The Impact of Demographics on Investment in Japan and China

1
The Impact of Demographics on Investment in Japan
and China

• JOHN GREENWOOD, WIESBADEN, 2. JUNE 2005

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The Impact of Demographics on Investment in
Japan and China
THE IMPACT OF DEMOGRAPHICS ON CAPITAL MARKETS
China will grow old before it grows rich

Stuart Leckie
3
OUTLINE
THE IMPACT OF DEMOGRAPHICS ON CAPITAL MARKETS
01 DEMOGRAPHIC TRENDS IN JAPAN CHINA 02 -
IMPACT OF AGING ON SAVINGS, INVESTMENT
CURRENT ACCOUNT BALANCES 03
IMPACT ON ECONOMIC GROWTH INVESTMENT
RETURNS
CONFIDENTIALITY NOTICE All material presented is
compiled from sources believed to be reliable and
current, but accuracy cannot be guaranteed. This
is not to be construed as an offer to buy or sell
any financial instruments. It is not our
intention to state, indicate or imply in any
manner that current or past results are
indicative of future profitability or
expectations. As with all investments there are
associated inherent risks. Please obtain and
review all financial material carefully before
investing. This publication may contain
confidential and proprietary information of
INVESCO Institutional and/or AMVESCAP
International Companies. Circulation, disclosure,
or dissemination of all or any part of this
material to any unauthorized persons is
prohibited. Unauthorized reproduction or
distribution of all or any part of this material
is prohibited.
4
Demographic Trends in Japan China


01
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Demographic Trends in Japan China

• The Populations of Japan and China are...
• At different stages of development
• Japans population has already peaked and is now
  starting to decline
• Chinas population is still increasing, and will
  continue to do so until around 2030, and then it
  too will start to decline
• Indias population, however, will continue to
  increase beyond 2050, exceeding Chinas
  population by around 2030.

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Demographic Trends in Japan China
Title
Source United Nations, World Population
Prospects, 2004 Revision, Medium variant
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Demographic Trends in Japan China

• Two Key Developments are Aging and the Increase
  in the Dependency Ratio, driven by
• Falling birth rate and increased life expectancy
• Decline in working age population as of total
  population
• Again, Japan and China are at different stages of
  development, notably
• -- Japan already has the longest life
  expectancy in the world (78.3 for men, and 85.3
  for women), but it is expected to increase
  further (to 84.1 and 92.5 respectively in 2050)
• -- Chinas dependency ratio is still falling as
  the birth rate is very low and the working age
  population is increasing, but the country is
  still younger than Japan (median age 32.6
  versus 42.9 in Japan in 2005).

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Demographic Trends in Japan China
Source United Nations, World Population
Prospects, 2004 Revision
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Demographic Trends in Japan China
Source United Nations, World Population
Prospects, 2004 Revision
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Demographic Trends in Japan China
Total Population (million)
Asia
Japan
China
India
2005
128.1
1,315.8
1,103.4
3,905.4
2050
112.2
1,392.3
1,592.7
5,217.2
Life Expectancy at Birth (years)
Japan
China
India
Asia
2005
81.9
71.5
63.1
67.3
2050
88.3
78.7
75.9
77.2
Elderly (65) as of Population
Japan
China
India
Asia
2005
19.7
7.6
5.3
6.4
2050
35.9
23.6
14.8
17.5
Source United Nations, World Population
Prospects, 2004 Revision
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Demographic Trends in Japan China - Summary

• Japan is leading the world trend in aging
• Japan has the highest life expectancy in the
  world, a high median age (42.9), and will have a
  dependency ratio by 2050 that implies one worker
  per dependent.
• Chinas median age is lower (32.6 versus 42.9 in
  Japan), and will remain lower even after 2050
  (44.8 versus 52.3 in Japan).
• Chinas dependency ratios are lagging about 20
  years behind Japans
• This should be advantageous to China. However,
  Chinas per capita income is far lower than
  Japans (1,100 versus 34,180), and will not
  catch up for many decades.

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Savings, Investment Current Account Balances
02
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Savings, Investment Current Account Balances

• Modigliani Brumberg Life Cycle Savings
  Hypothesis
• Low income households are disproportionately
  young and elderly
• High income households tend to be middle-aged
• Young and old households have high average
  propensity to consume
• Therefore societies with more middle-aged
  households will tend to have lower average
  propensity to consume, or higher average savings
  rate
• National Savings Current Account Balance
  Investment
• Japan model based on population projections,
  working age population, growth of output per
  worker.

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Savings, Investment Current Account Balances

• Chinas Savings Rate Still Rising
• Comparable to Japan in 1950-70
• Working age population still increasing,
  therefore we should expect high and rising
  savings rate
• Actual level between 45-50 of GDP

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Savings, Investment Current Account Balances
SourceThomson Datastream, May 2004
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Savings, Investment Current Account Balances

• Japans Saving Investment Rate Declining since
  1991
• Reaction to over-investment during asset bubble
  of 1985-90
• Impact of aging society starting to be apparent
• Working age population falling since 1998
• Corollary of Modigliani Brumberg hypothesis
  Societies with more older-aged households will
  tend to have higher average propensity to
  consume, or lower average savings rate

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Savings, Investment Current Account Balances
Peak, 1991
Verteilung der Weltbevölkerung
Source Thomson Datastream, May 2004
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Savings, Investment Current Account Balances

• Japan Model based on population projections,
  working age population, growth of output per
  worker.
• Population projection to 2050 (United Nations)
• Working age population projection (United
  Nations)
• Based on recent decade, assume stable
  participation rate (74)
• Estimate labour productivity based on 1991-2004
  average (1.2 p.a.)
• Calculate output per worker and output per capita
• Difference represents net amount of goods and
  services required to be imported
• Apply required net imports to current trade
  balance (as GDP)

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Savings, Investment Current Account Balances
JAPAN MODEL
Source Thomson Datastream, May 2004 and INVESCO
calculations
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Savings, Investment Current Account Balances
JAPAN MODEL
Source Thomson Datastream, May 2004 and INVESCO
calculations
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Savings, Investment Current Account Balances
JAPAN MODEL
Source Thomson Datastream, May 2004 and INVESCO
calculations
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Savings, Investment Current Account Balances -
Summary

• Theory (Modigliani Brumberg) suggests (1)
  societies with more middlle-aged households will
  tend to have lower average propensity to consume,
  or higher average savings rate, and (2) societies
  with more older-aged households will tend to have
  higher average propensity to consume, or lower
  average savings rate.
• Evidence from China (rising population of working
  age and rising savings rate) confirms hypothesis
  (1).
• Evidence from Japan (falling population of
  working age and falling savings rate) confirms
  hypothesis (2).
• Japan model based on population projections,
  working age population, growth of output per
  worker to explore current account implications.

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Economic Growth Investment Returns
03
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Economic Growth Investment Returns

• With aging population and rising dependency
  ratios, savings and investment rates tend to
  decline
• Adverse impact of aging on fiscal balance.
  Government revenues reduced by impact of lower
  working population on incomes, profits and
  output. Government expenditures increased by
  enhanced spending on pensions, health care, and
  long term residential care.
• In OECD, spending on the elderly estimated to
  rise by an average of 7 of GDP between 2000 and
  2050, with additional expenditures on health care
  exceeding those on pensions in a number of
  countries. (Casey 2003, European Commission 2001)
  .

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Economic Growth Investment Returns

• JAPANESE GROWTH PROSPECTS
• Output per worker 1991-2004 increased at 1.2
  p.a.
• Working population now declining
• Savings rate on long-term decline
• Rising dependency ratios implies higher social,
  pension and health care burdens
• Numerous negatives imply GDP growth only 0.9
  p.a. and per capita GDP growth only 1.2 p.a.
  (2000-2050) (McMorrow Roger, EC, April 2003)

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Economic Growth Investment Returns
(McMorrow Roger, EC, April 2003)
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Economic Growth Investment Returns
Deviation from baseline
(McMorrow Roger, EC, April 2003)
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Economic Growth Investment Returns

• Both Japan and China face difficult challenges
• Japan is rich, but has the greatest longevity and
  faces the highest dependency ratios.
• China is aging more slowly than Japan today, but
  it will not be so wealthy when its dependency
  ratios start to rise.
• Assuming Japans per capita income grows at 1
  p.a., and Chinas grows at 8 p.a (until 10,000)
  then 5 p.a., Chinas per capita income will be
  less than half of Japans in 2050.

Source World Bank, December 2004, and INVESCO
calculations
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Economic Growth Investment Returns

• INVESTMENT RETURNS
• Hypothesis A Profits f (Economic Growth Rate)
• Hypothesis B Integrated capital markets imply
  return on capital is equalised across
  economies and asset classes
• However, Chinas capital markets not integrated
  with global financial markets (due to foreign
  exchange controls)
• CURRENCY PROSPECTS
• Will RMB benefit from Balassa-Samuelson effect as
  the Yen did?

Source Bloomberg, May 2005
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Economic Growth Investment Returns - Summary

• JAPANs economic growth rate already impacted by
  decline of working age population and by aging.
• Prospects negative due to inability to expand
  labour supply, savings and investment rate
  falling, structural reforms proving difficult.
• CHINAs growth rate likely to remain high for
  next 2-3 decades
• Catch-up in productivity, import of capital and
  technology.
• INVESTMENT RETURNS Outlook ambiguous.
• Closed capital market implies differential
  returns, and not necessarily favourable, viz.
  Chinas A-share market.
• CURRENCY RMB could benefit from
  Balassa-Samuelson effect (real appreciation
  due to incremental productivity gains).

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OUTLINE
THE IMPACT OF DEMOGRAPHICS ON CAPITAL MARKETS
01 DEMOGRAPHIC TRENDS IN JAPAN CHINA 02 -
IMPACT OF AGING ON SAVINGS, INVESTMENT
CURRENT ACCOUNT BALANCES 03
IMPACT ON ECONOMIC GROWTH INVESTMENT
RETURNS
CONFIDENTIALITY NOTICE All material presented is
compiled from sources believed to be reliable and
current, but accuracy cannot be guaranteed. This
is not to be construed as an offer to buy or sell
any financial instruments. It is not our
intention to state, indicate or imply in any
manner that current or past results are
indicative of future profitability or
expectations. As with all investments there are
associated inherent risks. Please obtain and
review all financial material carefully before
investing. This publication may contain
confidential and proprietary information of
INVESCO Institutional and/or AMVESCAP
International Companies. Circulation, disclosure,
or dissemination of all or any part of this
material to any unauthorized persons is
prohibited. Unauthorized reproduction or
distribution of all or any part of this material
is prohibited.