Baby Come Back

Key Points:

• Global birth rates are declining toward below-replacement levels, with advanced economies already experiencing working-age population declines that threaten economic growth.

• The impact of this on markets is not positive. Lower economic growth, higher real interest rates and lower margins are negative for equities.

• Immigration offers only a partial solution due to political resistance, while government incentives have shown limited effectiveness in meaningfully increasing fertility rates.

• Technological advancement through AI and robotics may ultimately mitigate demographic impacts by enhancing productivity and addressing labour shortages.

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Families used to be a lot bigger. A multi-decade trend of declining birth rates has seen advanced economy populations flatline in recent years. The global population, even including poorer countries, is expected to peak in the decades ahead. Every year as part of our annual Strategic Asset Allocation Review, we highlight key themes which are likely to play out over the 10 year ahead forecast horizon. While the implications of a declining global population are slow burning, we could see some impact on markets in the next decade, particularly with respect to policy settings. Regardless, the consequences of a falling population are so substantial it is worth thinking about well in advance. As a result, in this month’s Market Insight, we delve into demographics, hopefully providing some insight into why populations will shrink, what it means for markets and if there is anything that can be done about it.

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Having kids is hard

There are many reasons why people have less children now than in the past.

• From an economist’s perspective, the opportunity cost of having children has risen substantially as workforce participation rates have increased and households now face substantial childcare costs. More children also mean bigger houses, bigger cars and more school fees.

• Changing societal norms and higher levels of wealth mean that you cannot (or no longer need to) rely on children to look after you in old age.

• In earlier decades, there was some “social cost” to childlessness. If a couple did not have children, they were somewhat of an outlier within society. Now, with a higher rate of childlessness, it is more socially acceptable to not have children if that is your preference.

• Even for those who want children, family formation starts much later now than it did in the past and starting later can mean fewer (or unfortunately for some, no) children than families who formed in their early 20s.

All of this has been playing out increasingly all over the world, including in developing countries, for many decades. Globally, the fertility rate is now just above replacement. Assuming the trend decline continues, which seems an almost certainty, the fertility rate will fall below the replacement rate in the decades ahead and the global population will begin to decline.

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While a decline in outright global population is many decades away, what matters most for an economy is the working age population. This has generally been trending lower in advanced economies since 2010 (see below). This matters for markets now, and will become increasingly important in the years to come.

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There are several implications:

• The dependency ratio (the ratio of children and elderly to working age population) is rising. Basically, there are fewer workers to support the number of retirees. Given across most of the rich world the elderly are largely supported by government pensions, the implication is there are not enough taxpayers to fund the level of care that society currently demands it provides the elderly. Either tax rates rise, the elderly get worse care, some other group gets less government support, or the number of workers is increased via immigration (more on this later). Every single one of these options is unappealing to the electorate. While some may argue higher government debt is a “solution,” this is temporary measure at best which would shift an ever increasing burden onto an even smaller workforce less able to pay for it. It is not sustainable.

• Productivity growth may be hamstrung. While older workers may be more productive than their younger counterparts, productivity growth is higher for younger people. Studies have indicated that productivity growth among workers in their 20s and 30s is around 1.5% to 2.5% higher than older workers. Alongside working age population growth, productivity growth is the other key ingredient of long-term potential economic growth. With both lower, overall economic growth will be lower than the norm.

• Global savings will fall. Although governments fund most retirements, there is a substantial pool of private savings which is set aside for that purpose. Long-term interest rates are influenced by the balance between demand and supply of savings (alongside many other things). As workers enter retirement, they supply less saving, meaning real interest rates could rise. However, retirees also spend less than workers, which could have an offsetting effect.

• Labour market dynamics may change. All else equal it is safe to assume that workers will be more scarce than in the past. Increased bargaining power due to this scarcity could put upward pressure on the share of national income which is directed towards workers rather than businesses / capital.  

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Who will buy the equities?

The financial market consequences of the above are probably negative in the aggregate. If declining labour forces more than offset productivity growth, economies will shrink year by year. Whether this will be the case is uncertain. Japan has managed to generate net positive real economic growth despite a shrinking labour force, though this may reflect access to overseas markets which will be less of an offset by the time everyone’s labour force is shrinking. If it is the case that the global economy starts to structurally shrink, it’s safe to assume that global share market earnings will also start to shrink. Like negative interest rates post Financial Crisis, this will be a novel problem for market participants to try and solve for in their valuation models. However, the direction of the impact is clear. A market with falling earnings should be worth less than one with rising earnings.

Higher government deficits and retiree dissaving could put upward pressure on real interest rates. All else equal, higher real interest rates also lower the fair value of equity and reduce economic growth. Lower productivity growth and higher tax rates will also likely reduce economic growth. Higher wages and higher interest costs will also reduce corporate margins. All up, there isn’t really a lot to be positive about with respect to negative demographics and equity markets.

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Plugging the labour force gap

Across much of the rich world, the solution to higher worker bargaining power and wages due to scarcity (or skills shortages if you are trying to sell it to the voting population) is immigration. Immigration will also likely be the response to the problem of who will pay the tax bill for government care of the elderly? While fertility rates are also declining in poor countries, they are still generally much higher than those in rich countries providing an ample source of willing labourers. The academic literature also suggests that immigration has a positive impact on productivity growth. Immigration also mechanically increases the size of the labour force. Combined, there is a strong positive impact on overall headline economic growth from immigration.

However, immigration is a sensitive topic, especially in more recent years where post Covid catch ups in migration (see below) have overwhelmed many housing markets, pushing rental vacancy rates down and rents uncomfortably high. Whether immigration, particularly at high levels (which would be needed to offset the declining labour force), benefits existing residents is debatable. The share of the economy per-person is what matters for the individual, not the size of the economy as a whole. Immigration can only impact that via higher productivity. Unless government planning is extremely well thought out years in advance (which governments don’t have a track record of achieving), high levels of immigration threaten to overwhelm public services and infrastructure. People don’t enjoy clogged roads, crowded trains and longer hospital waits. More people trying to access public spaces such as parks, stadiums and beaches also makes them less accessible at the margin. Babies are much easier for governments to plan for given they take between 18 and 30 years to move out of home. Immigration swings around a lot, making the planning process more complicated.  

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In response to turning public sentiment, there has been a push back on immigration by many governments recently. The Trump administration in the US has cracked down on illegal immigration. The UK recently announced comprehensive immigration reform to reduce net migration. Canada has tightened limits on student visas and temporary foreign workers as well as scaling back permanent residency admissions. To completely offset declining fertility, immigration will need to remain uncomfortably high. Given the recent political pushback, we don’t think this is a practical complete solution. Indeed, centrist governments relying too much on immigration risk losing ground to far right parties campaigning on nationalist or outright racist policies.

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Is it inevitable?

Many countries have experimented with measures to try and increase fertility rates. There is some evidence they have an impact. Australia’s cash baby bonus period coincided with an increase in births until it was transitioned into stepped payments and then merged into the existing welfare structure. Other countries also provide a variety of cash bonuses, childcare subsidies and paid parental leave.

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However, trying to stem the decline in fertility rates with piecemeal financial offerings to families is a Sisyphean task. There is no practical way for a government to financially offset the cost of having a child, let alone multiple children. A Danish study in 2019 indicated that motherhood reduced the lifetime earnings of woman by 20% given lower work hours, participation rates and wages. Another study in 2011 found delaying motherhood by one-year increased lifetime earnings by 3% to 9%.

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Rise of the robots

The future is one where robots will become ever more present in our lives. We think the intersection of AI, improved batteries, faster computers and worker scarcity mean investment to supplement the labour force with robots is coming in a meaningful way. The number robots used in industrial processes has been steadily increasing for years (see below) but they are notoriously hard to install and use. They require specialised programming languages, have clunky user interfaces and are often software locked by their manufactures, limiting their flexibility.

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AI will hopefully redress some of this and allow increased deployment of robots including at the household level. AI can allow the “programming” of robots without coding skills. Self-learning robots will get better at tasks all by themselves. Many households have robot vacuum cleaners now, but it’s not unreasonable to expect functional robot cooks and cleaners in the decade or decades ahead. A YouTube search shows surprisingly functional robots in testing now. Combine this with AI’s influence on the services side of the economy and potentially a significant part of the impact of declining fertility on labour force productivity could be redressed. Perhaps in the more distant future robots will allow the fertility rate to begin rising again, reducing the opportunity cost for women and families of having children by performing all domestic labour and childcare duties. Certainly, a dystopian future we can all look forward to. Ultimately, this is a thematic that will take many decades to fully play out, so it’s not necessarily something to position a portfolio for today. However, it is coming, and it is worthwhile thinking about the implications before they are fully felt.

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