Ageing and its impact on finance

What does an older population mean for markets? The last article of a four-part series on global ageing.

Japan's rapidly ageing population is well known, but the problems it creates are not confined to Japan. The rest of Asia is going to experience the same phenomenon, asserts Makoto Atoh, director-general at the National Institute of Population Research in Tokyo.

Japan has completed a 'fertility transition', where families produce not five but around two children. Its population has peaked and has begun to fall. Hong Kong and Singapore are about a decade behind. China, as well as the developing markets of South and Southeast Asia, will reach their peaks by 2050 û which means some Asian countries will experience growing work forces, more consumption and more investment opportunities for four more decades.

But 17% of Japan's population is elderly, and by 2010 over 25% Japanese will be over 65 years û creating what Atoh calls a 'hyper-aged society'. Hong Kong and Singapore will enter this state by 2010, China and Thailand will reach it by 2040, and India will in 2050.

By then, 58% of Japan's population will be elderly and financial dependents, a staggering burden worsened by modern society, which entails mobility, women workers and much less support from children. Many West European countries such as Germany and Italy will be in the same boat as Japan, with Britain and the United States facing these problems, but to a lesser degree. Nonetheless the developed and much of the developing world needs to upgrade its social infrastructure to deal with this reality.

Don Ezra, director of strategic advice at Frank Russell Company in the US, says these demographic pressures will reduce savings, as more old people spend their nest eggs. For East Asian countries, today's savings rates averaging 35% of GDP will fall to 30% by 2010, although beyond that the decline is difficult to assess. There is nothing governments can do to stop this fall, but they can improve living standards and blunt the impact by investing in education, social safety nets, etc.

They can also, because of their long-term nature, let the present generation trade with the future ones via social security or government debt. Makoto Utsumi, president of the Japan Centre for International Finance, argues this is essential because the notion of investing in less developed countries for better returns is a "red herring" because of the difference in risk. Furthermore, China and the rest of Asia, as well as Latin America and Eastern Europe, are ageing too û is the entire world going to invest in Ghana?

Robin Brooks, an analyst at the International Monetary Fund, wonders whether this decline in savings and of investment opportunities in developed countries heralds a global bear market. The fear is that as baby boomers retire, stock markets will collapse. Looking at the US, he notes the stock market has tracked the rise of the boomers, who have been proponents of buy-and-hold practices and pushed up equity premiums. But what if all these ageing people switch to bonds as they retire?

Unfortunately there is too little statistical data to draw conclusions, but Brooks says the 10-year outlook for equities overall does not look promising. Nonetheless he questions how dramatic the shift to bonds will really be, noting that while America has indeed developed an equities culture, nearly all the market is owned by only 10% of the population, and it is this segment that may invest across generations, either as institutions or to preserve family legacies. Furthermore, the returns on relatively unrisky investments will fall; Brooks estimates by 2030 the sheer weight of demand for bonds in the US will drive up prices so much that returns will in fact be as much as 30 basis points below what investors would expect.

The more urgent question for Japan is what ageing means for its ongoing corporate restructuring. "Societies with shrinking populations must become relentlessly efficient if they are to continue to grow," observes Jon Anderson, chairman of AIG Japan.

Yes, but is this a problem of demand as consumers dwindle or supply of investments, wonders Mineko Sasaki-Smith, chief strategist at PriceWaterhouseCoopers. Japan's demographics help explain a decade of deflation and value destruction, based on too little demand and oversupply, which in turn is due to inefficient capital allocation: since 1989 Japan's stock market capitalization has lost Y350 trillion, or 68% of GDP; land prices have lost $1,250 trillion in value.

Sasaki-Smith says on the bright side, globalization can allow market forces to clean up this mess. He argues that Schumpter-like 'creative destruction' has begun to occur in Japan, but what is not happening is an outright inflationary policy by the central bank to offset the pain of a bank shakeout. And while cleaning up the banks is painful, Sasaki-Smith says it will favour the elderly because it means lower prices, particularly for housing; already, he says, there is a shift in older people being able to afford returning to central urban areas, to be closer to their children.

If some believe a bank cleanup and reflation are needed to face the demographic crisis, other economists believe Japan must export its way out of its predicament. Andrew Smithers, chairman of Smithers & Company, argues Japan has no choice but to massively devalue the yen.

His argument is that Japan's refusal to face up to a structural savings surplus - a direct outgrowth of its demography - is the reason for its economic malaise. Its investment rate is far below that of other countries with stable populations, and its savings rate is higher û a mismatch that can only be met by a large current account surplus. As this is a long-term need, short-term budget deficits are of little help; aside from mass immigration, Smithers sees no solution beyond weakening the yen to around Y185 to the US dollar and create export-led growth. The problem here becomes political, because the United States will reject such a move, he says.

A corollary to this argument is that cost cutting, implicit in corporate restructuring, will not help Japan at the macro level. Rather, for investments to become more profitable, investments must decrease. Smithers says the notion of cost cutting as a way to make return on capital overall higher in Japan is a fallacy of likening countries to companies. "One company's costs is another's income," he says, noting that if a manufacturer makes steep cost cuts, it means its suppliers suffer, and if everyone is cutting costs, overall growth will fall, or at best stay neutral.

But Naohiro Yashiro, president of the Japan Centre for Economic Research, doubts the efficacy or need to weaken the yen. "We need another method, raising returns on investment," he argues.

He rejects the notion that cost-cutting won't work, noting that sectors such as agriculture and distribution are rife with inefficiencies. He believes what is required is strong political leadership to cut support from low-productivity sectors. Furthermore he believes the government's current pension commitments are ridiculously large and should be halved, with private fully funded schemes taking up the slack.

The postal savings system must also be privatized, he says. "It is a problem of both the government controlling too many savings and investment them badly," he says.

Norbert Walter, chief economist at Deutsche Bank, argues that Japan must internationalize to save itself. Education and training in particular need to be made international, with more foreign teachers and a serious promotion of English. "Female labour participation is not qualitatively good and must be improved," he adds. Universities are largely useless and need to be made competitive, while corporate managers need to become more creative. "The first thing I would do is throw out the personnel department," he says.

Growth may also come as the elderly gradually remain in the workforce, and become consumers themselves, says Shinji Fukukawa, CEO at Dentsu Institute for Human Studies. He argues to bring the elderly into the labour market requires a shift to merit pay, expanded occupational training and new technology to help the more physically frail work. He also notes the elderly are rich, with 53% of Japan's financial assets û Y85 trillion û held by people over 60. That amount will rise to Y125 trillion by 2025, he adds. "We must explore the silver market for leisure, tourism, mobility, health and financial services," he says.

What all these disagreeing voices suggest is that Japan faces pressures to change radically across many fronts: fiscal and monetary policy, exchange rate policy and trade relations with America, corporate culture regarding seniority and the role of women, attitudes toward foreigners, corporate restructuring, boosting profitability, increasing the role of personal responsibility for retirement savings, instituting an investment culture and embracing unfettered competition.

With its population facing a century-long decline and ever-greater greying, Japan is likely to become a very different country. Demographics is an inexorable trend that is almost impossible to alter, leaving Japan with increasingly few options. The rest of East Asia will be facing similar quandaries in the near future, but will have a chance to avoid Japan's mistakes and emulate what it gets right.

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