Risk Latte - On Demographic Transitions and Third Year Cycles

On Demographic Transitions and Third Year Cycles

Aditya Rana
February 21, 2011

I have summarised a review of the book "The Fourth Turning" (written in 1997) previously, co-authored by the prescient socio-economist Neil Howe which provided an uncannily accurate description of our current social (and economic) climate. I recently came across (via John Maudlin) an article co-authored by him titled "The Global Aging and the Crisis of the 2020s" which provides an important perspective on global aging and its implications on the type of social, economic and political environment we can expect to see in the next decade.

  • Demographic trends have paid a key role in many of the great invasions, political upheavals, migrations and environmental catastrophes of history.

  • The world’s developed nations are likely to experience a decade of rapidly aging and declining population during the 2020s.

  • The median ages of Western Europe and Japan, which were 34 and 33 in 1980, are expected to rise to 47 and 52 by 2030.

  • The working-age population has already started contracting in Germany and Japan, and will be stagnant or declining in almost all developed countries besides the US.

  • With the working-age populations expected to decline by 0.5% - 1.5% in Japan and many European countries, growth can stagnate or decline as the fall in workers may fall faster than rising productivity.

  • The aging of populations is likely to have a severe negative impact on the economies of the developed world, putting pressure on budgets with rising pensions and health care costs, and a transfer of resources from working-age adults to nonworking elders which are likely to cause political conflict.

  • The decline in savings in the developed world, as more people move into retirement, is either likely to cause cutbacks in investments and therefore lower growth, or an increased reliance in capital from the developing world which would imply higher debt service costs and loss of political leverage.

  • The weakening in the developed world is likely to occur with potentially destabilizing demographic trends in the developing world – with China facing a massive aging wave and Russia experiencing the most severe population implosion since the plague-ridden middleages.

  • While the demographic transition in the developing world from rapidly growing populations and young age structures ( usually associated with poverty and political instability) to low or stagnant population growth and older age structures could eventually result in social and political stability, the journey is likely to be perilous as typically social costs and stresses typically become most acute midway through the transition.

  • We have only one historical example of a large group of countries completing their entire demographic transition - theWestern World, and their experience was filled with the most destructive revolutions, civil wars and wars in the history of civilization.

  • China is likely to be the first country which grows old before it grows rich, and by 2030 will be an older country than the US leading to a weakening of the two pillars which provide legitimacy to the political regime – GDPgrowth and social stability.

  • China’s aging wave (with its resulting instability) is likely to coincide sometime in the 2020s with its expected overtaking of the US as the world’s leading economic power, and based on historical experience this period could be quite perilous.

  • In the 2020s, Russia, along with the rest of Eastern Europe, will be experiencing a population decline steeper than any in the developed world. Russian men’s current expected life expectancy is 60 – lessthan that of their grandfathers at the end of WW11. This weakening raises the prospect of a failing or failed state with nuclear weapons.

  • Some of the developing countries which have recently experienced a sharp fall in fertility rates (Latin America, South Asia and the Middle East) are likely to experience an echo boom in the 20s- in particular Pakistan and Iran, leading a sharp upsurge in young populations and thereby exacerbating social stresses.

  • Demographic changes may be more threatening to world security than even the cold war. Therefore planning national strategy over the next several decades without paying heed to this transition is akin to sailing ship without a map or compass.

  • Over the next several decades, the outlook for the US will be increasingly divergent from the rest of the developed world due to its higher fertility rate and net immigration – by 2030 its median age will only rise from 37 to 39 and its working age population will continue to grow in the 2020s and beyond.

  • While the share of Canada, France, Germany, Italy, Japan and the UK of total G-20 GDP is projected to fall from a current 38% to 16% by 2050 – the share of the US will drop from 34% to 24% by 2050. According to the UN, by 2050, theUS will be the only developed country in the most populous nations in the world – maintaining its current rank of third place.

  • "Population trends point inexorably towards a more dominant role of the US in the world that will need America more, not less"

The impact of demographic changes on economies and markets is a poorly understood (and recognised) phenomena and it pays to pay close attention to what Neil Howe has to say on the subject. Note that Japan’s working age population commenced its decline in the late nineties,while its economy and stock market peaked in 1990. China’s working age population is expected to start declining in the late 2010s, while Germany’s after 2015 and they will have a significant impact on their economies and markets well before that date. As Daniel Gross (Director of the Centre for European Policy Studies) points out in a recent note:

"While much has made of Japan’s lost decade as it grew by only 0.6% per annum over the last decade (versus 1.7% for the US and 0.6% - no typo- for Germany!) It actually outperformed the US by 0.5% per annum by another important measure – GDP per head of working-age population (WAP), which measures the true productive potential of an economy. Demographic differences are relevant not just in comparing Japan and the US, but also in explaining most of the differences in longer-term growth rates across developed economies. Looking to the decade ahead, this analysis suggests that one can predict the rich countries’ relative growth rates based on the growth pattern of their working-age populations, which one already knows today, given that anybody starting to work over the next two decades has already been born.

On this basis, Japan’s relative decline as a major economic power will continue, as its working-age population will continue to shrink by about 1% per year. Germany and Italy increasingly show Japanese patterns of decline in their working-age populations, and are thus likely to grow very little as well. The current strength of the German economy is also partly due to a temporary demographic stabilization. But a Japanese-style scenario seems inevitable after 2015. By contrast, the US, the United Kingdom, and France are likely to grow faster for the simple reason that their working-age populations are continuing to grow, even if at a relatively slow pace. Two lessons emerge from this consideration of the influence of demographic factors on economic growth. First, the idea of a Japanese-style "lost decade" is misleading – even when applied to Japan. Slow growth in Japan over the last decade was due not to insufficiently aggressive macroeconomic policies, but to an unfavourable demographic trend. Second, a further slowdown in rich countries’ growth rates appears inevitable, given that even in the more dynamic countries the growth rates of the working-age population is declining. In the less dynamic ones, like Japan, Germany, and Italy, near-stagnation seems inevitable."

To follow-up on last week’s newsletter – whereGrantham refers to the powerful impact of the Third Year of the Presidential Cycle on markets, driven by aggressive stimulus (further spiced this year by the addition of QE2), I present below a graph (via Marcomon) comparing the progress of the current market versus an average of previous Third Year cycles since 1955. By all means wait for corrections to accumulate exposure to equities - but you would be working against a powerful historical trend - a steady monthly accumulation into the summer would be a more rewarding strategy!

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