"Developing countries are positioned to enjoy a demographic dividend from now until 2030-35"
Population ageing has been an area of focus for the UN since it published a major report on the topic in 1956. In the past 25 years, the UN has organised three major international conferences on the topic, and published a number of detailed research reports. The most important of these for today's investor are the report on ‘World Population Ageing: 1950-2050', prepared for the 2002 World Assembly on Ageing, and its follow-up, ‘World Population Ageing 2007'.
The conclusions from the UN's research are clear. Firstly, as a result of the transition from high to low fertility and the continuous reduction of adult mortality, the population of most countries is ageing, and doing so at an unprecedented rate. A population ages when increases in the proportion of older persons (60 years or older) are accompanied by reductions in the proportions of working age persons (age 15-59). The number of older people exceeded the number of children in the developed world in 1998, and the UN forecasts that this will happen for the world population by 2047. Secondly, this is happening everywhere.
However, there are significant differences between developed and developing regions. In the developed regions, over 20% of the population is currently aged 60 years or over. By 2050, the UN predicts that this will reach a third of the population. In the developing regions, older people currently account for just 8% of the population. The UN predicts that this will rise to 20% of the population by 2050: in other words, the emerging world will be where the developed world is now.
Implications for developed economies
The ‘potential support ratio' indicates how many potential workers there are for each older person. As a population ages, the potential support ratio tends to fall; between 1950 and 2007, the potential support ratio declined from 12 to nine potential workers per person aged 65 or over. The UN predicts that globally the potential support ratio will drop to four.
Of the developed countries, Japan and much of western Europe face serious problems. Japan already has the world's oldest median age of 43 years. Both Japan and western Europe have well developed and comprehensive social security systems to support workers once they retire. However, this depends on having a suitable number of taxpayers supporting it. As the potential support ratio declines, both Japan and western Europe will need to review these systems and decide whether they are affordable. With the decline in the working population, income from tax is likely to come under pressure, everything else being equal. It seems likely that these countries will see their sovereign credit ratings under threat.
The US, the UK, Australia, Canada and Scandinavia have stronger demographics. However, the affordability of ageing and healthcare spending is still likely to be a substantial challenge for the authorities, particularly in the US. This has important implications for the affordability of social security schemes. An ageing population will affect the pace of economic growth, long-term savings and investment, consumption, labour markets and taxation. From a social perspective, population ageing influences family living arrangements, demand for housing and the need for healthcare, among other things.
Banking the demographic dividend
Although the world's population is ageing, this process is far more advanced in the developed world. Nevertheless, many of the world's developing markets still have favourable demographics - young, growing working age populations ready to enter the workplace.
The research carried out by the UN suggests that these countries are positioned to enjoy a ‘demographic dividend' from now until 2030-35, where economic growth and productivity should receive a boost from an influx of new workers.
Favourable demographics alone is not a guide to the countries most likely to realise this benefit. They can be supportive, but political stability and the availability of jobs for these new workers are essential ingredients, too, if the opportunity is not to be missed. In our view, India, the Middle East and North Africa, Indonesia and Malaysia are particularly well positioned to benefit from demographics over the coming decades. All of these countries have young populations ready to join the labour market.
While many developing countries should benefit from the demographic dividend, China and South Africa are the exceptions. Both countries have demographic profiles that are closer to developed markets than developing. We expect growth in the labour force to stall and in the case of China even shrink over the coming years.
This is not to say we believe the long-term prospects for these markets to be unattractive. On the contrary, we remain very positive on the long-term outlook for China in particular. However, neither China nor South Africa will receive support from a youthful demographic in the way that a number of other developing economies will.
We do expect the Chinese economy to find a degree of support from continued urbanisation. In its 2009 revision of ‘World Urbanisation Prospects', the UN expects urbanisation to continue rising across the world over the next 40 years, often at the expense of rural areas.
Once again, this is likely to play out across developed as well as in developing economies, although at a slower pace. The pace of urbanisation is likely to be most rapid in the developing world, particularly in China, bringing both potential for productivity gains and challenges to provide suitable infrastructure and to tackle rural depopulation.
Since the mid 1990s, the number of cities in China with at least one million inhabitants has increased. In 1980, China had only 51 cities of that size. This has risen to 235 today, and is forecast to rise to 369 by 2025. China's urban population has more than doubled over the last 30 years and is expected to reach 59% by 2025.
From an investment perspective, these developments have important consequences for growth, savings, investment and consumption, labour markets, pensions and taxation.
It is clear that Japan and much of developed Europe face a serious challenge if they are to maintain the current social security system for retirees, and it is not clear whether the political will exists to make the changes needed to fund them. It also seems likely that credit agencies will downgrade sovereign debt as a consequence. Indeed, S&P published a paper in in 2005 in which it projected likely sovereign trends based on a scenario with no change to government fiscal policies for age-related spending. The results were shocking and projected the collapse to junk ratings for each of the US, the UK, Germany and France by 2035.
We have long had a bias to the world's developing equity markets. However, we believe that favourable demographics strengthen the case for investing in the world's emerging debt markets, too.
The fundamentals for many of the world's developing countries look attractive, particularly when compared to the deteriorating public finances across many developed countries. With the prospect of faster growth and improved productivity over the coming decades, we expect the risk premium applied to emerging market debt to come down as the benefits start to come through. With local currencies additionally likely to strengthen against developed market counterparts, we believe the long-term investment prospects for local currency emerging market debt look attractive from here.