Graying Japan Can't Keep up

09/13/2010 11:19 am EST

Focus: GLOBAL

Deborah Owen

Columnist, The IRS Report

Graying Japan Can’t Keep up      

The sprightliest market gains will come in Asian countries where the population is growing rather than shrinking, writes Deborah Owen in The IRS Report.

The UK government has announced that it will be abolishing the [65-year-old] retirement age. At the same time, there has been speculation that the Work and Pensions Secretary, Iain Duncan Smith, will raise the pension age to 66 for both sexes much quicker than the step rises announced under the Labour government.

Both policies are inevitable. Although it is not very evident at the time, demographic trends exert a very powerful effect on economic growth. In many countries around the world, a reduction in the birth rate coupled with a rapid rise in life expectancy is creating a demographic time bomb.

Japan is at the leading edge of this demographic transition. The birth rate there has been falling for half a century, and in 2005 it reached a record low of 1.26. As a result, the overall size of the population has begun to fall and, on current trends, it is predicted that it will have shrunk by 20% by 2050. With approximately a fifth of the population over the age of 65, Japan has the largest proportion of elderly people in the world. The figure is projected to rise to almost 40% by 2050.

Instead of the traditional pyramid shape, Japan’s demographic profile will have become inverted. The low
number of young people at the bottom means that there will be a shortage of workers to pay for the pension and health care that will be needed to support the rapidly growing elderly cohort.

How will these trends affect investors? According to research by the International Monetary Fund, there is a positive correlation between a country's growth in [gross domestic product] per head and the size of its working-age population.

Not only does a large labor force contribute to the productive capacity of a country, but it also generates savings which are, in turn, invested, thereby further enhancing output. Over time, stock markets of countries whose working-age populations are growing strongly—such as India—are likely to outperform those where growth is more subdued.

Last month, we saw China overtake Japan as the world’s second largest economy. Looking further ahead, China will also experience extremely negative demographic trends as a result of its one-child policy but, in the short term, the migration of some 400 million people from the countryside to the cities will have the same positive effect on the economy as the Baby Boomer generation did in the US.

It would be a mistake to write off the Japanese stock market completely. There will be times when it outperforms the rest of the world—as it did between 2003 and 2006—but over the long term it is not likely to show the same level of gains as some of the other Far Eastern markets.

Investors should, therefore, be looking to capitalize on short-term spurts in the [Japanese] market rather than hang in for the long term.

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