A transformation is taking place in the Developed World. It is vital to understand that demographics will worsen over the next thirty-five years and this is already having a dramatic influence on economic growth and asset prices. 1) We are feeling the impact of a declining or slower-growing labor force, an aging population and lengthening life expectancy of dependents in the developed world, on growth and on wealth creation / destruction. 2) This is magnified by large levels of household and public debt. The impact suggests that slow growth, low inflation or deflation, economic dissatisfaction thus populist tendencies and low rates of economic return can be expected to be with us long into the future.
Long-term influence on our investment philosophy
Changing demographics will be the number one secular influence over the next 35 years. Potential GDP growth is going lower. GDP growth is the sum of working age population growth + productivity growth. Over the past 35 years, my entire working career, the working age population in the US has grown at 1% p.a., Europe at 0.1% p.a. and Japan at -0.4% in Japan. We have lived the effects of these population dynamics on growth and wealth creation/destruction, magnified by the growth in private and public debt, which is topping out now.
Unfortunately, these demographic impacts look set to worsen over the next 35 years and this has visibly started. Forward-looking US working age population growth is estimated at 0.3% per annum over the next 35 years, 1/3 of the historic 1% rate (same with France, the UK and Brazil). Worse however, China, Germany, Italy, Japan and Russia are all forecast to see working age populations decline between -0.6% and -1% p.a. (compound that over 10-20 years!). This is new and has a huge influence. Other headline countries that should experience rapidly deteriorating demographics include S. Korea, Taiwan, and Spain. Faced with this demographic headwind, it will take extraordinary productivity gains to return growth to the levels that we considered trend growth throughout our careers and which we are all trained to expect and operate under.
Unfortunately, productivity gains have also been declining. Post the financial crisis, productivity growth rates have averaged less than 1% p.a. in China, Brazil and India and are lower in all G7 countries. So we have declining population growth rates and declining productivity growth rates. Chances are growth will be slower (growth nonetheless, just sluggish). Countries that should do better are those countries that combine substantial state and private wealth and an openness to immigration – e.g. developed market economies such as the US, UK, Germany and Switzerland. Others that could do ok are recovering situations such as Argentina and Brazil where productivity must surely improve and demographics are not negative.
So, as a result, economies are not able to return to their virile selves as long as demographics and high levels of leverage remain a constraint on both consumption and investment. This suggests that sluggish growth, low levels of inflation and even deflation, and concomitant low rates – lower for longer – can be expected to be with us long into the future. Economies should remain sufficiently strong to enable slow growth and debt coverage. But general growth as a large driver of wealth creation should no longer be counted on as a strategy for generating and preserving wealth. And the risk is that any economic downturns will likely lead to negative growth and disinflation for potentially protracted periods and that this will be in conflict with the need to service debt. This is what the CB’s will fight.
(But it is not such a dark environment. Technological advance and digitization are advancing rapidly, which will benefit society and cause exciting creation and Schumpeterian destruction of wealth in tech, energy, finance and consumer markets.)