24 Feb 2011 | World

Global Economy - The Right Address 

As the world’s demographics change, Heather Connon
discusses the impact this will have on the global
economy and investments

Mark Urquhart, manager of the Edinburgh Worldwide Investment Trust plc, likes to imagine a Martian visiting the earth. They would look at a small island like Britain and expect it to be relatively unimportant in the world compared to a country the size of Russia or China. Yet, the UK accounts for over 4 per cent of the world’s gross domestic product (GDP) - almost twice that of Russia - and has the fourth largest stock exchange in the world, nearly a fifth larger than Shanghai’s.

Of course, the UK’s position in and influence over the world’s economic affairs is diminishing rapidly, while that of China, Russia and other emerging economies is rising. The Centre for Economic and Business Research (CEBR), estimates that the share of GDP taken by developed world members of the Organisation for European Economic Co-operation and Development (OECD) will fall to 65.7 per cent by 2015: it was 77.1 per cent in 2004.

One key reason for this rapid change is population. India and China, two of the fastest-growing economies, account for more than 35 per cent of the world’s population. As these countries develop and industrialise, their citizens become wealthier and consume more. This increased consumption is driving their economic growth.

SIZE ISSUES

The world maps, created using data from 2002, (shown above) are a graphic illustration of the vast discrepancies between landmass, population and GDP. The first, showing the world drawn according to a GDP scale, shows that the northern countries dominate – Britain and other European countries are many times their true size while India, China and Brazil are severely shrunken; if the scale shifts to population, however, Britain, Europe and the US are much smaller by comparison to China and India.

Mark believes the map should make us pause for thought. “Why shouldn’t Indonesia (which has the world’s fourth largest population) be a significant world economy? There are signs that it is becoming so.”

Changing population sizes, ages and wealth are already having a big impact on the global economy and will continue to do so: investors need to consider them when assessing how best to invest over the long-term.

“Historically, there has been too much willingness to group all emerging markets together because they used to behave in similar ways and had more in common than not,” says Mark. “Now, it is increasingly important to differentiate between them in the same way as we do between a German exporter and an Irish one. Part of this is demographics.”

FAMILY MATTERS

The answers are not always straightforward. Take China for instance. It currently has the world’s biggest population at 1.33bn, but 30 years of strict population controls through its one-child-per- family policy, introduced as a reaction to rapid growth during the 1960s and 1970s, means that its growth is slowing dramatically, while the population is also ageing fast. In 2010, China’s population is estimated to have grown by just under 0.5 per cent, slower even than developed economies like our own and France and well under half that of economies like Malaysia, Turkey and Indonesia.

The number of young people, particularly in China, is falling sharply. By 2050, the dependency ratio, which is the number of people, young and old, who need to be supported by their families or society, is expected to reach around 64. This means that for every 100 people of working age, there will be 64 people of non-working age who need to be financially supported. The median age in China, which was 33 in 2005, will be 45 by 2050, and the population will have stopped growing by around 2030.

Ageing populations are expensive to maintain, demanding more in health care, pension and other welfare costs. China is already taking steps to address the imbalance in its population, actively encouraging families in some areas to have more than one child, according to Christine Zhang, an investment analyst at Baillie Gifford.

She says the impact of the ageing population on China depends on its economic management: “It depends how strong China’s economic growth is,” says Christine. “If it can continue to grow at 7 or 8 per cent a year over the next 10 or 15 years, the impact will probably not be that severe because the economy will get to a reasonable level (of prosperity) and so could afford decent health and retirement benefits.”

BABY BOOM

Population trends certainly influence a region’s economic prospects and, therefore, their investment attractions. China is currently enjoying rapid growth and is expected to continue to outpace the Western world for some time; longerterm, however, it does face a challenge in dealing with its ageing population. Countries like Indonesia and Turkey, by contrast, have relatively young and growing populations that could mean they are more attractive in the long-term.

Population trends also influence the type of companies that investors should be considering. Mark points out that a number of giant US companies made their fortunes from the ‘baby-boomer’ generation in the US; now that its population is also ageing rapidly, some of these companies are now looking less attractive. “If a company’s natural customer group ages, can it age and develop with these customers, or does it lose out?” he asks. “The best thing for investors is if their products are ageless.”

There are industries that should prosper from ageing populations. Health care is an obvious one, as elderly people tend to require more treatment for age-related ailments. Likewise, the combination of growing populations and increasing wealth can also mean higher spending on health care as poorer sections of the population earn enough to get access to medicine. There could also be shifts in the way people access health care with, for example, more need for monitoring activity or home visits to a more elderly population.

HEALTH CARE REFORM

Governments are already striving to take costs out of their health care systems, notably in the US where President Obama is trying to push through health care reform – and in the UK where our own government is also changing the structure of the NHS.

Companies that could benefit from the drive for lower costs include Teva Pharmaceutical, the Israeli company which manufactures generic – and therefore usually cheaper – versions of out-of-patent medicines. Baillie Gifford’s Scottish Mortgage, Edinburgh Worldwide and Scottish American investment trusts all hold some Teva shares in their portfolios.

There could also be significant changes in financial services as people retire and start drawing down their retirement benefits. Will that send the savings ratio into reverse and how will governments cope with the cost of providing an income for their elderly? Mark thinks the latter is one of the most significant challenges facing all governments. “Only Australia has really had this policy debate and people are now used to providing pensions for themselves. They have managed to get an increase in the contribution rate from 9 to 12 per cent without missing a heartbeat.”

Researchers at management consultants McKinsey think that the ageing population will have a dramatic impact on the savings market. McKinsey’s 2005 analysis of the US, Japan, the UK, Germany and Italy – which together accounted for two-thirds of the world’s financial assets – shows that growth in household financial wealth will slow from 4.5 per cent a year to 1.3 per cent a year over the next two decades, so the total will be around $31trn, or more than a third, lower than would have been expected. This shortfall, left unchecked, could significantly reduce future economic well-being and exacerbate the challenge of funding the retirement and health care needs of an ageing population.

KEY CHANGES

The problem is clearest in Japan, which has a falling population, the highest proportion of over-65s in the world, and the lowest number of under-15s. Economic growth and stock market returns have been sluggish for 20 years partly because an ageing population has been spending less.

However, financial services are also an area that can benefit from a growing population. In India, for example, Housing Development Finance Corporation, which is part of the portfolio of Scottish Mortgage and Edinburgh Worldwide investment trusts, is already the largest mortgage lender in India and could benefit as a growing number of Indians grow wealthy enough to want to own their own homes.

What is clear is that the impact of demographic changes will have a profound effect on the world’s economies and the companies doing business in them. Analysing what these changes will be is one of the key challenges for investors.

LIFE ON THE CHINESE FARM By Heather Farmbrough The impact of industrial change on rural populations has historically often been disastrous, as depicted by Mrs Gaskell in her novel Cranford. More recently this has been starkly illustrated in countries like South Africa where rural poverty amidst rapid urbanisation is a major political and social issue. Yet this phenomenon does not seem to have played out in quite the same way in China. Why? Giovanni Arrighi argues in his book Adam Smith in Beijing, Lineages of the Twenty-First Century that the reforms of the 1970s assigned a key role to creating a domestic market and improving living conditions in rural areas, targeting the domestic economy and agriculture first. From 1978 onwards, control over decision-making and agricultural surpluses passed from the communes back to rural communities. Rural labour was still relatively immobile – the official line was encouragement to “leave the land without leaving the village” but in 1983, rural residents were allowed to travel long distances to transport and market produce. The following year, farmers were allowed to work in nearby towns in the new, collectively owned Township and Village Enterprises (TVEs). The rural labour force in non-agricultural work rose from 28m in 1978 to 176m in 2003, mainly in TVEs, which, because they were labour intensive, could absorb excess rural labour and improve rural incomes without a huge increase in migration to urban areas. They also generated a large proportion of rural tax revenues, while profits and rents were reinvested locally. Over the last three decades, Chinese rural low-income groups appear to have fared better than their counterparts in many other countries.

Please remember that ongoing stock market conditions and currency exchange rates will affect the value of investments and any income from them. Investors may not get back the amount invested.

Investing in emerging markets is only suitable for those investors prepared to accept a higher level of risk. This is because these markets could go down or up more than the main international markets.

This article was written and based on information correct as at December 2010.

Author: Heather Connon
Heather Connon has been a financial journalist for 25 years, writing for the Observer, The Independent and The Evening Standard.  She currently contributes to the Guardian, Prospect Magazine and Money Observer among others.