“So far as the original founders are concerned, the journey [of European integration] continues. The problem is it is not what most British people thought they were signing up for.” ____Andrew Stuttaford.
Andrew Stuttaford is a British-born contributing editor at National Review and a frequent writer on British and European topics. In recent months, he has been an advocate of ‘Brexit’, the United Kingdom leaving the European Union. A few days before the June 23rd referendum, Stuttaford explains the factors that made him increasingly wary of further European integration. Read more →
A fast growing economy usually requires a growing working-age population. It is informative in this regard to look at the size of the working-age population (wap) for different regions and countries of the world.
Hans Rosling, co-founder of Gapminder, calls it “the biggest change of our time”. It is Africa’s population growth from 1 billion people today to 2.5 billion by 2050 and 4 billion by 2100.
You could say that a close “second biggest change of our time” is the aging and stagnation of the population in rich countries. The combined population of North America, Europe, Japan and Australia/New Zealand is now at 1.3 billion and it will remain at 1.3 billion by 2050 and 2100 with small gains in North America and Oceania offset by declines in Europe and Japan. Read more →
The 2015 Revision of the UN’s World Population Prospects estimates a global 2050 population of 9.7 billion people. That is 420 million more than the UN had estimated as recently as 2010. The incremental rise comes from higher estimates for all continents, especially Africa which goes from 2.2 billion to 2.5 billion. Read more →
It is not an exaggeration to say that world demographics are entering uncharted territory. For the first time in a very long time, perhaps the first time ever, the dependency ratios (loosely, the ratio of dependents to workers) of all rich nations and of several emerging markets have started rising and will continue to rise for several decades.
This alone would be enough of a challenge for the world economy. But making things more complicated, it is taking place at the same time as the other big demographic transition of our age, the great population boom in some of the poorest nations of the world. Read more →
Of all major regions of the world, Europe has the most challenging demographics, combining a stagnant population and a rising dependency ratio. But within Europe, five countries have worse demographics than the European average: Germany, Italy, Portugal, Spain and Greece. Read more →
The growth prospects of Brazil, Russia and China are dimming, while those of India are flaring.
If one is a lonely number, then ‘I’ could be a lonely letter, at least when it comes to the ‘I’ of the BRIC countries. Brazil, Russia and China all face mounting challenges in 2015 but the road ahead seems wide open for India. The main concern with this opening statement is that it seems to be the view of a large majority of observers.
Still, a majority is not the same as a consensus and certainly not the same as an extreme consensus. In investing, the consensus view is often right but the extreme consensus is absolutely and always wrong. For example, the consensus to buy tech stocks in 1997 was right but the extreme consensus to sell all non-tech and buy only tech in early 2000 was very wrong. When it comes to India, we are with the majority view, edging into consensus territory, but still far from extreme consensus. There remain enough doubters to ensure that this story still has plenty of time to play out.
Our approach to the topic is resolutely from the point of view of demographics. Demographics are not the be all and end all of an economy, but they are a very important vector, one of three very important vectors, the other two being innovation and institutional strength. Looking at the BRIC countries, the demographics of Russia and China are poor and those of Brazil are neutral. By contrast, the demographics of India, though challenging due to the large population size, could hold much promise if this huge newly created human energy can be harnessed and channelled in the right directions.
In general, the best demographic profile for an economy would be a rising population coupled with a declining dependency ratio (the ratio of dependents to workers). The increase in population means that demand for goods and services continues to grow. And the declining dependency ratio means that there is plenty of discretionary capital for consuming and for investing.
The US, Europe and China were in this sweet spot until six or seven years ago. Indeed, much of the world was in this sweet spot, a fact which largely explains the enormous creation of wealth and improvement in living conditions for billions of people in the past few decades. Things got more challenging in the middle of the last decade when dependency ratios in several countries bottomed out and started to rise.
We can’t blame the 2008 crisis on demographics alone. There were many abuses and excesses in the system which brought about the crisis. But it is worth noting that the crisis struck about the same time that a big reversal in demographics was taking place. A crisis would have come any way but instead of 2008, perhaps it would have come in say 2012 if the dependency ratio had bottomed four years later than it did.
Nor should anyone be surprised that Japan peaked in the late 1980s and has been struggling since then. Its dependency ratio bottomed in the early 1990s. Or that China saw a huge boom since 1980 after it introduced its one-child policy, thus engineering a very steep decline in its dependency ratio. Or that the US recovery has been slow, given that its population growth has slowed down and its dependency ratio has been rising.
As shown in the first chart above, India is the only BRIC country with a declining dependency ratio between now and 2030. Russia and China’s are already rising and Brazil’s will bottom and rise by the end of this decade. Russia seems to be in the worst shape since it has both a declining population and a rising dependency ratio.
Finally two quick words on the other big vectors of economic growth: innovation and institutional strength. Innovation in Brazil, China (ex-Taiwan) and Russia has been slow and cannot be considered a factor in future growth. There was plenty of excess capital to invest in new businesses when the dependency ratio was declining in all those countries but it went instead into real estate and other unproductive investments. Innovation has been slightly better in India and could take a big leap forward with more capital investments in the decades ahead. India also has an immeasurably greater competitive advantage compared to the other BRIC members: its population speaks English.
Institutional Strength can be the subject of endless debate, especially if we try to draw comparisons across countries. All emerging countries have to make significant progress on this account.
In theory, the economy does better when the dependency ratio is falling and less well when it is rising. But, as discussed in this previous post, two important mitigating factors are a country’s rate of innovation and its institutional strength.
United States, Europe, Japan
Figure 1 shows the total dependency ratios of Europe, Japan and the US from 1950 to 2050.
Key takeaways are:
The ratio bottomed in Japan two decades before it bottomed in Europe and the US, which may explain Japan’s stagnation relative to the US and Europe in the 1990-2008 period.
In the 1980s, 1990s and early 2000s, Europe and the US benefited from a declining ratio.
All three ratios will rise from now into the foreseeable future. But Japan’s ratio will rise faster due to its older population.
Figure 2 shows the total dependency ratios of the BRIC countries: Brazil, Russia, India and China.
Key takeaways are:
The ratios of Russia and China are both bottoming in the middle of the present decade and will rise for the foreseeable future.
Brazil’s ratio will bottom later this decade and will subsequently rise.
India’s ratio will continue to fall until about 2030 and will level off until 2050, which may help its economy grow faster.
Following are charts for a few individual countries and for Europe and Africa, showing all three dependency ratios as defined above. The blue line is the total ratio, the red is the child ratio and the green is the old-age ratio.
In the case of the US, Europe, Japan and China, it is clear that the rise in the total dependency ratio is mainly driven by a rising old-age ratio. Japan has the fastest rising old-age ratio. None of these countries is expected to see a big rise in its child ratio.
Note the steep 40+ point decline in China’s total dependency and child dependency ratios between 1970-2010. It is due to the country’s one-child policy and it provided a big boost to the Chinese economy in recent decades.
The following chart compares the total dependency ratios of the US and China. China’s ratio fell faster and will also climb faster.
India and Sub-Saharan Africa have a more promising demographic profile. A declining total ratio could markedly improve their economies, if other obstacles can be overcome. In addition, unlike other regions, Sub-Saharan Africa will not have a rising old-age ratio for the foreseeable future.
America’s anemic recovery can be explained by its slowing demographics.
Politicians tend to overstate the positive impact of their policies on the economy and to also exaggerate the negative impact of their opponents’ policies. In all likelihood, there are other more potent factors at work.
Instead of GDP, we look at wealth creation as the main measure of the economy. GDP measures economic activity which means that building roads to nowhere is a positive contributor to GDP in the near term because of the jobs provided and the material and services purchased. But building roads to nowhere is a waste of money. By contrast, wealth creation accounts for the return on invested capital and differentiates between good and bad projects.
And wealth creation has three main drivers: innovation, demographics and the economy’s institutional framework.
To illustrate the importance of innovation, consider a country where there is little innovation and therefore little creation of intellectual property assets. The main assets in such an economy are hard assets, such as real estate, natural resources and the like. Unless there is strong demand for these assets from foreign markets, the economy of that country would stagnate or grow slowly with its population. Good examples of such countries today are commodity economies like the leading oil producers, industrial metal producers etc.
Now consider a country where there is innovation but where the population is small. Here the amount of wealth created by innovation would be quite small unless there is strong foreign demand for the products and services brought about by that innovation. A new iPhone that can only be marketed to a small population would create a lot less wealth than one marketed to a large population. Good examples are Switzerland and Finland which are quite innovative, have relatively small populations but export their products in large quantities.
Finally, consider a country that has lots of smart innovators and a large population but that suffers from a poor institutional framework. It is a country where the government and citizens are corrupt, where contract law is nonexistent, where capital markets are small, where property rights are not protected. There would be little wealth creation in such a country because the innovators would emigrate to another country where they could more readily prosper from their innovations.
Since 1945, the United States has been blessed by all three major contributors to wealth creation: strong innovation, strong demographics and a stable and supportive institutional framework. The same has been true for Europe, albeit with slower innovation and slightly worse demographics. The same has been true for Japan, with still worse demographics.
So where do we stand today? Of the three main engines in the US, innovation and the framework are still going strong. But demographics have weakened in several ways. First, after declining for several decades, the dependency ratio (number of dependents per worker) has been rising since 2005. Second, the number of Americans aged 30-60, arguably the most economically active age bracket, has stagnated at a little over 120 million people. Previously, the 30-60 group had grown steadily in every year from 1978 to 2005.
Presidents Reagan and Clinton are credited with a successful economy but their years in office also benefited greatly from a falling dependency ratio. The same is true for the second President Bush until mid-decade when the dependency ratio bottomed out and started to rise.
The anemic recovery since 2008 can largely be explained by our deteriorating demographics. The US population used to grow by 1 to 2% every year, which meant that companies could count on real growth of 1 to 2% and another 2 to 4% of inflation. But since 2007, annual population growth has fallen below 1% and inflation has also fallen. So what used to be safe annual domestic revenue growth of 3 to 6% is now looking more like 1 to 3%.
In Europe too, the dependency ratio bottomed and started to rise in the middle of the 2000s decade. In addition, Europe has been less innovative than the US in the past ten years, which explains its stock market lagging the US market. The rise of Google, Facebook and others and the resurgence of Apple have all taken place in the new millennium. Europe has had no such large success stories. Worse, one of its former superstars, Nokia, has nearly disappeared. So Europe still has a strong institutional framework but its other two engines of wealth creation are sputtering.
Japan’s dependency ratio bottomed in the early 1990s which may explain the country’s stagnation since then. It remains highly innovative but perhaps not sufficiently so in new focused companies with higher returns on capital.
The lesson of recent years is that US innovation may be strong enough to counter the effect of weakening demographics, but not strong enough to produce strong GDP growth. In addition, revenue growth in several industries has become highly dependent on exports to emerging markets. The economy and markets will do well if export demand continues to grow. But if emerging economies experience an important slowdown, our worsening demographics means that there will not be sufficient demand at home to pick up the slack.
For more data on US and world demographics, please refer to these previous posts: