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The Bid Episode 172. The Tides of Time: The Economic Impact of Aging Demographics

Episode Description:

The BlackRock Investment Institute has outlined five mega forces that are shaping the macroeconomic landscape and demographic divergence is another one of them. The aging of populations will limit how much major economies can produce and grow, leaving governments with less tax revenue to support rising retirement and healthcare expenses. The impact of fewer workers could result in lower corporate profits and higher government debt unless economies adapt to mitigate these pressures. So, what does this mean for investors and what risks and opportunities does this megaforce create?

Nicholas Fawcett, Senior Economist in the BlackRock Investment Institute and Peter Fisher, head of BlackRock's Global Retirement Initiative join Oscar to uncover the impact of this megaforce on global economies and the potential risks and opportunities investors should consider.

Sources: The peak 65® Zone Is Here, Retirement Income Institute, January 2024; Decoding Demographic Divergence, BlackRock, March 2024; U.N. World Population Projections (WPP) (2022): scenario assuming medium fertility; U.S. Congressional Budget Office (2024), The Budget and Economic Outlook: 2024 to 2034, February 2024

Written Disclosures in Episode Description:

This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.

For full disclosures go to Blackrock.com/corporate/compliance/bid-disclosures

TRANSCRIPT:

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Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

The BlackRock Investment Institute has outlined five mega forces that are shaping the macroeconomic landscape and demographic divergence is another one of them. The aging of populations will limit how much major economies can produce and grow, leaving governments with less tax revenue to support rising retirement and healthcare expenses. The impact of fewer workers could result in lower corporate profits and higher government debt unless economies adapt to mitigate these pressures. So, what does this mean for investors and what risks and opportunities does this megaforce create?

I'm pleased to welcome Nicholas Fawcett, senior Economist in the BlackRock Investment Institute and Peter Fisher, head of BlackRock's Global retirement initiative. Nicholas and Peter will help us uncover the impact of this megaforce on global economies and the potential risks and opportunities investors should consider. Peter And Nicholas thank you so much for joining us on The Bid.

Peter Fisher: Nice to be here.

Nicholas Fawcett: Thanks for having me.

Oscar Pulido: So, as both of you probably know, for several months now on The Bid, we've talked about the five mega forces the BlackRock Investment Institute has been talking about, today we're going to talk about one of those, and that's demographic divergence. Nicholas, perhaps I could start with you, which is why is it that we're considering this a mega force? Can you give us some of the terms and definitions to help understand what it is we're talking about?

Nicholas Fawcett: Thanks Oscar. You'll remember that when we talk about mega forces, what we're really talking about are big structural changes that are going to shape our economies over the next couple of decades. And these affect everything around production, the way we produce things, what we produce, and ultimately who produces it.

And crucially, that affects the investment landscape. It raises, opportunities and of course, it also raises risks. We think that investors need to pay attention to them now, even though they're going to play out over the course of several decades. As far as demographic change is concerned, what we're really talking about is the fact that populations are aging- . And when you combine that together, it means that working age populations, so give you a definition, it's those age between 15 to 64, in general, are shrinking relative to the size of the overall population. For a lot of large economies, especially in developed markets, that means that workforce growth over the next 20 years is going to be much lower than it was over the past 20.

In fact, in some countries it's actually going to shrink quite materially. And the numbers are big, so just to take a case in point, Now, that's the combined total population of Germany and Italy. These are big numbers, the key thing is that presents an economic challenge because taken by itself, slower workforce growth means slower economic growth overall. And something needs to change in order to alleviate that kind of constraint. So those are the facts. The population's aging.

With workforces either shrinking or growing less rapidly than they were in the past, there are some key implications that we need to think about from the investment landscape. We think there are three important debates to be had- population aging is the fact, but how it plays out really is, a matter for discussion.

The first is, does aging actually slow growth or are there things you can do to offset that? The second is what happens to inflation? Is all of this aging going to result in more inflation in the future or less? And then finally, what's that going to do for government debt? Are government's going to have to borrow more as a result of aging.

Oscar Pulido: Peter- Nicholas talks about, the fact that an aging population could slow growth. It's worth mentioning that Larry fink in his recent annual chairman's letter talks about this demographic slowdown, and so it sounds like it is a big global issue for the future, but let's just come back to why should an aging population slow growth in the first place?

Peter Fisher: Well, we measure economic growth by changes in hours worked, plus changes in productivity and then we add in new investment spending. And so when the working age population, the core workforce, starts to shrink, it's really hard to get more hours worked going because you actually have fewer hours work tend to come in, now there's some adaptations that countries can make. But so other things equal, you shrink the working age population, you shrink the economy, it's pretty direct.

Now, what countries can do to adapt is try to find other sources of workers. You can bring in more immigrants, you can increase the participation rate- people who are standing on the sidelines of the labor force, you can bring them into the workforce. That normally we think of happening cyclically in economy when the economy gets strong. You can push out retirement ages, get people to just keep working longer. And those are all ways you can add hours, or innovation and productivity, you have to get more out of each worker that you put in.

And so, these forces are how countries will adapt. a couple of quick examples. . They both would already have declining workforces without all that immigration. Even a country like the US and the UK, we would be having a shrinking working age population without immigration, we're already past that point. Another way to think about this is two countries that both have really stark shrinking populations, So, the Koreans are deploying more robots per worker than most countries in the world, they're in the top three in doing that, so they're adding to productivity another way. So those are different ways different countries adapt to this relentless force that if the working age population shrinks, the economy is also shrinking, other things being equal.

Oscar Pulido: And you shared a basic math equation at the beginning of your response and an important input was hours worked. If you have a declining working age population, all else equal, you have less hours worked, then that means less growth, but then you mentioned the number of ways in which countries can offset that. And you talked about immigration, you talked about productivity, we spoke with Belinda Boa recently about Japan, which is enjoying this Renaissance and economic growth and higher inflation, but they've also been dealing with the declining working age population. So how have they combated that?

Peter Fisher: Japan's had a shrinking working age population since 1994, and right after the bubble burst in Japan, that Belinda discussed, and we had a banking crisis then they've experienced the shrinking workforce, which was part of the deflationary environment that Japan found itself in.

. You need to go back and realize that's the world's second largest economy that just lost 10% of its mass. That's a really big number. Now, they were able to stabilize that, as Belinda described a little bit with Abenomics, Prime Minister Abe had some structural reforms. In hindsight, the one that's really astounding is how effectively he got women into the workforce. , and female retirement rates were pushed out by three years. That helped stabilize hours work to actually raise it a little bit and then stabilize it, which is a big part of how the Japanese economy is stabilized.

Oscar Pulido: Japan though, experienced deflation. You touched on that, that as the working age population was shrinking, it was deflationary. Nicholas to come back to you, you would actually argue that perhaps that was an anomaly that actually declining working age populations should be inflationary to an economy. So, tell us a little bit about why was Japan different and why is your view that the more common scenario is inflation?

Nicholas Fawcett: This is where things get really interesting, and in fact, that's the second key debate about the impact on inflation. Intuitively you would think that if we're talking about slower growth, as Peter just described, that's going to push down on inflationary pressure because there's just less demand. But here the problem is a completely different one. We're talking about less supply, so because there are fewer working age workers, the overall production capacity is lower than it would otherwise be, and so you can't produce as much from that working pool. As a result, people produce less as an overall group. You tend to find that with older workers on average are more likely to be retired. And so, as workers, overall get older, the total amount of production goes down.

But that's a view from the supply production capacity in the economy. Demand keeps on going. People don't just stop all spending when they hit retirement. In fact, even though they may change the nature of things they consume, they may consume more healthcare and social care, overall, in terms of value of spending it, it's actually pretty smooth over people's lifespan. The key thing is really what happens to the balance of demand and supply as a result of this. If demand proves quite resilient and supply capacity is going down, then that puts demand out of line with supply. And so, there's inflationary pressure that builds up. And Japan's a really interesting counterpoint to that.

But in a sense, Peter's already given the answer for why, it doesn't necessarily give us a good guide to what's going to happen in the future. Japan had a lot of other things going on at the same time. It had the financial crisis, banking crisis It also had its population aging around a period where globalization was on the up. That meant that a lot of Japanese producers could outsource production, especially in manufacturing, to other countries and escape the constraint of having a shrinking working age population. And so, on net, the Japanese circumstances is quite different to the one we see for other developed market and the large economies in the future.

That's why we think that on net the implication of population aging in the future is going to be inflationary. Now, what does that mean for monetary and fiscal policy? Well, central banks are going to face more persistent inflationary pressures in the future. They're going to have to respond to that with tighter monetary policy raising interest rates. And that's very different to the experience we saw before the Covid pandemic in the 2010s where they had to do the opposite. They had to cut interest rates to bring low inflation back up to target. Now, for governments, we think aging spells more debt. slower growth means slowing tax revenues, to cover spending. And all the while rousing interest rates just mentioned before means the governments are going to have to spend a lot more on interest costs than they previously did. And the numbers here are pretty stark.

Take the US for an example, the US Congressional Budget Office projects that within the next few years, . That's a pretty stark comparison. And cutting spending in other parts is going to require really difficult political decisions, and that's all against the backdrop of aging populations, probably meaning more spending on healthcare and social care than is currently the case. So, there's a real tug of war going on here, big trade off, and the big picture is that all of this means that government debt is on the up.

Oscar Pulido: Right. So, the working age population is getting older. that's causing inflationary pressures that causes interest rates to be higher, all else equal. And that challenges the fiscal position of a lot of these countries that are experiencing that aging of the working age population. So Maybe Peter to come back to you. What does this mean in terms of investment opportunities? Where are there sectors or countries that are benefiting from this demographic divergence?

Peter Fisher: Well, before I jump to the sectors, countries and companies will adapt. We've seen that in enough places. And I want to emphasize, we investors have to adapt to and learn to look for different things. A really simple one is we've normally, for the last 50 years, thought about cyclical changes in the unemployment rate as a really good guide to how strong the economy is. Unemployment rate goes up and down, it tells us how strong the economy's doing.

Or, if you have a persistently tight labor market, the unemployment rates always really low and there are not many changes in it. So, there's not much information content in that. So, we investors have to start looking for other things.

Now, the first thing I think we have to look for is how do companies source labor? If you've got a tight labor market, companies are going to have to have their own strategy. Maybe they have to bid up younger workers and pay more for that. That may just be the cost of doing business, and so we have to watch what happens to company margins. Now the sectoral impact, Nicholas has already mentioned one, the healthcare sector, people get older, they're going to spend more on healthcare. I really enjoyed, a couple months ago we had a group of investors, talking about the longevity opportunity, and a young equity investor was saying, you have no idea how much money people have to spend on cataract surgery and hearing aids. And I assured him, I knew exactly how much older people had to spend on cataract surgery and hearing aids.

It's a big opportunity for someone. Now, there's another flip side of that, which is longevity itself as an industry. There are huge amounts of money going into investments in startups and drugs to make people live longer. The obesity drugs are an example of that. They're going to take down all sorts of morbidity problems we have from heart failure and heart attack. People are healthier for longer; we're all going to live longer. That's an industry in itself that is an investment opportunity. There are other ones like big changes in demand for real estate, old people like me don't move around as often as my son and my daughter do.

Oscar Pulido: So, adaptability is a key theme. There are trends that have been in place for many decades and perhaps that's made us think about certain sectors or certain economic data points. Differently and we need to adapt. You mentioned the unemployment rate, that it's maybe not going to provide as much information as it has in the past when you have a tighter labor market.

We've talked a lot about, aging working populations, and mostly developed markets. Although Nicholas, you also mentioned this is a trend in China, but there are also countries that have younger populations and there are working age populations that are still growing in certain countries. So how do you think about the investment opportunities in those parts of the world?

Nicholas Fawcett: Yeah, absolutely right. So, if you look at . They're aging in a general sense, average age is going up and at some point in the future, that working age population growth is going to come to a halt. But compared to the other economies we were talking about earlier; they have a better dividend at the moment.

 In terms of how they translate that into stronger growth in the future, it really depends on a lot of, catalysts that enable them to take advantage. One of them is how effective they are in translating growing, working age population into growing actual employment.

Peter mentioned before, people sitting on the sidelines, not really looking for a job or in jobs. That's a big problem for some countries. The share of people actually in employment or looking for it is really low compared to advanced economies, there's a huge amount of catch-up potential there, but they really need to harness that extra workforce.

Or it might be in another really important part, which is, what we would call, productive ca, capital productive capacity. So, things like machinery, transport infrastructure, hospitals, schools, energy investment, especially with the low carbon transition over the next, couple of decades. These countries have to be able to harness the investment needs for all of that capital to be built up in order to take a full advantage of a bigger working age population.

Some countries are going to be much more effective than others in taking advantage of that demographic dividend. And that's where some of the investment opportunities are really going to lie in our view.

Oscar Pulido: And just hearing you say the word dispersion brings me back in in recent episodes where we've talked about this is a new market regime, the need to be granular and dynamic and, and these mega forces will play out over many decades. So actually, given that, given everything, you've said as you think about demographic divergence and its impact globally, what would be some parting thoughts that you would want investors to think about as they think about the world aging?

Peter Fisher: Well, where I started with the engine of growth, we are really going to need to focus on innovation, realized productivity. Not just gee-whiz technology, that's fun, but is this actually producing more output? Is this making workers more productive? Real innovation that gets embedded in the economy, that's going to be where we have to look for returns as investors.

And so, we have to switch and we're going to be a little less sort of momentum in the economy as a whole unless we can find returns coming from innovation. And I thought it was really interesting what Belinda said about Japan being a laboratory for innovation on a tight labor market. And that's the transition but from what both Nicholas and I were talking about, the 1990s where it was all blah in Japan and they weren't, didn't have any momentum, and now they're really ahead of us. They're figuring out what innovation you have to do to keep growing a company where there's so few workers and so they're on the front foot on a lot of robotics and technology. And so, I would emphasize that for investors going forward.

Oscar Pulido: Nicholas, what about you?

Nicholas Fawcett: Yeah, I agree with Peter. He really puts his finger on it saying there are opportunities in some of the countries we've been talking about, that face the biggest, countrywide headwinds. I think the key thing is that it's not a simple case of ignoring all the countries that have shrinking populations.

It's much more nuanced than that. There's a huge amount of dispersion across sectors that Peter alluded to. the really interesting thing from the investment point of view is these phenomena that we've been talking about are pretty predictable in the sense that we know how working age populations are going to evolve in the next kind of 30, 40, 50 years because of the nature of what we're trying to forecast here.

And yet, if you look back in history and look at the academic literature, there've been a lot of times where these kind of predictable demographic trends have been really slow to be priced in by markets. And so there should be ample opportunities, if that's true. And that continues in the future for investment opportunities because the things that aren't currently priced that we know with reasonable certainty are going to happen are where some of the greatest opportunities lie. It also helps us gauge where the risks are, but the bottom line, as you said is you really need to be selective.

Oscar Pulido: I was reading something this week and that I had read before, but it was a reminder, it was . And when I first saw that, I thought, that number can't be right because 12,000 is a lot to happen on a daily basis.

But it brings forward the magnitude of what both of you were talking about. Thank you for shedding some light on this Megaforce. I'm sure we'll have you back at some point to update us on where we are. Peter and Nicholas, thank you for joining us on The Bid.

Peter Fisher: Thank you.

Nicholas Fawcett: Thank you.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you've enjoyed this episode, check out the recent episode with Belinda Boa Is Japan at an inflection point? And subscribe to The Bid wherever you get your podcasts.

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<<SPOKEN DISCLOSURES>>

This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.

For full disclosures go to Blackrock.com/corporate/compliance/bid-disclosures

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