Entering uncharted demographic territory with James Pomeroy

Welcome to Beyond the Benchmark, the EFG podcast with Moz Afzal.

Moz Afzal:
Hi everyone. Today we have James Pomeroy from HSBC. Actually, I'm just looking through my notes here actually the fourth time or fifth time even. Actually, James.

James Pomeroy:
Yeah, yeah. Good to be back.

Moz Afzal:
Yeah, no, absolutely. So we're can go straight to it. And James HSBC and yourselves have recently launched a research as an update of your research on demographics. Maybe if you give us the key themes that came out of that and then certainly we can have a discussion. I guess then the ancillary point, what does it mean for all the debt that's out there?

James Pomeroy:
Exactly. There's a lot of challenges around demographics that many economies across the world are facing, and we've written a lot in the past about birth rates. And this is where I think a lot of the discussion is focused at the moment thinking about these collapsing birth rates across the world and saying, you know what? Actually if you start getting birth rates below one child per woman or below 1.3 children per woman, as in many economies, now this is completely unsustainable from a population perspective, but what we've decided to look at in this latest report is almost swing it around the other way and say, well, that's a problem that's building in the future, but what is the problem right now? And in many western economies, there is an enormous challenge of populations ageing very, very quickly at a time where commitments to that older population are extraordinarily generous given the size of that population.

So what you're talking about in terms of pensions and healthcare provision and social care provision by themselves are not overly generous to the people involved. But when you scale that up by the share of the population that are now of pensionable age or going to be in the near future or going to be demanding more use of national healthcare systems, it starts to look really, really scary. And so some of the numbers we're talking about is across Europe, you're talking about by 2050, the most common age of someone in Europe is going to be 63 and you've got a sort of a hump in the population around that age. What does that do in terms of fiscal costs, in terms of managing healthcare systems? Completely unworkable. And if you look across Europe, Europe's really the epicentre for this. But if you look across Europe, 20% of the population is over the age of 65.

By 2050 it's going to be about a third. And if you've got a third of your population of pension millage, this starts to become a massive headwind for both growth but also for government spending. And essentially what we're saying in the report is that the fiscal bill that countries have committed to is growing so quickly that you almost can't fight it anymore. And that becomes a huge fiscal challenge, not just in 10 years time, but it's a fiscal challenge today, next year and beyond. And countries across the world are finding this out right now. They're trying to come with budgets, they're trying to work out how to balance the book and they can't. And it is almost entirely due to these commitments down to pensions and healthcare spending.

Moz Afzal:
So I guess doing a deeper dive on that, maybe we start with maybe Asia actually, which is probably the acutest, basically like Korea, Japan of course, and China in the future, which are going to have these huge problems. I guess from your work, what can we learn from them so far or have we learned anything so far?

James Pomeroy:
Yeah, I think there's a few things that are really interesting. So Japan is a particularly interesting case here because you have a much older population today than many other parts of the world. But what Japan has been able to do is limit really quite how much of the public purse is spent on that elderly population. So we've got a chart in the report that basically looks at the share of the population aged over 65 and the share of spending by the government that goes on pension. So pension spending as a share of GDP and Japan is a big outlier. So Japan has nearly 30% of the population over the age of 65, yet its spending on pensioners is about 10% of GDP on pensions. That's the same as somewhere like Sweden or Denmark, which has only about 20% of the population of that age group.

And it's almost like this chart is almost, as you'd imagine almost perfectly correlating Japan stands out. So it's a really interesting case study there that actually there's a way you can manage this, which is by making benefits slightly less generous. But if you look in some of these economies, the numbers are absolutely terrifying. If you look at somewhere like Korea, you're talking about the population by if things go as they stand by 2086 is the slightly niche date in the future, but two thirds of the population would be over the age of 65 on current trajectories. Now that just makes running an economy or functioning economy absolutely impossible. It just can't work. But if you know are on that sort of trajectory, you have to be really, really cautious about what you do in terms of pensions and healthcare spending and so forth. And these demographic issues are a massive, massive problem in Asia, but the fiscal dynamics are slightly less problematic now in Europe because you don't have the breadth of commitments to that population.

You don't have the enormous amount of public spending on health like you do in many European countries. You don't have the spending on social care, you don't have the spending on pensions. They will rise as these populations continue to get much, much older. It's a massive, massive problem. But this is something that these countries got to adapt to. And Korea is a really fascinating case study on demographics at the moment because the population transition change is so fast because the birth rate has collapsed so quickly. So just to go back to modal ages and the most common age in your population pyramid, at the start of this century year 2000, the most common age in career was 29 by 2050, it's 69 and you're talking about a fraction of the population being children at that age. Now this population pretty bit just keeps getting worse and worse and worse. And it means actually you start to think about the fiscal dynamics that creates commitments the government's made in terms of pensions, it starts to become unsustainable. So there's got to be some serious questions asked in Asia as well as in Europe about how you tackle these ageing populations.

Moz Afzal:
Let's just touch upon China just for a few moments. Obviously their problems are also acute, but I guess with a little bit more of a delay than Korea or Japan, what's your thoughts around China? And I guess the sheer scale I always quote is that their birth death rate obviously is very negative, but roughly means by the end of the century 600 and well, I guess 550 to 650 million people are off their population, which is, I remind people that's the entire population of Latin America.

James Pomeroy:
The Chinese numbers are extraordinary. And as you say, that birth rate has calmed down some way. It's not quite at career levels, but it's pretty close. And in China you're talking about a similar story. By the time you get to the second half of this century, you're going to have more than half the population of pensioners. That's the sort of numbers we're talking about here, the differences in China, yes, that becomes a massive growth problem. It's very hard to have dynamic economies with very, very inverted population pyramids. And that's for a number of reasons. It's partly because of generally when people are older, they work less, their incomes are lower, they spend less. It's pretty simple, but it's also an investment story. Now actually, when you've got populations that are ageing that quickly, the incentive to invest for the future completely diminishes because addressable market is permanently shrinking.

I always talk about this with schools for example, like private schools or nurseries, it's not a functional business when your addressable market is falling by 3 or 4% a year. And that's the same sort of thing you start to think about in broader investment across the economies. These birth rates start to really impact the demographics, so it hurts your overall growth rate, but in China it's less of a fiscal problem because you haven't got the same commitments for now in terms of pensions and in terms of healthcare spending from the government, which does make it slightly easier. You've seen a bit of a change recently this year in terms of making some of that sort of elderly care slightly more funded by the state, but you haven't got those same commitments as you have in some of the more developed economies. So it's a potential, I think in China's case, it's more a growth problem than a fiscal problem, at least for now. Whereas in rest of Asia, it's sort of a growth problem and a little bit of a fiscal problem unless they keep things under control. In Europe, it's almost entirely a fiscal problem.

Moz Afzal:
So in Japan, I guess the other dynamic has been women going into the workforce that's been a big development and obviously then working age population also going up. Maybe talk us through that.

James Pomeroy:
Yeah, there's a lot of ways you can fight this. And so you can, essentially what you want to do of an ageing population is you want to somehow minimise the shrinkage of your working age population or somehow grow it in other ways. And your options are essentially bring who are outside the labour force, into the labour force. So that could be female participation rates which have been rising in Japan. The problem is that's less of an option in other economies where that female participation rate is much higher or has risen already. So it's almost like it's a policy tool that you can only use once, and it feels like in Japan you're getting close to the end of that run rate of that increase in female participation rates. The other option you have is you get people to stay in the workforce longer, and that can be either through not very generous pensions or changing the age at which they get those pensions.

And so I think it almost in different countries that option of what you're going to have to use is going to be very different. But once you've got female participation rates up to a certain level, that's no longer an option for you as a policy tool so to speak, to try and increase that working age population and therefore you're left with some of these other tools. And I think that's the interesting case in Japan is they've been able to manage the ageing population. They've had that other lever. But if you look across other countries in the world where female participation rates are much higher or higher than Japan's ever was when its ageing population became a huge problem, that's not an option for them. So Japan is a really interesting case, but now the translation of that into some of these other good economies that are ageing very quickly, it's not so easy to copy that sort of approach.

Moz Afzal:
And I guess the last lever there is immigration, right? Japan notoriously been horrible at immigration, although you're starting to see that actually starting to turn a bit obviously very, very slowly, but there's clearly a turn.

James Pomeroy:
Yeah, there's almost an economic reality here that you do need people to do certain jobs and particularly when you've got a very ageing population, there's certain number of physical labour jobs which are harder to fill. And that's been the case in Japan. It's it's going to be the case in other countries as well, finding manual labour, manufacturing, agriculture, anything that involves heavy lifting, those sort of jobs are typically going to be done by younger people. And that's actually somewhere where Japan has now had to almost open up the economy to a little bit more migration to make that possible. Now, will we see a similar thing elsewhere? Well, potentially because it's a very easy lever to pull. The advantage of immigration as a demographics tool is it's super quick. You can bring people in of working age who can work right away. It's much quicker than raising the birth rate.

If we raise the birth rate very, very quickly overnight, if we managed to double the birth rate of an economy overnight, you still wouldn't see the economic impact for 20 years. Whereas in immigration, you can see the impact immediately. And that's the real power of that as a policy tool. The problem of immigration is it requires two things to happen. One is you need to make sure it's the right type of immigration. That means you're bringing in the right skills, people who are able to integrate both economically but also socially. So you avoid some of the tensions we've seen in some economies in recent years. And that requires money. And I think this is the bit that's often forgotten. And when you think about immigration as a policy tool around demographics is integration is expensive and it's expensive in terms of getting languages taught, getting cultural norms taught, getting people housing, getting people properly into the labour force, making sure skills are up to scratch.

All of these things are really important, but if you don't do it right, it doesn't work. But if you do it right, it can be a really, really powerful tool. But to do it right costs money. And when you've got a real strain on government finances and a whole load of other areas, it's a very easy place to not spend the money. And when you don't spend the money, the economic benefits of immigration are much, much smaller than they otherwise could be. And I think that's a challenge for a lot of countries. It's almost going, you know what, we've got strain deficits, but what we're going to do is we're going to commit more money in English language courses or Japanese language courses, depending on where you are in the world, that becomes a very hard sell to your population when actually it's probably what you should be doing if immigration is the policy tool that you want to follow.

Moz Afzal:
So before we go step into Europe, which just feels like a bit of a landmine, let's just talk about maybe history. Have you done any work on, I know obviously what we're facing is quite unusual in world economic history. The craziest thing though is probably the most accurate thing that economists can actually do, but has there been any precedent, I don’t know, in certain states or any countries in the past where they've had such a population shrinkage?

James Pomeroy:
No, this is completely unprecedented. And as you say, demographics data is super interesting because one of the easiest ways you can look at the data, you can look at over the course of 10 years, demographics data is by and large going to be spot on. And there's the odd area around immigration that could be different, but in most countries, immigration is not a massive share of your population story. So you can look at deaths, you can look at birth and you can get a pretty good idea of what's going to happen. It allows you to see almost crystal ball into the future. Beyond 10 years it gets harder because structural changes in the economy happen, birth rates change and so forth. But 10 years is a pretty good guide and even 20 years maybe is a good guide in terms of your working age population.

And I think that's where demographics has its power. The problem you have is that two things are happening at once now. One is that birth rates are falling and secondly that populations are ageing. And those two things together has never happened in history. You've had periods of birth rates going down and then picking back up in different countries due to socioeconomic impacts, but never in a way that they're so low. And that's the difference I think if you have birth rates going from four children per woman or three children per woman to two children per woman, that's sort of manageable is when you start getting into the numbers we're talking about where the number of workers per pensioner starts to become hugely, hugely problematic in almost every single economy across the world. It is almost like you can't make this work. Before we talk about Europe, let's just talk about Korea one more time in career in the year 2000, there was about nine workers per pensioner.

In 2060, it'll be one just that change is completely unprecedented. And that's the difference between now and any other point in history. It's that both sides of your population period and moving at extreme rates. And so you've got the number of births falling quickly in most countries at the moment, births are falling by about 3% per year and you've got this rapid ageing because of previous births that have happened. And so you get that double whammy makes all of these ratios look horrific very, very quickly. And that is the bit that creates a lot of strain in a lot of economies.

Moz Afzal:
So let's move to where we both live, the UK and from everything you've said in terms of what's going on in Asia, the UK, obviously we have democracy, so we have typically older people, the ones who come out to vote, younger people don't. And obviously you have situations like the triple lock, which is completely against the trend that we've seen in Asia. And I guess you and I just looking and thinking this is just absolutely unsustainable, what are your thoughts around that?

James Pomeroy:
It is completely unsustainable. And we would go through, in the report we're thinking about what are the options for you? And the options are essentially you either magically grow the economy, which is basically what every government in the world is hoping for at the moment. Do we magically get some booster growth? And it's all fine. And if GDP growth magically out of nowhere picks up to four or 5% to you, it's all fine. So we'll just assume that happens. That seems to be what pretty much every government across the world is doing at the moment. Or you basically tackle the demographic problem like we've discussed of birth rates, immigration, et cetera, but they don't work very well and they're very slow on the birth rate side and not guaranteed. And immigration as we've discussed, isn't perfect. So then you are really left with two options, either A, you let debt rise and you run big deficits or two, you have to make really, really unpopular policy decisions.

And what I would just say are not necessarily unpopular policy decisions such as changing things in the UK's case like the triple lock or the winter fuel allowance for pensioners in the UK. They are very, very unpopular amongst a certain demographic, i.e. those who are most affected by them. And when you look at a combination of the changing shape of the populations and voter turnout, that's why governments don't want to make these tough decisions. So sticking with the UK, if you look at data for the 2019 election votes turnout amongst young people, so under 24s was about 50%, just over 50% amongst the over 65 it was 80%. And then you couple that up with the population pyramid and basically around now the voter base in the UK just shy of 50% of the voters who are likely to turn up at the ballot box are over the age of 55.

So are you most affected by the policy tools that you would probably need to think about here. And that means that what do you do if you're a government who wants to win election, you don't do anything and you actually are incentivized politically to spend more money on pensioners, lift pensions, commit more spending on public healthcare, more support for people in those age groups. And that's politically what you do, but economically makes the pit get bigger and bigger and bigger and makes it even harder to reverse from. And this is the challenge, it's a challenge in the UK it's a challenge across the developed world in general is that the economics and the politics are completely at odds with each other. And it worries me because it makes me think that you're going to get more politicians playing the short-term game pandering to that electorate. And as a result, making the fiscal dynamics even worse in a way that gets even more unsustainable. And this is exactly why there's discussions at the moment about the UK or about France talking about the IMF because something has to change. You fundamentally cannot keep giving more and more money into healthcare into pensions when the population dynamic looks like it is. And that's a very, very hard thing for any politician to say because it's not a vote winner, but it is sadly a reality that both the UK and other European economies is facing.

Moz Afzal:
I just wonder whether it's from a politician standpoint, isn't it easier to just bring in the IMF and say, well help us because actually we can blame you rather than ourselves.

James Pomeroy:
Exactly. I think there's an element to this. I mean it's still politically unpopular to say you've had to bring in the IMF, but it is basically a short circuit to making the tough decisions. We nod this in the report basically saying, look, what causes something to break is either markets force your hand or someone like the IMF forces your hand or someone, some sort of renegade politician comes in and says, you know what? We need to fix this. And you've had that over Argentina is the latter choice, right? That's essentially what's happened there. Or you get the IMF and as you say, for any politician, it's actually quite a nice out, yes, you're probably going to lose your next election because your opposition will just say, well, these guys can't manage the books. They have to get the IMF in. But if the IMF comes in and says in the UK, well I'm sorry, you're going to have to change the way you fund X, Y and Z and we're going to have to fundamentally reset it, that makes a big difference.

And actually one of the points we make is if you do this right, you can actually free up quite a lot of fiscal space. And a great example is raising the retirement age. Now, raising the retirement age is such a fiscal win that it really does allow you to turn things around. If we use the UK as an example taking at the moment in the UK, about 15% of the population are over the age of 65 by 2050 be 25%. Okay? So that's your direction of travel. If by 2050 you raise the retirement age to 75, that's less than 15% of the population getting that pension. In 2050, if you raised it to 75 today, you're going to 7% of the population. So you're suddenly saving a massive amount of money by raising that retirement date. Our back envelope calculation is from pretty much every country in the western world, the retirement date should be somewhere around 72, 73.

That sounds brutal, but you've got to remember when these retirement age were put in place, life expectancy was about 68. Now life expectancy for most countries is 85 and rising. So you're talking about having to do this fiscally. It is so, so unpopular, but it makes a huge difference. And if you can use the cloud of the IMF to say, I'm really sorry, we've got to do this, and it allows you to do the big reforms i.e. raising retirement age by five years or something, it buys you so much fiscal headroom. And I think that's the challenge. I think politically, the only way I think you could sell this is yes, we're going to do X, but what it does allow us to do is cut your income taxes or cut your corporate taxes or whatever else we need to do. Because the problem you've got at the moment is a government in the UK is a perfect example of this at the moment is you're running up against such tight fiscal constraints that every single year the amount you've got to spend on healthcare pensions and so forth is rising by a percent.

And that's a big share of the budget. That means a percent has got to come out of something else and that means you're cutting spending on other benefits for people that need them. You're cutting capital spending, you're cutting long-term investment in the country just to keep paying for that. And this is why everyone will say, oh, but my public services aren't getting any better. Well, of course they can't because you're having to put more money into them just to try and keep them the same. The UK government will have to spend about 10 or 15% more in the NHS in the next 10 years just to keep things the same. That is the sort of challenges you're talking about for a lot of these countries that bill gets too big, you cut spending elsewhere, and if you can sell it as that package, the IMF said, we've got to do it, and as a result we can do X, Y, and Z. You might be able to get a little bit of buy-in, but it's still going to be pretty politically unpopular.

Moz Afzal:
Yes, it's going to be, well, political suicide essentially getting them in, right? I think we've seen that in the past, but just can't see any options. I think one of the things that strikes me when I'm looking at, let's look at France and the UK are definitely in the crosshairs France. It's pretty poor in the sense that whenever retirement age comes up in France, there's riots on the streets and everyone goes mad and you won't be able to travel anywhere. You just can't see any of that being sustainable. It just can't happen.

James Pomeroy:
No. And so what you might be able to do is some of the other changes. So you can make pensions much less generous, which is really hard. But the easiest way to do that politically is means testing them and means testing pensions feels like a really, really good idea. Again, politically unpopular. I didn't think it'd be as politically unpopular as maybe it is. And the great example of this is the winter fuel allowance in the UK. How politically unpopular was that taking that away or reducing how many people get it? But actually economically it makes quite a lot of sense. And one of the stats we use in the report is if you take the UK, we get great data from the ONS on a whole load of different things in the UK, if you look at people aged 65 plus, 50% of them have household wealth over 500,000 pounds.

Now obviously a lot of that is in property and so forth, but you have to start questioning, and this is again hugely unpopular, start questioning whether giving public funds in form of pension to millionaires is the best form of spending money and it might be more palatable to people than raising their retirement age. It might be a way you can sell it as this, it will be hugely unpopular. Any of these things are hugely unpopular, but it's a slightly more palatable thing to say, your state pension is X, if your lifetime earnings were Y and we scale it accordingly, and if your lifetime earnings have been X, Y, Z, you get much less. That would make a big difference. And I say half of the population, and when you look at millionaires over between 55 and 64 year olds, it's about 25% of those people have million pounds in assets and they're still going to get government pensions.

So it sounds brutal, but we're in such a constrained position fiscally these tough decisions have to be made. And I always joke to people when I talk about this at conferences, this is why I will never get elected into office because my flagship policies are almost all entirely incredibly unpopular. But we're hitting this breaking point and as you say, France and the UK in the crosshairs right now, the reality of this is right here today and it's going to get worse in the coming years unless you make some dramatic changes and means testing some of these payments is potentially more palatable than changing the access to them for all.

Moz Afzal:
Well, let's turn to a more positive note in the final few minutes we have, and I guess we talk about countries like India and Africa and those other places where obviously they have growing populations or suddenly for the time being, although India is starting to turn a bit, certainly from the latest data, maybe a bit of a positive spin on demographics.

James Pomeroy:
Yes, exactly. So all the negative news and demographics are very, very concentrated in developed economies as say Europe is really the epicentre because of that double-edged sword of ageing populations and previous commitments in other parts of the world, you've almost now got perfect ageing. So here I would say largely Southeast Asia, Africa's maybe a little bit further away from perfect ageing, but it's getting there where you have population that's slowing down but slowing down to something that's healthy. You almost don't want population growth of like 3, 4% a year. It is unmanageable. You can't keep creating enough jobs, but population growth of 2% a year or something like that is really quite good. And you're settling into something like that in somewhere like India. But it's not just about that being manageable, it's about the structure of the population since some are like India, the average age of the population.

So the median age historically has been in the teens, that's now in the twenties. And that's what you want to see is people ageing from being in their mid twenties to their mid thirties to mid forties. That carries with a huge productivity increase as well when people are going into workforce, picking up skills, et cetera, et cetera. So you're seeing that happen in India, most of ASEAN at the moment, that right structure of ageing and a more manageable population growth level, that's a huge upside risk to growth in those economies because it allows you to get that transition of the economy to more consumers. It helps to grow domestic markets, it helps to grow middle class consumption. And actually this is our big story when we think thematically about the world, is it's about global growth rotating away from those ageing fiscally constrained economies of Europe into those more dynamic fast growing economies in Asia. And I think that's the way I see the world for the next 10, 15 years is that slow tilt of growth going in that direction.

Moz Afzal:
So those are certainly so things we can look forward to as a much, much more positive story. And I think again, it kind of makes sense. I guess India stories fairly well understood the ASEAN story not so well understood, which I think is quite interesting.

James Pomeroy:
I think it goes under the radar a little bit because you've got lots of smaller economies. It's not like you've got one big one that then you add into the global mix. But if you think about ASEAN as a collective, you've got more than 500 million people across those markets. You've got economies that are a slightly higher broadly income per capital level than somewhere like India. So your transition is into middle class consumers, happens a little bit quicker and a little bit more aggressively. You've got economies that yes, they might get caught up a little bit in the tariff trade war things at the moment, but the domestic economies in these markets are picking up quite nicely. And you've got broadly pretty good fundamentals in terms of education rates, access to technology investment, capital investment happening. I think they're good news stories. And if you take ASEAN as a group, some of our work from even before the pandemic, we're suggesting actually when you look at that as a group, you've got economies that are already contributing as much to global growth as the whole of Europe.

And I think that's the way you have to think about the world in the next 10 years is Europe's role diminishing and the rise of India, the rise of ASEAN economies that start to move the dial on that global growth rate and going to be the most interesting since the largest economy in the region. But Vietnam is super interesting. The Philippines is super interesting. Malaysia is super interesting for different reasons, but they all together are quite a potent region that will matter for global growth. And so for all the pessimism we've talked about during the course of this podcast, the big picture story for global growth is probably not that negative. It's just that rotation away from those demographically challenged economies into those who've got a more favourable demographic backdrop.

Moz Afzal:
Well certainly has very important implications for global investment strategies. So James, thank you very much for coming on the podcast. Always fascinating, a lot more new information. So James, thank you very much again for coming on the call. So that wraps us up for today, and of course we'll be back again very soon. Thank you.

 

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