Do demographics really condemn us to a bleak future?

Do demographics drive markets? George Magnus of UBS, who I interviewed last week, isn’t convinced.

He accepts that the “halcyon era of sustained equity and real estate price appreciation from the 1980s until the financial crisis” happened just as the baby boomers of the 1960s entered the work force. Clearly this brought women, and well educated women at that, into the workforce and meant the quantity and the quality of labour rose at the same time.

So consumption rose and savings rose too. Those savings went into equities in one way or another (via pensions and so on). They also went into property (particularly in the US and the UK).

He isn’t so sure of the rest. According to the next part of the story, this “demographic dividend” was the main reason – perhaps the only reason – why the prices of all these assets rose.

The problem now is that this process has run its course. For the last 30 years or so, falling fertility has reduced child dependency, yet, with the size of the working population rising, we haven’t had to worry too much about the ratio of dependent old people either.

Today, low fertility rates mean there isn’t a ready supply of new workers, and the baby boomers themselves are on the verge of being old – demanding care costs and endless time from their children.

As far as the demographic doomers are concerned, this means that we can just turn our charts upside down. Savings will fall at the same time as the number of people of first-time-buyer age falls: “the number of 20-44 year-olds, deemed to be the prime first-time home buyer cohort, will fall by 10-20% in the next two to three decades in most advanced nations, but by 30% in Spain and China, and by a whopping 40% in South Korea.”

The result? Equity prices will fall. And so will property prices. Fast.

It sounds like a good story, I say to Magnus. What’s wrong with it? The main thing, he says, is that “the whole aging thing is unique in human history” so we just don’t know how it will pan out.

It might make sense to say that returns on equity will be lower than they have been. But to suggest that “the entire asset appreciation of the last 30 years” is down to demographics? Here he explains why that is “patently absurd”, given that it totally ignores the “effects of financial deregulation and innovation and a virulent expansion of credit.”

And what of “macroeconomic management, profits, innovation, governance and financial stability”?

It is also the case that “capitalism rewards scarcity,” so we can expect, in the West at least, to see labour beginning to claw back some of the rewards that have accrued to management and equity over the last decade. Some may think that a bad thing. I am pretty certain it isnot.

Either way, the point is that it isn’t a given that aging populations make for falling asset markets. And even it turns out that they do, the effect won’t be seen for a while. ”Demographics are slow moving and relatively predictable, and asset markets are sensitive to an array of economic and financial developments, most notably the credit cycle.”

It is also worth noting that forecasting markets based on demographics is only as good as the forecasting of the demographics. Which isn’t generally very good. 

Every year, Japan’s National Institute of Population and Social Security Research (NIPSSR) puts out a forecast for Japan’s future population. They usually get it wrong. In 2006, their medium forecast for the Japanese population was 127.18 million. Their most optimistic forecast (of nine) was 127.64 million. The actual number in 2010 was 128.06 million.

The difference, says Jonathan Allum of Mizuho in the Blah, comes down to fertility. 2005, when fertility in Japan was 1.26, did not mark, as everyone thought it did, just another point on a downward path. It was the bottom. The number is now 1.39.

The world’s many Malthusians have, as Allum says, long “been confounded” by the fact that fertility falls as wealth increases. However this inverse correlation does not last forever. 

Here is Matt Ridley on the subject in his 2010 book The Rational Optimist: “The latest research uncovers a second demographic transition in which the very richest countries see a slight increase in their birth rate once they pass a certain level of prosperity. The United States, for example, saw its birth rate bottom out at 1.74 children per woman in about 1976; since then it has risen to 2.05. Birth rates have risen in eighteen of the twenty-four countries that have a Human Development Index greater than 0.94.”

At the time, Ridley referred to Japan and Korea as “puzzling exceptions” to this rule. They are not. Both have, against all expectations, seen rises in their fertility rates in the last few years. Another reason perhaps why things in Japan aren’t quite as bad as the bears think they are.