China is entering a “danger zone”where a financial crisis may become more likely because of increases in loans and property prices coinciding with an aging of the population, a Bank of Japan (8301) official said.
“If a demographic change, a property-price bubble, and a steep increase in loans coincide, then a financial crisis seems more likely,” BOJ Deputy Governor Kiyohiko Nishimura said in a speech for a conference in Sydney, posted on the central bank’s website today. “And China is now entering the danger zone.”
China is at risk of emulating crises in Japan in the 1990s and the U.S. in the 2000s, according to Nishimura, who cited a Chinese working-age population that is “close” to peaking as a proportion of the total. Demographic changes can provide fertile ground for “malign property bubbles” because of the effect on demand for real estate, he said. READ MORE.
Japan’s population fell by 263,727, or 0.21 percent, from a year earlier to 126,659,683 as of March 31, marking the largest annual drop and a fall for the third consecutive year, the Internal Affairs and Communications Ministry said Tuesday.
The previous record drop — 134,450 — was last year.
The number of births — 1,049,553, — was the lowest since the survey began in 1968, while the number of deaths hit a record high of 1,256,125. READ MORE.
Diamonds are forever. What about growth in the luxury sector?
A few months after Porsche teamed up with RIM to offer the Porsche Blackberry, Tonino Lamborghini recently announced the introduction of three gold plated cell phones (priced $1,850 to $2,750) and of an Android tablet ($2,300) aimed at the Russian market. This story neatly captures the current state of play in the global luxury industry: a prestigious European brand flashing a status product at a BRIC consumer. Notwithstanding the gloom emanating from daily European headlines, the continent’s luxury sector has been riding an unprecedented expansion. With their aggregate 70% market share in global luxury goods, a slew of European companies have been living their best years ever.
The Best of Times
Sales have risen strongly at BMW. And at LVMH, the French parent of Louis Vuitton, Dom Perignon, Bulgari and Tag Heuer. And at Hermes and Burberry. And at Swatch Group, the Swiss parent of Breguet, Glashütte, Blancpain and Omega. In the two years 2010-11, BMW increased its sales by over 17% annually. LVMH increased theirs by an average 14%, Hermes by 18%, and Swatch by 22%. With record margins and cash flows, these results are oddly incongruous with a global economy limping and stumbling out of (or through, or back into) the 2008 financial crisis.
The boom has been fuelled by rising demand in the BRIC countries and, to a lesser extent, in the United States. In 2011, sales in Asia (including Japan) were 28% of total revenues at BMW, 35% at LVMH, and as much as 54% at Swatch. At LVMH in 2011, sales in Asia ex-Japan and in the US grew by 27% and 18% year-on-year, respectively. For BMW, Asia represented 22.5% of unit sales in 2011, up from 10.6% in 2007.
If the rich, per F. Scott Fitzgerald, are different from you and me, then the suppliers and courtiers who pander assiduously to their vanity or sense of perfectionism, the purveyors of the finest consumer products on earth, are certainly different from the average consumer company. Whether by sheer luck or brilliant foresight, luxury goods companies now find themselves at the nexus of two main drivers of demand. First, the global rich, whose numbers have been increasing, are less sensitive to the economic cycle. They have big reserves of savings and can spend on luxury items even if their incomes falter for a year or two. Most will continue to consume luxury unless the economy is hit by a severe downturn. One of the reasons that BMW is bullish on the future is its expectation that the number of millionaires will continue to rise in developed markets as well as in the BRIC countries and Turkey and South Korea (identified as the BRIKT + China in a BMW presentation).
Second, the newly rich and middle class in emerging markets have embraced luxury products with a vengeance. Like the Japanese in the 1990s, shoppers in the BRIC countries are today’s most profligate luxury customers. Chinese buyers discovered luxury brands years ago and they have been buying with gusto. Significantly, their buying power and obsession with luxury is felt far beyond their borders. According to the Boston Consulting Group, travelers from emerging markets (tourists and business people) account for a large share of global luxury sales, even if some of these sales are recorded in Paris, New York or Tokyo. BCG says that the Chinese spend as much on luxury while away as they do at home.
Barring a global recession, these two groups, the rich everywhere and the middle class in emerging markets, will continue to spend on luxury products and, increasingly, on luxury services. These are undoubtedly the best of times for the luxury sector. The question then becomes: what will derail the boom? A shift in demographics could do it.
A Brief Digression on Demographics and Markets
In general, the world is full of coincidences but it would be foolish to accept all of them at face value. Sometimes it makes sense to ask questions to find out whether two concurrent events are really a coincidence or whether they are related. Among coincidences that we should not take at face value are important reversals in markets which occur at the same time as demographic inflection points. For example, the Japanese stock market peaked in 1990, the same year that the number of Japanese turning 40 also peaked. It could be a coincidence but then the US stock market peaked in 2000, the same year that the number of Americans turning 40 also peaked. It could be another coincidence or alternatively, there could be a poorly understood dynamic underlying the stock market, a dynamic directly linked to demographics, aging and investing etc. (The Chinese stock market peaked in 2007, one to five years after the number of Chinese turning 40 hit its own peak).
Demographics are generally ignored or underestimated by market participants. They are often seen as far-removed inputs in the economy which eventually manifest themselves through other measures. For example, an investor may ignore the change in demographics in a given area or region or country, confident in the knowledge that any significant shift will eventually appear in monthly retail or housing data or other economic indicators. The only problem with this thinking is a large gap in timing. Monthly status updates from the economy are mostly embedded in market prices by the time they are released. By contrast, an analysis of demographic trends can help make a forecast several months or even years before significant changes filter through the monthly economic data.
One demographic measure which should certainly be examined in its relation to markets is the dependency ratio which measures the number of dependents per working adult (it is the sum of people under 14 and over 65, divided by the number of people aged 15-64). The table (compiled from a UN 2010 report) shows the ratio (per 100 people) for various countries and regions. A declining ratio is generally positive for the economy because income earners have fewer dependents and can divert dollars to investing and spending.
The world’s dependency ratio which fell steadily from 1970 to 2010 will be essentially flat until 2020-30 and will start to rise beyond 2030. In the US and Europe, the ratio hit bottom around 2010 and will rise in future decades. But in Japan, it hit bottom in 1990 and has been rising ever since. Perhaps this explains in part Japan’s lost decade which turned into two lost decades.
In the BRIC countries, the dependency ratio is still falling in Brazil and India, but it is near bottom and is set to rise in Russia and China. And in Africa, the ratio will continue to fall for a long time.
As the ratio rises, there will be fewer dollars to spend on discretionary items because more of these dollars will have to be redirected to taking care of dependents, whether this is done directly through assisting family members or indirectly through charities or government social programs.
Which brings us back to luxury goods, in some ways the quintessential discretionary items. Will a rise in the dependency ratio in developed countries, in Russia and in China lead to a slowdown for the sector?
Looking into the future, the case of Japan can be informative. It was not long ago that the Japanese were avid buyers of luxury goods, both at home and while traveling. But a 2009 study by McKinsey found that the Japanese appetite for luxury goods has been on the wane since 2001 (in volume terms) and it noted that their purchases started to decline (in currency terms) in mid-2006, two full years before the onset of the financial crisis.
Whether by coincidence or causality (the latter in my opinion), the demographic data fits well with this turn of events. Because of a low birth rate and an ageing population, Japan’s dependency ratio, 0.43 in 1990, rose modestly to 0.47 by 2000 and more briskly to 0.56 by 2010. It is on its way to 0.7 in 2020.
Nonetheless, heavy investing by luxury companies over several decades means that the Japanese luxury market remains the second largest in the world, after that of the United States. LVMH has 360 stores in Japan, a country 10% smaller than California, vs. 621 for all of the US.
The dependency ratio is bottoming in Russia and China but it will only rise slowly for the next 10 to 15 years. This suggests that, barring other developments, the luxury sector could continue to do well, but its growth rate may taper off. Of all the BRIC countries, India’s ratio looks the most promising and it offers the best longer term profile if its policymakers can set the country on a path to reap the demographic dividend resulting from a decline in its fertility rate. Although luxury companies have a presence in India, their footprint is much smaller than in China and Japan. For example, Louis Vuitton has over 50 stores in Japan, 39 stores in China and 4 in India.
Africa will see a steady decline of its dependency ratio in the 21st century. Luxury companies have a small to nonexistent presence on the continent. Swatch Group records a minuscule 0.6% of its sales there. Louis Vuitton has three stores, of which two in South Africa and one in Morocco, but none in oil-rich Angola or Nigeria. Porsche has seven ‘Porsche Centres’ in Africa, of which three in South Africa and one each in Angola, Nigeria, Egypt and Ghana. But it has 42 ‘Centres’ in China, 23 in Russia and 8 in Brazil. Although store count is an incomplete measure (because of sales through third party outlets), a larger number of own-brand stores denotes a greater confidence in the stability and growth of a given market. If Africa is the next economic frontier, these are indeed very early days for luxury goods companies on the continent.
They should sit up and take note. A team led by Hinh T. Dinh, Chief Economist at the World Bank, recently examined Africa’s prospects as a new manufacturing hub. Dinh writes:
“The ongoing redistribution of cost advantages in labor-intensive manufacturing presents an opportunity for Sub-Saharan Africa to start producing many light manufactures, enhance private investment and create millions of jobs.
According to new evidence, feasible, low-cost, sharply focused policy initiatives aimed at enhancing private investment could launch the region on a path to becoming competitive in light manufacturing.
These initiatives would complement progress on broader investment reforms and could foster industrialization and raise the market share of domestically produced goods in rapidly growing local markets for light manufacturers.”
Rise of Experiential Luxury
In its report, BCG estimated that sales of the global luxury sector amounted to $660 billion in goods (including luxury cars) and another $770 billion in services. BCG also highlighted a gradual shift in customer preference from owning luxury (goods) to experiencing luxury (services). Experiential luxury includes spa services, safaris, luxury travel, fine dining, special art auctions and other services. BCG deems this subsector to be growing by 12% per year while the market for luxury goods grows by 3 to 7%.
A key driver of experiential luxury is the aging of the population in North America, Europe, Japan and China. As people get older, they are less interested in owning expensive watches and handbags and more interested in valuable experiences. Some luxury product companies are trying to position accordingly. In its considerable portfolio, LVMH now also counts Cheval Blanc, a high-end hotel in Courchevel. But these efforts are so far embryonic.
So can the boom last? Yes, but projecting into the future the strategy of the past ten years will not be enough. The reversal of the dependency ratio in several BRIC countries and the rise of experiential luxury in developed markets pose the biggest challenges. Luxury goods companies will have to adapt their geographic and product footprint accordingly. In the near-term, wider concerns about the global economy override demographic developments. But in the longer term, India and Africa look like promising frontiers while the rest of the world (including China) grapples with an older population and a rising number of dependents.
A new report from the Boston Consulting Group says that shifting demographics is one of the main drivers in the growth of experiential luxury, a subsector which caters to people who favor experiencing luxury (for example at a spa or safari) over owning luxury.
“The research behind the report shows that experiential luxury now makes up almost 55 percent of total luxury spending worldwide and, year on year, has grown 50 percent faster than sales of luxury goods.”
“Four trends are driving the move toward experiential luxury:
The dictates of demographics. In developed economies such as the U.S., Japan, and Europe, consumers who drove the luxury boom in the 1990s are now beginning to retire. They have reached a stage in life when they no longer need nor want to own new “things”—so they are primary customers for experiential-luxury offerings.” READ MORE.
The world’s changing demographics will have a far-reaching impact on our economy.
Context, as we know, can be very important in economics and in investing. Some of the most successful investors of our time might have been unknown humble laborers if they had instead been born in a poor country far away or born in this country at a less propitious time. Context is made of several components including, among others, political risk, the rate of innovation, fiscal and monetary policy, and of course demographics. Some or all of these components can remain unchanged for years or even decades, which may lead a majority of economists and investors to mistakenly view them as permanently fixed. Yet each inevitably comes to an inflection point which destabilizes economic or investment projections built on assumptions derived from the old paradigm.
In the case of demographics, they have acted for decades as sustained tailwinds for the US and global economies. The main drivers of these tailwinds were 1) the rise of the baby boomers and 2) the subsequent decline in the birth rate in North America, Asia and Europe, which resulted in a fall of the dependency ratio (number of dependents per working adult). Because these tailwinds have now largely died down (except in India and other parts of Asia), demographics can no longer be seen as a fixed component of the economic or investment context. What was true for decades is no longer true because we have recently passed an inflection point in demographics.
Going forward, changes in the populations of North America, Europe, Asia and Sub-Saharan Africa will likely undermine economic projections derived from the habits and assumptions of an obsolete context. Unlike the past few decades, demographics should now be considered as a moving variable which may be supportive or adverse to one’s economic or investment thesis. (In my view, every investment portfolio should be subjected to a ‘demographic audit’ which incorporates the impending changes).
Some demographic megatrends were quantified in 2010 by a United Nations report, World Population Prospects, and are summarized in the table below. Forecasting is a difficult endeavor and the UN tries to mitigate the uncertainty by creating four different scenarios, or ‘variants’ of the Total Fertility Rate (TFR), for population projections: constant-fertility, high, medium and low. The constant-fertility variant assumes that the fertility rate (the number of children per woman) in each country and region of the world remains at the same level as it was in 2005-10. This variant shows a shocking increase in the world population to levels which are probably unmanageable, from 7 billion today to 11 billion in 2050 to 27 billion in 2100. It is highly unlikely therefore that fertility rates will remain unchanged. They are today exceedingly high in Sub-Saharan Africa and exceedingly low in Russia, Germany and Japan. The three other variants all result in lower population counts for 2050 and 2100. I use the medium variant below and all figures are UN estimates, not my own (for more detail on fertility assumptions of the four variants, see pages 27-35 of the UN report).
The key points are as follows:
The population in each of the more advanced economies of North America, Europe and Oceania will either grow slowly, stagnate or fall precipitously. In the US and Canada, it will grow slowly. In a large majority of European countries, it will stagnate or shrink moderately. And in Russia, Japan and Italy, it will fall or fall precipitously.
Europe faces a significant demographic challenge. It is in its causes and chronology similar to the challenge we face in the United States but it is more severe because Europe has a lower fertility rate. How do you keep the economy growing when the size of the population and its age distribution are no longer working in the direction of growth? It can be done but it is certainly more difficult. And how do you maintain Europe’s cherished social programs when the number of workers stagnates or declines and the number of retirees increases?
Europe’s population is expected to fall from 738 million in 2010, to 719m in 2050 to 675m in 2100. Because of some growth in Ireland, France and the United Kingdom, the population of Northern Europe would maintain itself or grow modestly. But it will decline in Southern Europe in large part because of Italy, Portugal and Serbia. On medium variant estimates, the number of Italians would shrink from 61m in 2010 to 59m in 2050 to 56m in 2100. Germans would also be fewer, from 82m to 75m to 70m. Eastern Europe (including Russia) would shrink from 295m to 257m to 222m, with every state except the Czech Republic, Hungary and Slovakia losing 20 to 30% of its population count by 2100.
The UN report projects that, at constant-fertility rates, the population of Russia would fall from 142 million in 2010 to 114m in 2050 to 67m in 2100. The more probable medium variant predicts a Russian population of 126m in 2050 and 111m in 2100, still a decline of 31m by the end of the century. Russia suffers from a low fertility rate and a low life expectancy, two factors which are likely to improve in coming years.
Africa presents the opposite profile with the population of Sub-Saharan Africa continuing to grow rapidly. In 2010, the fertility rate in Africa was 4.37 children per woman (5.43 in Nigeria) compared to 1.59 in Europe and 2.08 in the United States. Although fertility rates are expected to fall dramatically, the population of Africa will first grow from 1.02 billion in 2010 to 2.19b in 2050 to 3.57b in 2100 (again, using the UN’s median variant). Of these numbers, Sub-Saharan Africa which has 856 million people today will total 1.96b and 3.36b. Given that the world population is expected to grow from 6.9 billion in 2010 to 9.3b in 2050 to 10.1b in 2100, it is easy to see that a huge part of this growth, 77%, will be coming from Sub-Saharan Africa.
If these numbers are surprising, consider that the world fertility rate stands today at 2.45 children per woman but that it is 4.78 in Sub-Saharan Africa. And while the Sub-Saharan rate is expected to decline to 2.85 by 2050 and 2.14 by 2100, it will not decline fast enough to avert the incoming boom. Indeed, the numbers above already assume such a decline. A fall in the fertility rate usually follows an improvement in health care and a fall in the mortality rate. There is excellent news on this front. As recently reported by the Economist, “16 of the 20 African countries which have had detailed surveys of living conditions since 2005 reported falls in their child-mortality rates”. The World Bank calls this “a tremendous success story that has only barely been recognised”.
China, India and Japan
China was the most populous nation in 2010 with 1.35 billion people but it will be overtaken by India around 2020 when both countries will have 1.39 billion. The impact of China’s one-child policy means that its population count will fade to 1.3b by 2050 and 952 million by 2100, while India continues to grow to 1.69b by 2050 before it also fades to 1.55b in 2100. The assumptions built into these numbers are not extreme. Starting at 1.56 in 2010 (well below the world average), China’s fertility rate would rise to 1.81 by 2050 and 2.01 by 2100. India’s TFR now 2.54 (slightly higher than the world average) would fall to 1.84 by 2050 and tick up to 1.88 by 2100.
Like Europe, Japan’s population will fall by a large percentage. Japan’s fertility rate of 1.42 was in 2010 one of the lowest in the world, but the UN is expecting it to recover to 2.04 by the end of the century. This will not be soon enough to avert a precipitous decline from 126m Japanese in 2010 to 109m in 2050 to 91m in 2100.
The UN expects the population of North America to grow from 344 million in 2010 to 447m in 2050 to 526m in 2100 with nearly all of this growth taking place in the United States (respectively at 310m, 403m, 478m). My own estimate of the US population, published in America Heading for Zero Population Growth?, is lower. Without new immigration, I found that the US population would not grow at all in the 2030s and 2040s. The difference between my estimate and the UN estimate is of the order of 25 to 35 million Americans by 2050, which is significant for the US, but not so significant in the context of global demographics where the numbers are much larger.
On the Demographic Dividend
The demographic dividend is an economic benefit which can occur after mortality and fertility rates decline in a given country. A decline in the mortality rate is generally followed by a decline in the fertility rate, as more women gain access to better health care and to some form of birth control. Over a period of decades, each adult and each working person will have fewer dependents to support. In the right context and with the right policies, this decline in the dependency ratio will yield a demographic dividend. The best examples of the demographic dividend are found in East Asia, and in developed countries. The demographic dividend in the US has largely been reaped and it now threatens to turn into a liability unless we enact the policies needed to deal with its aftermath. I wrote in Our Growing Inactive Population that the dependency ratio is about to reverse unless the retirement age is raised to 70 years.
In theory, Africa could be the next place to benefit from a demographic dividend. This would require not only a big decline in mortality and fertility rates, but also the adoption of government policies which foster political stability and encourage economic development. As to timing, it may be decades before the dividend appears, if at all. Outside of Africa, India could also reap a large demographic dividend.
Outside of the sheer numbers which are startling enough, there are other considerations which flow from the age distributions and economic conditions in various countries. The challenges posed by aging populations on developed economies and their government social programs are well known and documented. It is enough to say that the status quo is untenable since it would lead inevitably to an explosion in government liabilities and to a severe deterioration of the economy. This statement applies easily to North America, Europe and Japan.
“China is confronting the demographic version of “the perfect storm” and these new demographic realities may ultimately force us to revise today‘s received wisdom about “China‘s rise”.”
“China‘s future demographic profile will differ substantially from its current population situation, mainly because of the country‘s low levels of fertility. Although there are some inconsistencies and problems in official Chinese population data, population specialists believe that China became a sub-replacement fertility society about two decades ago—and that birth rates have fallen far below the replacement level since then.”
“In the decades immediately ahead, China will see the emergence of a growing host of essentially unmarriageable young men. This outcome will be the all but inescapable arithmetic consequence of the gender imbalance that has accompanied the country‘s “One Child Policy” – while ordinary human populations regularly and predictably report 103 to 105 baby boys for every 100 baby girls, China‘s officially reported sex ratio at birth (or SRB) was almost 120 boys for every 100 girls in 2005. This imbalance between the numbers of little boys and little girls in China sets the stage for a “marriage squeeze” of monumental proportions in the decades just ahead.”
In India, Eberstadt sees a significant North-South divide correlating the birth rate with education and economic opportunity:
“[India’s] dilemma can be highlighted by contrasting the prospective educational profiles of Kerala (which is now one of India‘s most prosperous states) and Bihar (one of its poorest). In just over a decade and a half, Kerala‘s working-age population will be on the brink of stagnation—but the state‘s working age manpower will be fairly well trained (roughly half of Keralites aged 15-64 would have high school education or better). By contrast, Bihar‘s working-age manpower will still be growing briskly—but as 2030 approaches, these projections suggest that well over half of working-age Biharis will have received no more than some primary schooling, and nearly a third of the state‘s working age manpower will have no formal education at all.”
Globally, Eberstadt sees a slowdown in the growth of the working-age population:
“By the reckoning of the UN Population Division, the world‘s population of “working age” (conventionally, albeit somewhat imperfectly, defined as men and women 15-64 years of age) grew by 1.3 billion, or about 40%, between 1990 and 2010: a pace averaging about 1.7% a year. Given the pronounced global fall-off in fertility over the recent past, however, the world‘s manpower of economically-active ages is set to grow much more slowly between now and the year 2030. By the Census Bureau‘s projections, the absolute increase in the world‘s working age population for 2010-2030 would be around 900 million—400 million fewer than over the past two decades—and the projected average rate of global manpower growth for the coming decades is 0.9% per annum—that is to say, only just over half the tempo for 1990-2010.”
Demographics are not the be all and end all of economics but they are one important factor among many important factors. They open or close a window of opportunity. There is always a risk in extrapolating the present to predict the future and we should view these figures with some skepticism. However the trends outlined above are undeniable, even if their magnitude turns out to be greater or smaller than the figures suggest.