Economic outlook: Beware of demographic risks
One of the biggest drivers of global growth is demographics. These should continue to push emerging economies forward over the coming years, while weighing heavily on the public finances of already stressed developed government finances
Europe is currently the biggest risk to the global economy. At this point, we see the dissolution of the eurozone as a remote possibility. The cost of disintegration, relative to the benefit, would be too high for the member countries and the world.
The European debt crisis has more to do with the lack of fiscal union than it has to do with debt. The proposals presented at the December 9 EU summit are positive steps toward a fiscal union and necessary for survival of the region. We think this is just the beginning of fiscal integration, and we are likely to see more proposals in the future.
There still needs to be a sufficient backstop in place to regain market confidence, such as more bond buying by the European Central Bank, IMF loans, and a larger and more robust EFSF/ESM. These are not solutions to the sovereign debt problem but will buy the eurozone time, as the move to fiscal union through austerity and debt reductions will take several years.
There’s also a risk that markets will turn their attention to other debt-ridden nations, especially if European concerns intensify. The US and Japan are the biggest risks since they are large economies that have similar, if not worse, debt positions than Europe. US gross debt outstanding as a percentage of GDP is slightly higher than the overall eurozone’s, while Japan’s government debt is roughly double that.
Emerging economies, however, have managed to keep their debt positions low. The Bric economies have roughly half of the sovereign debt outstanding as a share of GDP that these developed economies have.
Several years from now, many of the highly indebted countries might see their debt positions improve, whether through faster economic growth, inflation, or financial repression. But many developed economies will face a big lingering challenge: an ageing population. The most negatively affected will be developed Europe and Japan.
Most countries’ populations are getting older, but some faster than others. According to the US Census Bureau, the world’s median age is around 29 and is projected to rise to over 37 by 2050. Japan and Germany already have median ages close to 45. This compares with the Philippines, Egypt, South Africa, and Saudi Arabia, where the median age is still under 25.
Some of the fastest-ageing populations come from the Asian Tigers, which have the lowest fertility rates in the world, even lower than China’s. Hong Kong, for example, will have a median age of almost 60 by 2050. The median age in some developed economies, such as the US and Australia, will remain fairly stable through 2050. Much of this is due to relatively high fertility rates and immigration. In fact, the US will have the smallest increases and therefore one of the lowest median ages by 2050.
One of the most beneficial demographic periods that all countries have experienced or will experience is called the demographic dividend. This is when the working population is rising, while the share of the dependent young and old is falling.
Assuming all else is constant, a rising share of the population that is working translates to increased output per capita. This period has been associated with rising tax revenues, savings, and incomes, and can last for several decades. Research has shown that these favourable demographics in East Asia have accounted for one-third of growth in per capita GDP since the mid-1970s.
In developed Europe and Japan the demographic dividends peaked in the mid-1980s to early 1990s. Led by Japan, many of these countries will have almost one dependent per working-age individual by 2040. The US, Australia, and Canada have the most favorable demographic dividends among developed markets, but these are currently around their optimal levels.
Many emerging markets have several good years ahead of them. Working-age populations in Latin America will not peak until the mid-2020s. Asian countries, such as India and the Philippines, as well as South Africa and the Muslim world, will not see a peak for at least another three decades.
China, the Asian Tigers, Russia, and some other former Soviet countries are approaching the climax of their prime demographic period, with low fertility rates mostly to blame. Unlike some of their more developed counterparts, their peaks come at a time when their population are not as affluent. Turkey is one of the few bright spots in eastern Europe; its working-age population is not expected to peak for another decade.
An ageing population will put an increased burden on governments, which often provide aid to seniors through various forms of income support.
The Center for Strategic and International Studies estimates that public benefits to the elderly as a percentage of GDP is the highest in developed economies, where social safety nets are relatively sophisticated and inclusive.
Developed Europe’s public spending on the elderly is among the highest, making up roughly 15% of GDP. That ratio is expected to reach about a quarter of GDP by 2040. Not only is this because the region’s populations will be some of the oldest in world, but also because pension schemes are relatively more generous.
This increases incentives to retire early, putting even more pressure on government finances. According to the OECD, the gross public pension replacement rate is over 50% for most of developed Europe’s main economies. Notably, in Greece it is 95.7% and 81.2% in Spain. While Japan faces one of the fastest-ageing populations in the world, its less generous pension system will put a comparatively smaller burden on public finances. The US, Canada, and Australia face less of a weight relative to other developed economies because of more favorable demographics.
The government burden in emerging economies is expected to be much smaller. This is mostly because their populations are not ageing as quickly, but it’s also because there is less-developed old-age income support. According to the OECD, only 9.1% of Indians and 20.5% of Chinese are covered by mandatory pension schemes. This compares with the developed world, where more than 90% of the population is covered. Emerging economies instead rely on families for old-age support. These countries will eventually have to come up with a more formal way of providing for their ageing populations, but there’s still plenty of time to do so.
Emerging economies are generally the winners. They currently have some of the lowest debt burdens in the world and face a much more favourable demographic outlook, with many countries having up to 30 years before their working-age populations peak. The result is higher economic potential and a smaller burden on government finances. Low fertility rates in some parts of Asia and in eastern Europe might present risks to these economies in the next decade or two.
Japan and developed Europe have the biggest ageing problems. Their demographic dividends peaked in the early 1990s and they are likely to be feeling the impact of their ageing populations, as per capita GDP growth has been slowing since then. Sovereign debt as a share of GDP for most of these countries is around 100% or even more. A quickly ageng population will exacerbate government burdens even more, unless big reforms are undertaken.
The US and dollar bloc countries of Australia and Canada have a much more favorable demographic outlook compared with other developed economies amid higher fertility rates and greater immigration. If the US can focus on reducing its debt and eliminating its structural imbalances, its favorable demographic profile should create a positive economic future.
Alejandra Grindal is senior international economist at Ned Davis Research, a leading independent research group.
This article, with supporting data, will be published in the January issue of Euromoney.
For more information on Ned Davis Research Group, visit ndr.com