Emerging markets to benefit from a demographic dividend

In 1950, the world population was 2.5 billion. Today, there are more than 8 billion people on the planet – a 220% increase in just over 70 years. By 2100, the UN expects a global population of around 10.4 billion¹. However, this population growth will not be evenly spread – and this change in the composition of the world population will have major implications for economies and investors.

Demographics have a direct bearing on economic growth, the balance between young and old is particularly important. For any country, a ‘baby boom’ is typically followed by a demographic dividend: as the share of the dependent young generation declines, the proportion of the working age population increases. This means there’s potential for more people to be productive and contribute to economic growth. While this isn’t a panacea for economic strength, it can provide a significant boost.

In recent decades, advanced economies have benefitted from this transition: as the post WWII baby boomer generation aged, the working-age population ratio surged, generating growth and productivity. However, as this generation reaches retirement age, the share of workers will fall, creating a drag on the productive capacity of an economy. The proportion of taxpayers is also declining, which increases the burden on the state through pensions and healthcare costs.

As demographics evolve in the advanced world, we believe they will shift from being a tailwind to more of a headwind. In contrast, emerging economies could benefit from a demographic dividend. High birth rates in recent decades means that countries such as Pakistan, Nigeria, Egypt and India will see their working age population increase. This population growth is supported by improving life expectancies as healthcare standards improve.

Of the seven continents, Africa is expected to have the highest population growth rate at 2.2% per year until 2040. By the end of the century, the continent will be home to 40% of the world’s population, compared to 18% currently. Lagos, the largest city in Nigeria, is expected to swell from 16 million people to 24.5 million people by 2035⁵. Some parts of Asia are also experiencing considerable growth, notably Pakistan and India. This demographic dividend is not universal among emerging economies: China and Russia both face demographic headwinds, with low projected population growth rates and declining working age population ratios.

However, the real weak spots are found in developed markets. Japan, for example, is expected to see some of the largest declines in their populations. The country is plagued by low fertility rates and low levels of immigration.

The composition of a population is also crucial. Pakistan, Nigeria and Egypt are expected to see big increases in their working age population ratios, which measures the share of the population aged between 20-65 relative to the total population. Whereas South Korea is expected to see a massive 11 percentage point fall in its working age population ratio between 2023 and 2040¹. This is driven by its low fertility rate in recent decades and its high life expectancy, meaning there are fewer young workers coming through to replace those entering retirement. It’s a similar story in Italy and Germany.

At a global level, the working age population ratio is expected to be steady from 2023 to 2040. This implies the improvement in the working age population ratio in certain emerging economies is enough to offset the falls seen in others.

Demographics can help reshape a country’s economy. As the working age population ratio increases and the economy grows, there is usually an expansion in the middle classes. HSBC estimates that in India alone, the middle/upper class will grow by over 400 million people – the equivalent to six United Kingdoms – in the next two decades². All things being equal, this will power a significant increase in consumer demand in these economies.

Higher income levels do not just bring about more demand, but also a shift in consumption patterns. This means greater spending on leisure, vehicles, home furnishings and household maintenance. Spending on insurance rises as households and businesses have more assets to protect.

Population growth also brings greater investment needs, especially in areas such as housing and infrastructure. It can change diets, create demand for better healthcare and education. In this way, demographic shifts can spread through an economy.

In our view, countries that are set to receive a demographic dividend offer more growth opportunities for equity investors. Countries in Asia and Africa look set to enjoy the largest increases in real spending growth. In absolute terms, India is the clear winner with consumer market set to increase by over 400 million people by 2040. The absolute increase in China will also be high as more people move into a higher income bracket, but smaller relative to the size of its population². The leisure, vehicle and insurance sectors look set to benefit from these changes in composition.

There are also sectors that gain from aging societies in the developed world. Some of the largest increases in spending will come in the healthcare and pharmaceutical categories. We continue to like exposure to these area over the long-term for this reason.

Despite the positive demographic outlook for emerging markets, there remains a number of risks for investors. A higher share of workers is only effective if those workers are being employed productively. Other factors are important determinants of growth—which, in turn, can drive returns to equity markets. Pakistan, for example, has favourable demographics, but its financial markets are illiquid and narrow. The country also faces significant political risk.

Over the past 50 years, many promising economies have become ensnared in the middle-income trap, a situation where they find it difficult to transition to a higher income economy. Analysis by the Economist finds that India, China and several other emerging economies are currently stuck in this trap³.

To escape, the International Monetary Fund (IMF) argues that alongside demographics, there are five other important drivers that can help economies to sustain high growth rates: effective infrastructure, sound macroeconomic policy, a diversified economic structure, supportive trade policy and strong institutions⁴.

As emerging economies try to capitalise on their demographic dividend, they will do well to heed the advice of the IMF. Investment and difficult reforms are required. Whether they can escape the middle-income trap, only time will tell. But if they can take advantage of this significant potential, the upcoming decades will reward people invested in these countries.

¹ UN Population Division

² HSBC, The next generation of spenders

³ https://www.economist.com/finance-and-economics/2023/03/30/which-countries-have-escaped-the-middle-income-trap

⁴ IMF, Growth Slowdowns and the Middle-Income Trap

⁵ The Guardian, Megalopolis: how coastal west Africa will shape the coming century