A look at demographics and economic growth

Jonathan Lemco, a senior investment strategist, and Andrew Patterson, a senior economist, in Vanguard’s Investment Strategy Group look at how shifts in the world’s populations affect economic growth.


Global macro matters

Lara DeLaIglesia

Lara de la Iglesia: Age, income, education—these are just a few of the characteristics that differentiate the world’s populations. We all know that. But what you might not realize is just how profound an impact those demographics have on a country’s economic growth. So, to discuss this, I am joined today by Jonathan Lemco, a senior investment strategist, and Andrew Patterson, a senior economist, in Vanguard’s Investment Strategy Group. Guys, thanks very much for being here.

Jonathan Lemco: Thank you.

Andrew Patterson: My pleasure.

Lara de la Iglesia: All right, so let’s start with a broad perspective, Jonathan. You’re the father of millennials. And by that, I mean people generally in their 20s and 30s. Share with us, at a high level, what are some of the big differences between your generation and your children’s.

Jonathan Lemco

Jonathan Lemco: Well, I’m a baby boomer, which is approximately 1946 to ’64, and we are told by demographers that baby boomers seem to value more material things. They like houses, cars, things you can buy that are objects, if you will, much of the time. I suspect that the generation before me, the so-called World War II generation, was not all that different, really, and, of course, they were molded by the Great Depression.

But by contrast, my kids, who are in their late 20s, the so-called millennial generation, I think are typical of many North American kids in that they value experiences more than material things. They like social media, extremely important; communicating with friends, extremely important. If they’re going to be working, they’re going to look for opportunities to work elsewhere, ideally in another country if they can or a different culture if they can. They’re going to put a lot of value on vacations but, again, less on houses and certainly less on cars.

Lara de la Iglesia: Interesting; so that’s a bit on consumer spending. I would like to ask, when we have a large population shift, how does that impact government spending then?

Andrew Patterson
Andrew Patterson

Andrew Patterson: So, if you look at the government spending numbers, the vast majority of that really has to do with entitlement spending. So, what do we mean when we say entitlement spending? Well, we can talk about the United States as an example, but this spreads across borders. This is an issue for all, particularly developed-market economies that have slow or, in some cases, even falling population rates where you have the cohort of individuals age 65+ who tend to retire being supported by the working-age population. If that working-age population is not growing as fast as the population of retirees, that tends to weigh more on government budgets. You don’t necessarily have the tax revenue growth that you would need to sustain spending on priorities such as Social Security here in the United States.

We’re not here to say that that’s a good or a bad thing, just more that the numbers are what the numbers are. So, it’s something that does need to be considered as we continue to age.

Lara de la Iglesia: So, then, what is the impact on economic fundamentals? How does this all factor in, something that we monitor?

Andrew Patterson: So, with the government spending side, government spending is, by its nature, spending, right? So that tends to be, again, at its base, positive for economic growth. You can get into a lot of arguments about what that could mean from a crowding-out perspective. Is government spending more efficient or productive than what would have been accomplished within the private sector if the government hadn’t had to use those resources themselves?

There’s days and days and months and months of debate on that. What we like to think about when thinking about demographics, really, is more on the spending side on the individuals.

Lara de la Iglesia: So, the consumer spending, as Jonathan was addressing earlier.

Andrew Patterson: Exactly, exactly. And the way that we view that is more, as the population ages, if you will, different rather than more or less.

Lara de la Iglesia: What does that mean—different?

Andrew Patterson: By different I mean that, now there are studies that show that millennials may be a bit more risk-averse than some previous generations, maybe as a result of the GFC, the Global Financial Crisis, if you will. But the data’s just really starting to come in on that.

What we’ve seen historically, though, is that, as a population ages, you tend to spend more on things, whether it’s an individual or government, on things like health care, right, and less so on things like education or the costs associated with raising a child. Such that in aggregate, growth may not be as impacted as some might think because you’re just shifting those spending habits. Inflation, likewise, may not be as directly impacted as some might think because it’s more of a shifting of the composition of the basket of goods and services that people spend on rather than outright increase or reduction.

Lara de la Iglesia: Interesting. So then what might all of this mean for investors? Is there a key takeaway here or something that they should remember?

Andrew Patterson: So, I think when you’re looking on the investment front, I mentioned before—difficulty in assigning impacts to growth, inflation, based on spending habits, whether it’s coming from consumers or coming from the government, right? There’s going to be pockets of increased spending on certain goods and services, decreased spending on certain goods and services because of this aging of the population.

I would say that demographics, in general, tend to feed into our views on relatively lower growth, relative to where we were pre-crisis; relatively lower inflation, which leads to our view, helps to inform our view—that interest rates are likely to be lower relative to where they were pre-crisis, which then feeds into broader portfolio implications, where portfolio returns for similarly allocated portfolios may be somewhat lower going forward.

But I would say at the end of the day, you as an individual, you as an institution—it’s your own demographics that really matter the most for your investment decisions and your investment success. Has there been a big change in those? Have you seen a big change in the population of your workforce? As an individual, has something in your situation changed?

Lara de la Iglesia: Just helpful to understand your situation and helping to explain setting expectations accordingly for what growth might look like going forward, right?

Andrew Patterson: Absolutely.

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