Why Demographics Matter to Investors

How Who's Born When Affects Growth, Rates, and Votes

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If you’re looking for a simple way to think about economics, you can start by imagining every participant in the economy as an immortal being that's relentlessly committed to maximizing its utility.1 But if you want to describe real people, though, at some point you need to concede that some of us, like infants and octogenarians, are less productive than others. At a micro scale, the main consequence of this is that 22-to-65-year-olds are a lot easier to model as Homo Economicus than people outside that age range. At a macro scale, though, things start to get interesting: with a constant demographic structure (i.e. reproduction at the replacement rate, no net immigration, and stable birthrates over time), you can simplify things by thinking about households rather than individuals—but that falls apart as soon as demographics shift.

The first demographics-related macro fact we need to consider is that "GDP per capita" is an average based on the economic activity of working and non-working people. In a static economy, this is fine: averaging everyone at one moment gives you the same picture as averaging the average person’s income over their entire life. If you increase the share of non-working people, then you dilute the GDP per capita. There are two relevantly different ways that can happen: everyone has babies, or everyone gets old.

Babies are, among other things, quite inflationary. In addition to direct spending on kids, parents usually consume more housing and buy more (and larger!) cars relative to those without kids. And the time demands of childcare are inflationary as well, since its impact is some combination of lower working hours for parents and higher demand for childcare.

And that's just the start. The real inflationary impact of a baby boom is when the babies produced by that boom start forming families of their own: the CPI hit its year-over-year records in the 70s and 80s right around the time when the baby boomers were at their peak childbearing (and home/car/appliance-buying) years.

Having kids doesn't have to consume lots of space and money, but it usually does. So, naturally, governments tend to implicitly subsidize access to credit for young families. In fact, one way to look at the US mortgage system is that it is, in practice, the US's most significant fertility surplus program. But having an open-ended policy of providing credit for people who buy expensive assets often drives the price of those assets, and the inputs required to make them, higher. There were plenty of other factors behind the great inflation of the 1970s; the oil embargo had nothing to do with demographics, for example. But the coincidence of these factors certainly had an impact.2

In general, it's feasible for a country to normalize after a baby boom. Higher populations push up real estate prices, which slows family formation. As those kids age up and join the workforce, they end up contributing, on the margin, to economies of scale and to the diffusion of productivity-improving technologies. A larger and more complex economy can support more R&D, more management consultants, a more complex financial system, and other factors that either create or spread new ideas.

The flip side of this demographic factor is what happens when there's a significant drop in birthrates, and an increase in average age. If a baby boom is pro-growth and inflationary, it's natural to infer that a silver tide will be anti-growth and deflationary. That's probably the direction to bet in, but the details get tricky.

To understand the inflationary impact of aging, it's helpful to drill down into where people's spending and income peaks. Typically, personal consumption for households reaches its highest levels when the heads of the household are in their early 40s, and then declines from there. Meanwhile, incomes peak in the 50s, on average.3 That means that the fraction of the population in their fifties is a major driver of savings rates; they're making more than ever but spending less than they used to, and that money has to go somewhere. Typically, it will go into a mix of equities, fixed income, and housing.

After that, though, the aging picture gets more ambiguous. There's been an increasing bifurcation among the elderly, where some of them are basically surviving on modest savings and significant government transfers, while others achieved the escape velocity at which their wealth compounds faster than their spending ever could. But this can't be universal, and it can't last forever, because it implies a large surplus of investable wealth at exactly the same time that consumption is declining, which should reduce the number of decent investment opportunities. The net effect of this should be a steady decline in interest rates and increase in the valuations of stocks and homes—perhaps interrupted now and then by the inflationary impacts of pandemics and wars, but mostly trending towards zero or negative real returns on savings.

But that’s all relatively straightforward—what makes this tricky to model is the political dynamic. In other words: old people vote! Millennials have been the largest generational cohort in the US for a while, but unless current trends change, they won't be the largest share of the electorate until the 2030s, because Baby Boomer turnout offsets millennial numbers. This matters because one category of things people vote for is government-subsidized healthcare, so it should come as no surprise that the US government's single largest off-balance sheet liability is Medicare, i.e. promises current politicians have made with respect to how future spending will be directed towards healthcare.

If that continues, aging could end up being inflationary, but just in that one category. And improving productivity in healthcare is notoriously hard, for famously complex reasons, so all else equal, reallocating spending to that sector would lead to slower productivity growth.

Overall, the inflationary/deflationary question for aging societies is inherently hard to answer. Answering has to involve knowing how much voters vote purely out of self-interest, how effective they'll be at getting their desired policies enacted, and whether or not successes lead to some kind of coalition opposing it. (For what it’s worth, it's always possible that some level of automation in healthcare turns out to be possible, and productivity metrics start improving.)

The default bet, though, is that the rough status quo will continue to prevail. In that case, increasing average ages will tend to reliably produce slow growth, with an uncertain impact on inflation. This is a problem across all economic systems. Capitalism, socialism, communism, isms as yet undiscovered will all run into the problem that some predictable fraction of the population can't work, but everyone needs to eat.

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Read More in The Diff

The Diff has looked at the impact of demographics on finance in several different contexts:

  • The Baby Boomer Rollup Industry ($) examines companies that systematically acquire small businesses founded or owned by older people who want to retire.

  • In A Uranium Shortage, Someday ($), we use this analysis at the career level: when an industry goes from hot to not, there’s a bulge in the population pyramid that makes the industry more risk-averse until those people start to retire.

  • Does the US Electorate Prefer Deflation ($)? Many voters had their formative experiences around inflation in the 70s, which has made price levels a more salient issue than they otherwise would be.

  • And in What Happened to all the Diamonds in the Rough? We look at the dispersion in US companies’ management quality has gone down, with some of the cycle driven by when large numbers of MBAs entered the workforce: “28% of Harvard Business School's class of 1949 retired with the job title of President, CEO, or board chair.”

1. As many people have pointed out, utility-maximizing is a tautology, since you infer someone's utility function based on their goals and then define their goal-seeking behavior in terms of utility. But that tautology gets you pretty far! It's right up there with "genes are selected to maximize fitness, where fitness is defined by which genes have been selected for" in terms of its utility.

2. If you want to be very precise, the oil embargo was partly a function of these demographic issues, since a larger-than-usual number of young families probably makes energy demand even less elastic than usual. But that exacerbated the degree to which the embargo itself was a factor, rather than being the underlying cause.

3. And in a slowing economy, they might actually peak later. The less things change, the more accumulated knowledge and social connections matter relative to the ability to rapidly adopt new technologies or to pull consecutive all-nighters finishing a project. Accumulated wisdom beats cleverness when there isn't much new to discover, and when it's especially hard to act on novel ideas. So it's possible that in the future, the old-age wage premium will be even higher. There's plenty of anecdotal evidence against this, of course, but almost all of it comes from particularly dynamic sectors which, while important, are a comparatively small share of the economy. It only took GM about forty years to go from being a scrappy startup to being the symbol of corporate conformism. Perhaps by the late 2030s, Google will fill the same role.

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