Accepting a New Normal as Working-Age Populations Shrink

The risk associated with longevity means it’s time for pension fund managers, among others, to get real about returns and growth.


The good news is that we’re all living longer. The bad news — at least for our economy — is that we’re all living longer. Our population is aging, dependency ratios are rising, and birth rates are plummeting around the globe, particularly in the world’s 20 largest economies. The net effect is a significant decline in the working-age population in many G-20 member nations. These demographic trends are hurting global growth prospects for our economy right now. Their full impact over the next century is unknown — and unsettling.

Long-term economic growth is largely determined by two factors: productivity and population growth. Whereas productivity growth isn’t inevitable or predetermined — many older, healthy workers choose to continue working to stay engaged and productive — demographic trends are what they are, and there’s no reversing course on our aging population any time soon.

The population of those of working age, roughly defined as between 16 and 64, has already peaked in many of the world’s largest economies, such as Italy, Germany and Japan. For the G-20 as a whole, the size of this cohort is predicted to peak in 2035 and then begin to decline over the rest of the century. Factor in a drop in birth rates, and it’s difficult to foresee a meaningful long-term growth rate in developed-market economies in the near future.

Japan’s economy offers the perfect example of the potential impact of population growth on economic activity and investment performance. Japan’s working-age population grew rapidly in the 1950s and 1960s and stayed strong during the following two decades. In the first half of the 1990s, however, that working-age demographic group grew only 1.6 percent before peaking at 86.6 million people and starting its long-term decline. The fall in working-age population growth corresponded almost directly to a significant decline in Japan’s gross domestic product growth over the same period.

The future outlook for Japan isn’t much better. Japan may have just 42.5 million working-age people by the end of this century — less than half the number at its peak. Play out this Japanese economic scenario on a global scale, and economic growth rates could be in for a chilling effect over the next century, affecting everything from GDP to interest rates to investment strategies.

Although the twin demographic patterns, low birth rates and increasing longevity, are seen elsewhere in the developed world, the news isn’t all that bleak yet for the U.S. The working-age population in the U.S. is expected to continue to grow, albeit at a much-reduced pace, thanks in part to a retiring baby boom population. Trend data suggest, however, that even if the overall G-20 working-age population is not yet declining, its growth rate is already markedly slowing.

What does this mean for the many investors who are anticipating a long-awaited acceleration in economic growth? It may be time to temper those expectations. Average growth rates across the major economies are likely to prove weaker than what many people expect. For global central banks, this is likely to mean that any thought of policy normalization is misguided. Whereas there is much talk about the Federal Reserve normalizing rates, we may be in for a new normal in the future.

Pension funds are clearly having to react to market conditions by adapting their investment strategies. According to State Street research published in 2015 and conducted by London-headquartered Longitude Research, 65 percent of pension funds reported that it is difficult to deliver investment returns that ensure good retirement income for their members. As a consequence, 36 percent of funds are pursuing high-risk, high-return investment strategies. Over the coming year, nearly half — 48 percent of pension funds surveyed — plan to increase their exposure to private equity, 45 percent to hedge funds, 44 percent to real estate and 40 percent to direct loans. But with increasing risk appetite comes certain challenges: 46 percent of pension funds participating in the study note that they have yet to achieve transparency on risks stemming from alternative investments.

The bottom line is that over the past ten years or so, the world has been changing to adjust to a new demographic trend. It’s time to face the reality and understand its impact on our future global economic landscape. Given such a fundamental change in the economic backdrop, we all need to stop expecting the economy to return to previous growth and interest rate levels and start getting more comfortable with the new normal.

Lee Ferridge is managing director and senior macro strategist for State Street Global Markets in Boston.

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