Quick Thoughts: Demographics are not destiny

Demographics as a driver of economic growth

Conventional wisdom points to young demographics being 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.

Many observers say China’s shrinking population is an indicator of the country’s economic slowdown. However, populations that are educated can fight the negative impact of aging via retraining and adapting the workforce to new technologies. In China, every two workers who retire will have had around six years of formal schooling. They are being replaced by 1.6 young people with around 14 years¹ of formal schooling. The country is upskilling its labor force by default.

Having a lot of young people is clearly good, but they need to be healthy enough to work and able to learn the skills that are in demand in 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 tends to attract investment in high margin, productive areas, providing the positive driver for economic growth.

Pensions and healthcare

A wave of liabilities is growing around the world, driven by aging populations that imply significantly higher healthcare and pension costs. It is not about the number of young people; we think 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 1 illustrates the incremental cost of pension provision up to 2050, expressed as a percentage of 2022 gross domestic product (GDP). The colors denote each country’s position away from that optimum point of “demographic dividend.”²

“Early demographic dividend” countries also risk significant growth in liabilities in the next generation. For example, Saudi Arabia has a relatively young population and needs to finance the equivalent of over 160% of 2022 GDP to pay for pensions provision by 2050. China, a giant economy with a shrinking population and a liability of 95% of 2022 GDP, is another example. The impact of policymaking is very clear in the few countries we highlight that have essentially overfunded their pension obligations. They include Estonia, Denmark, Sweden and Australia.

Exhibit 2 above demonstrates the difference in healthcare liabilities between, for example, Nigeria and the United States. The longer people live, the more healthcare they will typically require; therefore, the higher the cost. In the United Kingdom, an equivalent of more than 64% of 2022 GDP will be needed to cover the healthcare liabilities of 2050. In the United States, that number is 150% of 2022 GDP. The point about policy remains the most important variable, in our view. In the countries we highlight here, Sweden is the best-prepared aging country—because of historic policy action.

Conclusion

The traditional view of demographics as a driver of economic growth is no longer appropriate, in our view. 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 countries with more youthful demographics, the challenge is similarly education-related, because they need to offer more than cheap unit labor costs.

However, the global economic and geopolitical environment has constrained policymakers’ options, as businesses diversify supply chains and respond to incentives for investment, such as the US government’s Inflation Reduction Act. This means that high-fertility countries cannot simply follow the old playbook of attracting foreign direct investment 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 can set parameters.