chief Investment Officer, Investec Bank Switzerland examines the impact of ageing populations on global growth and inflation.
Ageing populations globally have been receiving a lot of press lately. In this article we’ll look at the impact of this megatrend on global growth and inflation.
The last 30 to 40 years of Baby Boomers’ aging has resulted in US growth slowing down and inflation dropping from close to 14% down to 1.9% currently – a near 12% drop.
We focus here on the US, as this economy was the main driver of consumption. American consumers have used debt to maintain consumption, even as growth rates started to slow. This trend has been stopped in its tracks by the ageing population, who are now saving for retirement. In addition to this, debt levels have reached a ceiling in what was called the Debt Super Cycle, which has further constrained growth.
The US has seen a marked slowdown in growth, from above 3% to 1.2%, over the last 11 years. The graph below shows the boost to overall GDP growth from the growth in workers. However, this component has declined by 0.7% from the 1.6% seen in the late 1980s to early 1990s. Growth should thus continue to decline in the next 10 years and sluggish productivity growth might not be enough to counter this trend.
US consumption has benefitted China and other Asian emerging markets, in that they have been able to use their labour forces to industrialise via cheap exports to the West.
The unwritten understanding was that these Asian powerhouses would then take over the role as global consumer. However, China has one of the fastest aging populations globally, due to the one child policy.
China, Europe and Japan make up 42.5% of global GDP and these have the worst demographic profiles to boot.
The top 10 economies in the world contribute 79.8% or $73.4 trillion to global GDP and have 55.5% of the total world population, as demonstrated in table 1 and graph 2.
Savings and inflation
Together with the ageing population, reaching the debt ceiling has forced people to start saving, as evidenced by the increase in the pool of global savings. Thus, the excess supply of savings/money has led to the price of money/interest rates falling in the last 30 to 40 years. Inflation, which is controlled by central banks via their interest rates policies, has also been declining as growth rates fell and the supply of cheap goods increased, while technology added to productivity.
From Graph 2 the gap/indent from age 35 to 41 helps to explain slowing economic growth following the 2008-2009 recession and Global Financial Crisis, as Baby Boomers started to retire.
The pyramid from 45 to 80 was better balanced to keep growth at a healthy pace. The smaller 0-24 age group versus that of the 24 upwards age group implies that this age group will be overburdened by the older generations receiving government entitlements and pensions, which mean that excess capital will not be directed towards generating returns on capital.
The fact that people live longer will be the tipping point of increased savings rolling over and starting to decline, as this older population starts drawing on savings to fund their expenses in retirement, as well as experiencing increased health care costs.
Ageing populations and lower interest rates
Over the past 35 years central bankers have been responding to slowdowns by cutting interest rates in order to stimulate growth. A policy of lower interest rates is particularly effective in supporting economic growth in populations where people are sensitive to interest rates in order to take on debt. Younger populations accumulate debt as they spend to set themselves up in life. This policy, however, will have limited impact as the world ages.
Older populations are less sensitive to interest rate changes because they are typically more likely to save than to borrow.
The fiscal side will also be impacted as governments will have to increase taxes, in order to pay for health care costs, and pension funds will come under strain as older people draw pensions faster than younger people can contribute. Higher taxes will put pressure on growth as people will have less money to spend and governments will have to balance their books by limiting government and infrastructural spending.
From the above it is clear that the ageing population megatrend implies lower growth and therefore lower interest rates. However, the fact that the savings pool is shrinking implies that there will be upward pressure on the price of money. Interest rates will not necessarily increase overnight to pre-Global Financial Crisis levels and it will take time for the opposing forces to establish a new trend. Every time we face a recession, interest rates will have to decline to near current levels in order to provide liquidity and stimulate the economy.
In this environment of ageing populations, rates can change direction frequently in the face of overheating or flagging economies and this will make it a challenging environment for bond investors, who are used to buying corporate bonds for yield and holding it until the debt matures. Volatility will likely be more present and interest rates could average between 1% and 3% for the next 10 to 15 years.
This effect can be assuaged however, if the right policies and practices are introduced. Labour, pension and retirement reforms can help. These include promoting labour force participation of women and the elderly, as well as minimum pension guarantees, according to a report by the International Monetary Fund (IMF). New financial products to reduce precautionary savings and increase the availability of safe assets would also be useful.
New technologies, new ways of organising production processes, research and development (R&D) expenditure, exports, imports, and foreign direct investment (FDI) are all key drivers of productivity growth, according to the IMF.
This article originally appeared in Investec Wealth & Investment’s quarterly client publication ONE Magazine edition 2, 2017