Economists have long studied demographics to identify trends such as population shifts and changes in spending or savings rates that help predict substantial upheaval in the international economic order. Some investors leverage economists’ findings on demographics as a basis of their investment strategies, sometimes mistakenly assuming that picking a fast-growing national economy is akin to choosing a stock on the rise.
The difference is that while demographic shifts within a particular country – rapid population growth in India or rising education levels in Brazil, for example – can signal that the country’s economy is poised for a surge relative to peer nations, using demographic projections to form the basis for investment strategies can be risky. Even when predictions based on demographic trends turn into economic realities, they can frustrate investors. For example, during the last 20 years, indexed stock market returns in Latin America have outpaced those in Asia, even though Asia’s national economies grew more rapidly.
Should individual investors incorporate demographic forecasts into their investment strategies? The bottom line is this: Demographic analysis must be combined with an assessment of economic policy and politics in order to help guide investment decisions.
Dependency Ratio & Higher Productivity
Growth in an emerging economy is usually measured in terms of gross domestic product (GDP), driven most reliably by a working-age population and the productivity of that population.
Raw population increases are generally higher in emerging economies than in developed ones (see “Raw Population”). But the key to economic growth is the working-age population, finds Jim McDonald, Northern Trust’s chief investment strategist. So in addition to tracking overall population gains, economists measure a country’s “dependency ratio,” which is the number of non-working residents compared with the number who are of working age (McDonald uses the working age range of 15–59).
According to the United Nations, the current dependency ratio is about even at 62% for both developing and developed nations. An important difference between developing and developed countries is the type of dependents: The majority of non-workers in developed countries are past the working age; the majority of non-workers in developing countries are not yet old enough to enter the workforce. Based on the United Nations’ projection of demographic trends to 2050, emerging countries are poised to gain a substantial advantage over developed ones (see “Dependency Ratio”).
Population isn’t the only driver of economic growth, however. Productivity gains are also critical, and that’s where developed countries have a strong advantage. Their workers tend to be better educated and connected. In the United States and Japan, for example, approximately 75% of the population had Internet access in 2008, compared with 22.3% in China and 4.4% in India.
Higher productivity enables developed economies to do more with less, and accelerate development and adoption of breakthrough technologies. Long term, however, it’s an area in which emerging countries can make inroads. High working-age populations generally translate to higher savings rates, which, at the national level, means greater investment in resources such as education and technology – and eventually, greater productivity.
A Tale of Two Emerging Economies
Generally speaking, having more workers is a precondition for economic growth. “[An economy] just can’t grow consistently at 10% per year without rapid labor growth,” says Richard Marston, the James RF Guy professor of finance at the University of Pennsylvania’s Wharton School of Business, and academic director of Wharton’s Private Wealth Management Program.
The labor pool can grow in a few different ways. One is through a sustained high birthrate; another is when a substantial population of low-productivity workers is drawn into higher-productivity jobs. Both factors contributed to the rise of two rapidly emerging economies: China and India.
“The key to China growing so rapidly [in the 1990s and 2000s] was its ability to draw in a surplus of manufacturing labor from the countryside. They used this underutilized raw labor, fed these people into the manufacturing sector, and it allowed them to grow rapidly,” Marston says. That high-rate, rural-to-urban labor infusion isn’t sustainable, however, as China’s population growth rate slows as a result of its one-child-per-family policy and fewer workers move into the manufacturing sector. That’s one reason some economists believe India will overtake China in economic growth.
In fact, China’s projected population growth rate is much lower than that of both India and the United States. The U.N. projects China’s population to grow approximately 5% by 2050, compared with nearly 35% for India and 28% for the United States. With the one-child-per-family policy as evidence, it appears the Chinese government encourages that decline. But why would China intentionally stunt its economic growth? Because GDP is not the best indicator of a country’s economic health.
“Your highest priority economically is not growth itself, but growth in per-capita income and family income,” he says. “In any economy, if everything else is equal, your growth slows down as you become wealthier.”
In terms of pure GDP growth, India is poised to surge – in part because its population is surging and in part because its economy is less developed. Plus, India could still benefit from a rural-to-urban labor infusion. Only 29% of its population is currently urban, compared with 43% in China and 82% in the United States, according to the Central Intelligence Agency’s World Factbook. India’s annual rate of urbanization is 2.4%, just under China’s 2.7%.
“India’s long-term demographic picture may mean it will increasingly challenge China as the emerging market darling over the next decade,” McDonald says.
Long-term trends indicate that eventually – decades from now – China and India may join the ranks of developed, global economic powerhouses. Other emerging countries such as Brazil may make strides, as well. As the economies mature, the international balance of power may shift.
If that happens, the United States is still well-positioned as a global economic leader because it combines the advantages of a fully developed market with some of the factors working in favor of emerging economies, such as strong population growth. In addition, although its aging population will influence the dependency ratio in the United States, the effect will be somewhat mitigated by the fact that Americans are retiring later than they previously did.
What to Make of Growth
A fast-growing GDP doesn’t necessarily indicate market success, and thus it’s risky to bet on index funds from emerging markets. But according to McDonald, a much stronger correlation exists between slow-growing economies and poor market performance. One strategic investment takeaway is to avoid companies and index funds from slow-growing markets.
Investors also should beware of assuming too much about individual companies based on where they are headquartered. Exporters and multinational corporations are likely to do business in many markets, lessening the degree to which their success is tied to the national economy of their home country. And, as mentioned earlier, per capita income is a much better indicator of a country’s spending capacity than national GDP. So while India may be best poised to grow its GDP, China’s controlled growth and more advanced economy are more likely to create a middle class with purchasing power.
Today, exporters may be a more attractive investment, although there’s still risk involved.
“Right now, exporters are outperforming other sectors because these emerging market economies [like China and India] are growing faster than expected. So a U.S. or European company that is successful in exporting to those emerging markets is benefiting,” Marston says. “Over time, though, there will be periods when the big multinationals will do worse, as the dollar fluctuates.”
Looking ahead over the next 10 to 20 years, however, emerging markets are expected to grow further and become more consumer-oriented. “So it’s a reasonable bet to bias your portfolio to larger emphasis on export-oriented multinationals in the U.S., Germany and northern Europe,” Marston says.
Tracking global demographic changes alone can be a dangerous exercise when it comes to informing individual investment strategies. But by identifying the countries that will grow more populous and productive, investors may be able to anticipate important shifts in the international economy.