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Demographics and the shifting economic centre of gravity

8 min read 8 Dec 22

An update on demographics and the shifting economic centre of gravity and what they mean for Pru multi-asset portfolios?

In November, the UN’S Department of Economic and Social Affairs marked a milestone, setting 2022 as the year the world population would reach 8bn people. The geographical composition of the world’s population highlights an ongoing shift in the demographic, and economic, centre of gravity of the world. These are themes we have written about previously and are key factors that have influenced the evolution of multi asset portfolios across equity, fixed income, property and alternatives.

We reflect on the current impact of global demographics on our Capital Markets Assumptions (CMAs) and the implications this has on our outlook and investment strategy.

In this article

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Demographics as destiny

Few things in economic forecasting are certain. And when forecasting population growth, there are many assumptions relating to fertility rates, migration and so on that must be factored in. That said, existing population cohorts can still offer a relatively reliable indication of how the working populations of economies can be expected to evolve over coming decades. 

But why do demographic trends matter?

In fact, demographics are a key structural factor, influencing growth potential of an economy, and are thought to also have a bearing on trend inflation. These are both key inputs to our CMAs . Additionally, since savings/portfolio preferences are expected to evolve over a person’s lifetime, large-scale shifts in the relative weights of age cohorts in a population can have a large bearing on the supply of capital and the required return for particular asset classes. (this bit isn’t very clear?)

Our own in-house modelling of the potential growth of world economies features demographic projections as a key factor to the production function of economies, alongside required capital investment and productivity growth.

Figure: Annual real GDP growth projection; rolling 5-year averages measured at current Purchasing Power Parity (PPP)

Source: Datastream & LTIS calculations, as of June 2022

Looking across the different regions of the world, there are clear divergences in demographic trends, with implications for the outlook for economic growth and capital markets. Aggregating up country-level estimates, we see continue to see scope for Asian and emerging market regions to gain a larger weight in the global economy over time.

Divergent demographic trends across global regions

In Western economies, the post-war decades saw a burst of population growth that led working populations to grow rapidly, supporting aggregate economic growth. Recent decades have seen fertility rates in these countries fall steadily and this is bringing about a turning point for demographics in these economies on two fronts. Firstly, fewer young people are entering the workforce and secondly, a significant portion of the population is getting closer to retirement.

Other regions offer brighter prospects. As can be seen in updated projections from the UN, the geographical split of the global population is rapidly evolving, with the representation of Asian and African populations set to rise materially over the course of the coming thirty years, as birth rates for the region continue to rank as the highest and life expectancy improves.

This has certainly been reflected in our decisions to add Indian equities and Emerging Market debt while also increasing exposure to African equities, Asian property and Asian bonds, for example.

Figure: Rankings of the world’s ten most populous countries, 1990 to 2022, and UN projections for 2050

Source: UN

Implications for the global economy: a shift from West to East

By extension of these demographic trends, we can expect the economic centre of gravity to also shift over time. As we have previously discussed with our work on shifting economic centre of gravity, it is easy to forget that the Western dominance of the 20th century was preceded by Eastern supremacy.

Figure: Long-run trends in regional shares of world GDP

Source: University of Groningen, 2018

And the prospects for faster economic growth are not just underpinned by more bodies on the factory floor. Since the onset of globalisation, increased economic integration and knowledge sharing has begun to bear fruit for middle- and lower-income economies. These regions also have a lower base with respect to productivity per worker; a convergence toward advanced economy productivity levels, can further raise the scope for relative outperformance.

Alongside a growing relative weight in global activity, our analysis of global trade flows indicates that a greater degree of EM trade is intra-regional between EM trade partners, also suggesting there is an increasing degree of internally-generated activity.

Whilst developed markets and in particular the US, will still have a significant bearing on emerging market economic and financial market conditions in coming years, these trends do suggest increasing scope for internally-generated demand to help emerging markets to become more independent of developed market cycles over time.

Focusing on future economic prospects, not current market capitalisation

Over the long run, the market capitalisation of domestic equity and bond markets tend to be closely correlated with the size of the economy. However, when comparing the capitalisation of global markets, we see a large concentration in weight toward advanced economies, that is disproportionate to their relative economic weight, as at current levels of GDP. The contrast is even more stark when viewed in the context of contrasting growth outlooks.

Figure: Economic weight versus global equity benchmark weight

Source: Datastream & LTIS calculations, as of June 2021

Summary

The most obvious implication for our investment strategy has been the greater allocation to Asian and Emerging Markets assets (specifically India, Asia and Africa) within a global portfolio than might be expected if basing allocation weights purely on relative market capitalisation in global benchmarks.

While long term growth prospects offer compelling arguments to invest in EMs as a group, there is a fair amount of risks and uncertainty about the outcomes for specific countries. Not all of them will necessarily reach developed country status, and each of them have risk characteristics which are distinct. Hence there is a case for diversification within EMs and any concentration risk needs to be carefully monitored and managed.

Additionally, local market expertise is required for managing these investments and our preference is for managers with a local presence who understand the country-specific risks and have a track record of managing investments in these markets.

Long Term Investment Strategy is part of Investment Office of M&G. It is responsible for generating economic and capital markets assumptions, setting investment strategies and Strategic Asset Allocation for Prudential’s with-profits, annuities and unit linked products.

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