The Disruptive Destiny of Demographics

Few things in this world can be predicted with accuracy over multiyear periods and fewer still over multidecade spans. One exception is population demographics. Based on data today, we have a good idea how populations will develop through 2050. For some countries, demographics will provide a tailwind toward possibly robust economic growth in the coming years. Others, such as the United States, face a headwind, but not an insurmountable one. For one unfortunate group, however, demographics will disrupt current conditions and present myriad challenges to policy makers. Interestingly, challenges can arise from a rapidly growing population as well as from a shrinking one. In this note we will examine the potential disruption from population changes in Japan and the Middle East.

Make That the Setting Sun

Japan and Europe feature aging populations that will decline over the coming decades. For example, in 2016 Finland experienced the lowest number of live births in 148 years, since the end of the great famine of 1866-1868, which reduced the population by 15%.1 While a remarkable and disconcerting statistic, Japan is the poster geriatric for this phenomenon. Its population is estimated to have peaked at 128.5 million in 2010 and, as of September 2017, had fallen to 127 million, shrinking at an annual rate of -0.21%.2 The Japanese government projects the population will decline to 117 million by 2030 and 97 million by 2050.3 As a result of the distribution of Japan's age cohorts, its population "pyramid" is anything but.4

There are two significant issues arising from Japan's population structure. First, consistent economic growth becomes difficult to sustain, being a function of labor force and productivity. The latter would have to increase dramatically to overcome population declines averaging -0.8% annually and an even faster erosion of the working age population. Second, Japan's dependency ratio will soar as fewer workers are available to support a growing number of retirees. The scale of the problem dwarfs anything the US faces with Social Security. Through 2050 the US population is anticipated to expand 19% to 388 million, while Japan's population shrinks 23%! When we consider that Japan already labors under a public debt burden equivalent to 235% of its GDP,5 by far the largest in the world, one rightly wonders how the country can ever dig itself out of this mess.

Two potential solutions are often suggested, with the first being increased participation of Japanese women in the labor force. The talents of Japanese women are irrefutably underutilized in the economy, and the female labor participation rate of 49% stands below the 56% rate in the US. Still, it's just below the 50% rate seen in the euro area6 so we cannot expect too much help there. Immigration is often suggested as another solution, but in ethnically and culturally homogenous Japan, "Immigration remains deeply unpopular…according to public opinion polls."7 In 2012, Japan introduced a Highly Skilled Foreign Professional (HSFP) visa program, but the 2,642 visas issued in 20158 will hardly address the issue. Japan is probably the one country in the world where labor-replacing automation is seen as a positive. It is definitely seen as preferable to large increases in immigration.

Given these developments, it appears obvious that certain industries will be disadvantaged. Any company involved in domestic retail, processed foods, or consumer goods will have difficulty maintaining sales in an environment of ever fewer consumers. How do telecommunications companies grow revenue when the number of people speaking on the phone, sending text messages, or streaming video declines by one million annually over the next three decades? Equally, it’s hard to imagine real estate providing attractive returns. Ignoring the potential disruptions of automated driving and the sharing economy, the automotive companies will face challenges. In the financial year ended March 2017, Toyota derived 25% of its sales and, due to high margins, 60% of its operating income from Japanese activities.9 Admittedly, a portion of the sales and income were generated by exports. Regardless, Toyota holds a 46% share in the Japanese car market (excluding mini vehicles)10 and is captive to reductions in market size.

Silver linings? Anyone seeking employment will have little difficulty finding it. Certain industries, such as health care, may benefit. Japan’s population is aging more quickly than it’s shrinking, so health care expenditures will rise with a large bulge in the 65-75 age cohort. Eventually, they will depart the scene, but Japan’s largest group is in the 40-50 cohort, and their spending will start to increase just as it’s ending for the earlier group.

As alluded to above, industrial automation companies are another potential beneficiary. Japan’s unemployment rate already stands at a low 2.8%.11 With the accelerating labor force decline, any innovation that replaces a human worker will be readily embraced.

Perhaps the greatest mystery is what will happen to the currency; an important point given that the Japanese stock market has shown an inverse correlation with the strength of the yen over the past several years. One would normally consider a shrinking population and minimal economic growth to be a recipe for deflation. On the other hand, staggering debt levels and a need for the Bank of Japan (BoJ) to create money out of thin air to support the growing raft of retirees implies inflationary pressure. Despite the deflationary real environment, we have not been able to wrap our minds around how the BoJ and the Japanese government can continue to operate unless they ultimately absolve trillions of US dollars' worth of government debt while printing money — and not have those actions lead to currency depreciation and concomitant domestic inflation. Interestingly, Japanese homogeneity and the fact that nearly all of the debt is held domestically may provide an avenue for netting off exposures and containing the problem.