Saturday, July 14, 2012

Demography is destiny

... was the recent tagline of the morning briefing that Dr. Ed Yardeni sent out to his clients on June 13th. He achieved rock star following on Wall Street when he prognosticated in the late eighties that the Dow will reach 10,000 following the down-fall of communism in Europe. He argued that worldwide prosperity and peace that would follow the fall of  communism in eastern Europe would spur US equity markets to greater heights.  Oh boy! did did that come true or not. He has been known often to correlate equity market performance with demographic shifts. We are equally thrilled to refer to that piece here, for he used the  publication on demography that chief market strategist, Sailesh Radha, of IMRA developed for his firm Yardeni Research Inc. to build his narrative...   

This is what Yardeni told his clients about demography in his briefing today:

....." Demography. Demography is destiny. If so, then the future will be challenging in many countries around the world where fertility rates have dropped below the replacement rate . At the same time, people are living longer. So dependency ratios are destined to soar.

Why have fertility rates fallen around the world? There are a few plausible explanations. One of them stands out, in my opinion: Socialism may breed infertility! In the past, people relied on their children to support them in their old age. Your children were your old-age insurance policy. Over the past few decades, people have come to depend increasingly on social security provided by their governments. So they are having fewer kids.

That’s fine as long as the ratio of retirees to workers isn't so high that the burden of supporting our senior citizens crushes any incentive to work resulting from excessively high tax rates. The cost of increasingly generous and excessive entitlements has been soaring relative to taxable earned incomes even before dependency ratios are set to rise in many countries. Governments have chosen to borrow to finance social security and other entitlements, to avoid burdening workers with the extremely high tax rates that are necessary to balance entitlement-bloated budgets.

Bond markets may be starting to shut down for countries that have accumulated too much debt. That’s creating a Debt Trap for debt-challenged governments. If they slash their spending and raise their tax rates, economic growth will tend to slow. If tax revenues fall faster than spending, their budget deficits will widen. There has recently been an outcry about the hopelessness of such “austerian” policies that perversely lead to higher, rather than lower, debt-to-GDP ratios. Let’s examine some of the relevant demographic developments around the world:

(1) Median ages are highest in advanced economies with large social welfare states. The UN compiles all sorts of demographic data. Among the most interesting are median ages for the countries of the world. I asked Sailesh Radha, our consultant, to collect the data. He did so for 45 countries for 2010. Japan has the highest median age (44.7), while the Philippines has the lowest (22.2). Advanced economies tend to have higher median ages than emerging ones because they provide more social welfare, which boosts longevity and depresses fertility.

(2) China is aging quickly. Among emerging economies, China has one of the highest median ages at 34.5, up from a low of 19.7 during 1970 (Fig. 10). The country’s fertility rate plunged from a high of 5.9 births per woman during 1966 to a replacement rate of 2.1 during 1992. It has been below this rate ever since then, falling to a record low of 1.6 during 2009.

The UN’s population projections show that the cohort of 15- to 24-year-olds rose from 98 million in 1950 to a peak of 249.8 million during 1990. It is projected to fall back down to 124.2 million by 2050. Of course, China’s demographic profile is a consequence of the one-child policy imposed by the government during 1979. Now anecdotal evidence suggests that China’s labor force growth is already slowing along with the supply of new entrants. This is why the country’s growth rate is slowing.

(3) Europe is old and infertile. The median age in Germany was 44.3 in 2010. It was 43.2 in Italy, 40.1 in Spain, 39.9 in France, and 39.8 in the UK. UN population projections show a plunge in the 15- to 24-year-old age group exceeding 20 million over the next two decades in Europe. That’s because fertility rates dropped below the replacement rate in most European countries during the late 1970s and early 1980s."...