Demographics are not destiny, but they can set parameters

The traditional view of demographics as a catalyst for economic growth is no longer appropriate, writes Kim Catechis, investment strategist at Franklin Templeton Investment Institute.

Conventional wisdom points to young demographics as an impetus of economic advancement. The rationale is that young populations indicate a growing labour force, suggesting that there will be productivity gains long into the future. The reality is more complicated.

A large population of young people is good for several reasons, but they need to be healthy enough to work and able to learn skills appropriate for the labour market. A relatively well-educated pool of young people is preferred as they are more employable and, given the trend towards automation and artificial intelligence, the growth of the knowledge economy urges demand for skilled workers. A young, learned labour force will attract investment in high-margin, productive areas, providing a positive push for economic growth.

The countries that have propelled global economic growth in the last generation have historically been those with ageing populations – which will most likely result in slower economic growth in the future. Even though many individuals are working beyond the typical retirement age, working-age populations are shrinking. As the pension-age cohort increases, governments will try to find solutions to the anticipated slowdown in economic growth. Figure 1 demonstrates the importance of net labour-force growth as a contributor to gross domestic product growth.

Figure 1. The contribution of net labour-force growth to GDP growth

Annualised growth rate of Organisation for Economic Co-operation and Development countries, 1995-2022 (%)

Source: OECD, World Bank, Macrobond, Franklin Templeton analysis

 A wave of liabilities is growing around the world as ageing populations imply higher healthcare and pension costs. It is not about the number of young people; 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.

Figure 2 illustrates the incremental cost of pension and healthcare provision up to 2050, expressed as a percentage of 2021 GDP. The colours denote each country’s position away from the optimum point of demographic dividend.

Figure 2. The economic and fiscal impact of ageing populations

Net present value of pension spending 2021-50 (estimated % of GDP)

Net present value of health care spending 2021-50 (estimated % of GDP)

Source: IMF, Macrobond.
Note: The United Nations Population Fund definition holds that there is a demographic dividend, i.e. a period of accelerated economic growth that may occur when a country has a growing population of workers, because they are productive generators of economic wealth.

Early-demographic-dividend countries also risk marked growth in liabilities in the next generation. Saudi Arabia, for example, has a relatively young population and needs to finance the equivalent of over 115% of 2021 GDP by 2050. China, a large economy with a shrinking population, has a liability of 120% of 2021 GDP. The impact of policy-making is very clear in the few countries in this selection that have overfunded their pension obligations – including Estonia, Denmark, Sweden and Australia.

France suffered a credit-rating downgrade amid the struggle to raise the retirement age by two years, to 64. The rationale for the downgrade rests on the inconvenient truth that even a single percentage-point increase in borrowing costs has a compounding effect over a decade, resulting in major growth of the debt burden. The conclusion, however, is that any government’s visible difficulty in enacting reforms bodes poorly for a course correction to avoid further difficulties in the future. Growing pressure on public finances demands reform of social service provisions and/or fiscal policy to keep government finances sustainable.

The traditional view of demographics as a catalyst for economic growth is no longer appropriate. Qualitative factors override this assumption. For ageing countries, the challenge is primarily to ensure continuous improvement in educational standards because their economies are becoming more focused on knowledge and technology. For younger countries, the challenge is also education-related with the need to offer more than cheap unit labour costs.

Policy-makers have few options. Where businesses are diversifying supply chains and responding to incentives for investment –such as in the US’s Inflation Reduction Act – high-fertility countries cannot simply follow the old playbook of attracting foreign direct investment into labour-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 will generally change. This evolution of savings and investment will drive real interest rates, real exchange rates and even returns on investment. While demography sometimes falls short of drawing the blueprint, it can certainly lay the groundwork for future growth if correctly harnessed.

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