Consider This: Demographics and long-term growth

Demographics as a driver of economic growth

Conventional wisdom points to young demographics being a driver of economic growth. The thesis is that young populations indicate a growing labor force, suggesting productivity gains long into the future. The reality is more complicated.

Having a lot of young people is clearly good, but they need to be healthy enough to work and able to learn the skills that are in demand in the labor market. We don’t need millions of Ph.D.s—but rather, a relatively well-educated pool of young people, because they are more easily employable. Given the trend toward automation and artificial intelligence (AI), the growth of the “knowledge” economy drives demand for skilled workers. A young, well-educated labor force tends to attract investment in high margin, productive areas, providing the positive driver for economic growth.

Example: Many observers cite China’s shrinking population as an indicator of the country’s economic slowdown. However, populations that are educated can fight the negative impact of aging via retraining and adapting the workforce to new technologies. In China, every two workers who retire will have had around six years of formal schooling. They are being replaced by 1.6 young people with around 14 years¹ of formal schooling. The country is literally upskilling its labor force by default.

The countries that have driven global economic growth in the last generation are those with aging populations, which likely will result in slower economic growth in the future. As the working-age populations shrink despite the fact that individuals are working past traditional retirement ages, and as the pension-age cohort increases, governments will likely try to find solutions to the anticipated slowdown in economic growth. Exhibit 1 below demonstrates the importance of net labor-force growth as a contributor to gross domestic product (GDP) growth.

Demographics is also an important driver of debt issuance—and of ratings

A wave of liabilities is growing around the world, driven by aging populations that imply significantly higher healthcare and pension costs. It is not about the number of young people; we think 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.

Exhibit 2 illustrates the incremental cost of pension and healthcare provision up to 2050, expressed as a percentage of 2022 GDP. The colors denote each country’s position away from that optimum point of “demographic dividend.”²

“Early demographic dividend” countries also risk significant growth in liabilities in the next generation. For example, Saudi Arabia has a relatively young population and needs to finance the equivalent of over 160% of 2022 GDP to pay for pensions provision by 2050. China, a giant economy with a shrinking population and a liability of 95% of 2022 GDP, is another example. The impact of policymaking is very clear in the few countries we highlight that have essentially overfunded their pension obligations. They include Estonia, Denmark, Sweden and Australia.

Considering the declining demographics in the developed world, Exhibit 3 above demonstrates the difference in healthcare liabilities between, for example, Nigeria and the United States. The longer people live, the more healthcare they will typically require; therefore, the higher the cost. In the United Kingdom, an equivalent of more than 64% of 2022 GDP will be needed to cover the healthcare liabilities of 2050. In the United States, that number is 150% of 2022 GDP. The point about policy remains the most important variable, in our view. In the countries we highlight here, Sweden is the best-prepared aging country—because of historic policy action.

The role of demographics in country credit ratings

France suffered a credit rating downgrade in 2023 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 significant growth of the debt burden. The conclusion, however, is that any government’s visible difficulty in enacting reforms bodes ill for the prospects of a course correction to avoid further difficulties in the future. Growing pressure on public finances demands reform of the extent of social service provision, or of fiscal policy, or both, to keep government finances sustainable.

Conclusion

The traditional view of demographics as a driver of economic growth is no longer appropriate, in our view. Qualitative factors override this assumption. For aging countries, the challenge is primarily to ensure continuous improvement in educational standards, because their economies are becoming more knowledge- and technology-driven. For countries with more youthful demographics, the challenge is similarly education-related, because they need to offer more than cheap unit labor costs.

However, the global economic and geopolitical environment has constrained policymakers’ options, as businesses diversify supply chains and respond to incentives for investment, such as the US government’s Inflation Reduction Act. This means that high-fertility countries cannot simply follow the old playbook of attracting foreign direct investment into labor-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 generally will change. This evolution of savings and investment will drive real interest rates, real exchange rates and even returns on investment. Demographics are not destiny, but can set parameters.