A version of this article, authored by Kim Catechis, Investment Strategist at Franklin Templeton Investment Institute, first appeared in The Bulletin: Demographics and long-term growth. OMFIF, Summer 2023.
Demographics as a driver of economic growth
Conventional wisdom points to young demographics as a driver of economic growth.
The thesis is that young populations indicate a growing labor force, suggesting productivity gains long into the future. The reality is more complicated.
Having a lot of young people is clearly good, but they need to be healthy enough to work and able to learn appropriate skills for the labor market. We don’t need millions of Ph.D.s, but rather, a relatively well-educated pool of young people, because they are more easily employable. Given the trend toward automation and artificial intelligence (AI), the growth of the “knowledge” economy drives demand for skilled workers. A young, well- educated labor force will attract investment in high-margin, productive areas, providing the positive driver for economic growth.
The countries that have driven global economic growth in the last generation are those with aging populations, which likely will result in slower economic growth in the future. Even though many individuals are working beyond the typical retirement age, working age-populations are shrinking. As the pension-age cohort increases, governments will try to find solutions to the anticipated slowdown in economic growth. Exhibit 1 on the next page demonstrates the importance of net labor-force growth as a contributor to gross domestic product (GDP) growth.
Demographics is also an important driver of debt issuance—
and of ratings
A wave of liabilities is growing around the world, as aging populations imply significantly higher healthcare and pension costs. It is not about the number of young people; it is policy direction that matters. Governments that implement policies to encourage savings for pensions and invest in healthcare provision are less likely to be challenged.
Exhibit 2, on the next page, illustrates the incremental cost of pension and healthcare provision up to 2050, expressed as a percentage of 2021 GDP. The colors denote each country’s position away from that optimum point of “demographic dividend1:”
Exhibit 1: Contributors to Annualized GDP Growth of OECD Countries
January 1995–June 2022
Exhibit 2: The Economic and Fiscal Impact of Aging Populations
2021–2050 Estimated Change as Percent of GDP
“Early demographic dividend” countries also risk significant growth in liabilities in the next generation. Saudi Arabia for example, has a relatively young population, and needs to finance the equivalent of over 115% of 2021 GDP by 2050. China, a giant economy with a shrinking population, has a liability of 120% of 2021 GDP. The impact of policymaking is very clear in the few countries in this selection that have essentially overfunded their pension obligations. They include Estonia, Denmark, Sweden and Australia.
The role of demographics in country credit ratings
France recently suffered a credit-rating downgrade amid the struggle to raise the retirement age by two years, to 64. The rationale for the downgrade rests on the inconvenient truth that even a single percentage-point increase in borrowing costs has a compounding effect over a decade, resulting in significant growth of the debt burden. The conclusion, however, is that any government’s visible difficulty in enacting reforms bodes poorly for the prospects of a course correction to avoid further difficulties in the future. Growing pressure on public finances demands reform of the extent of social service provisions and/or fiscal policy, to keep government finances sustainable.
The traditional view of demographics as a driver of economic growth is no longer appro- priate. Qualitative factors override this assumption. For aging countries, the challenge is primarily to ensure continuous improvement in educational standards, because their economies are becoming more knowledge and technology-driven. For “younger” countries, the challenge is similarly education-related, because they need to offer more than cheap unit-labor costs.
However, the global economic and geopolitical environment constrains policymakers’ options as businesses diversify supply chains and respond to incentives for investment, like the US government’s Inflation Reduction Act. This means that high-fertility countries cannot simply follow the old playbook of attracting foreign direct investment FDI into labor-intensive industries; they must try to leverage their mineral wealth or their strategic positioning instead.
Allowing for cultural and wealth disparities between countries, consumption patterns generally will change. This evolution of savings and investment will drive real interest rates, real exchange rates and even returns on investment. Demographics is not destiny, but it can set parameters.
1. The United Nations Population Fund definition holds that there is a demographic dividend, i.e., a period of accelerated economic growth that may occur when a country has a growing population of workers, because they are productive generators of economic wealth.
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