Demographic divergence

Aging populations in major economies are poised to limit how much countries can produce and grow, leaving governments with less tax revenue to support rising retirement and healthcare expenses. Fewer workers likely mean lower corporate profits and higher government debt – unless economies adapt to mitigate these pressures.

We see potential for technology and medical breakthroughs to help offset these risks – and present opportunities. By contrast, selected emerging market economies are poised to benefit from younger populations and growing middle classes.

All else equal, a shrinking workforce means an economy cannot grow as fast as before. That’s because expanding what a country produces relies on expanding the number of workers and/or expanding how much each worker produces. Governments can try to boost a shrinking workforce by attracting workers from other countries, increasing the share of women and other underrepresented groups in the labor force, and/or raising productivity by investing in automation and artificial intelligence. We think these strategies can provide some offset, but not enough to keep G7 workforces – and economies – growing as fast as before.

Aging could also prove inflationary, in our view. Retirees stop producing economic output but don’t typically spend less. And governments are likely to spend more on healthcare. That means central banks will likely have to keep interest rates higher than before the pandemic – and governments will face higher debt servicing costs at the same time as slowing tax revenues.

Japan’s working-age population has been shrinking since 1994. The country didn’t see higher inflation because economic activity was hurt by the bursting of its asset price bubble in the early 1990s. Yet it does give a glimpse of the growth effect: Since 1990, government data show that hours worked in Japan fell as the working-age population peaked and started to shrink. Still, Japan was able to offset some of the fall in working-age population by substantially growing the share of women in the workforce.

Demographic changes – and their effects – will vary across countries. We think that dispersion of outcomes will create plentiful investment opportunities. We believe the key for investors is to be selective and assess what markets have priced in. Research finds they can be slow to price in the impact of even predictable demographic shifts. That looks to be the case now in the U.S. and Europe – and is why we like the healthcare sector in both regions.

Within emerging markets, we see opportunities in those that can best capitalize on their still-growing working-age populations – for example, by improving workforce participation or look to ramp up investment in productive capital, like public infrastructure. That could enable them to outperform what markets have already priced. We think higher returns could be on offer in countries with greater demand for investment – like India, Indonesia, Mexico and Saudi Arabia.

Read more in our Weekly market commentary, Playing demographic divergence now.