Demographics and Long Term Investing Part I: Demographic Decline

With easy access to country specific ETFs, we can invest in any and all country's markets. Of course - not all countries are going to do equally well long term - so we have to figure ways to identify countries that will do well over the long term. There are several factors that will play a hand in determining long term performance - one of them is demographic trends.

Consider the case of Japan (EWJ). Japan has been very successful. However, they are facing a steep demographic decline. Their current population (127.8M) is the high water mark - the population is projected to decline significantly in coming years:

In next few decades, Japan will lose 30% of its population - and the population will grow substantially older. Even if Japan manages to improve per person productivity significantly, they will not be able to make up for all the loss of labor. The problem would be manageable if the country was open to immigration - but that's not so. So Japan will continue to depend on home-grown labor. Trouble is that Japan is not producing enough babies - not nearly enough.

Number of births in Japan today are lower than any time in more than 100 years. Year 1900 had 1.47M births compared to 1.06M births in 2012! Number of deaths have just overtaken number of births in past couple years - but the gap is going to explode pretty soon. Even if the country starts taking some remedial measures (tax incentives for more babies, anyone?), demographic tides take a long long while to turn. While this does not make Japan toxic for the short term, surely for a long term bet Japan is not ideal.

There are other countries that are in the same category as Japan - imminent demographic decline and cultural opposition to immigration as a solution to the decline. Foremost is South Korea (EWY). Korea is still a few years away from the time when deaths will outnumber birth - but the time is surely coming as the fertility rate in Korea is just about 1.2 - far too low from the replacement level fertility of 2.1. For my money - Korea is not a safe long term bet either.

If Korea is a few years behind Japan, Russia (RSX) is a few years ahead. Russia has had births < deaths since 1992. Population is rapidly declining. Even though fertility has improved recently to 1.61 in 2011, it is still well below replacement and Russia is looking at continuing population decline. However, the multi-ethnic nature of Russian society and recent history means that immigration into Russia is culturally acceptable and quite significant in scale. This makes Russia in a bit better position than Japan and Korea. In fact, this is almost the model to the problem of demographic decline - try to push up fertility and use immigration to plus the holes.

While many countries in the Euro zone also face the problem of long term demographic decline, the problem is much less concerning because of free labor movement within the euro zone. There is enough of accessible labor pool available in poorer euro countries that low fertility countries like Germany need not worry much at the moment.

Countries with constrained long term outlook because of demographic decline is only one part of the story. I will follow up with countries that are likely to benefit from labor mobility through immigration systems focused on skilled professionals. The last group comprises the countries that are losing well educated workforce because of emigration. Those are topic for future posts.

All charts and most data in this post is from Wikipedia. The pages on demographics of Japan, South Korea, and Russia are excellent. Fareed Zakaria wrote an excellent article on immigration around the world recently.