Population growth and economic growth correlation
Final report, Assessment 3
EFN427 Behavioural Finance
- Topic: The Baby boom, shares, property and sustainability.
This short essay will discuss the post World War Two (WW2) baby boom, its connection to asset prices including shares and property, and also its sustainability with changing demographics. The thesis argued here is that high birth rates, high immigration, high demand for material output contribute to increased asset prices. Further that a reversal of these factors such as a demographic decline render the previous gains unsustainable. The end of the baby boom era will impact on asset prices and monetary loosening is only a short term fix.
Equities and the baby boom
Following WW2 there was a “baby boom” and consequently a baby boom effect. This was where many more children were born, survived childhood and entered the labour market. These children grew up at a time of relative global peace. World War One and WW2 were not repeated in this generated. The Cold War conflicts of the Korean and Vietnam Wars were much smaller in size and loss. There was an economic recovery never seen before, bigger than the post Black Plague inflationary booms of 542AD and 1353AD that were more driven by labour shortages than an increase in populatio. New market entrants required new materials, firms innovated and produced labour saving devices that increased productivity, and workers enjoyed low unemployment with increasing wages. These workers could afford more consumer goods and buy property and shares. It was a virtuous economic cycle that continued until the 1973 inflation shocks, but otherwise continued on an uptrend until recently.
Economic growth, a growing economy means more firms, doing more business with more customers. More cashflows coming in, more positive NPV projects undertaken, more people employed, and consequently higher share valuations on expected future company revenues.
From 1900 to 1955 the Dow Jones Industrial Average (DJIA) moved to 500 points. From 1956 to 2017 from 500 to 20,000 points and at last checking was 26,958.06 on 25/10/19. The great crash of 1929 is barely a dent on the 117 year chart below at figure 1. The economy grew slowly but nothing like the break neck speeds of the baby boom era. What is the difference? This paper suggests that the baby boom and peace dividend from WW2 victory are highly correlated and potentially causal.
Figure 1: Dow Jones Industrial Average Index 1900 to 2009. Businessinsider.com
The Australian share market has had a similar upward trend. Equities (shares) standout as the highest returning asset class over the long term, albeit with more volatility in the short term, see figure 2. Australia is a much smaller market than the DJIA. An idiosyncrasy for Australia is that firms pay dividends more and higher compared with USA firms. Further Australia since 1987 has a beneficial dividend imputation tax system. Australian firms unable to expand and grow are instead distributing profits to shareholders rather than take on new projects that may have a return lower than the discount rate and therefore do not have an attractive NPV. Contrasted to USA firms that pay lower or no dividends and are more orientated to share price growth.
Figure 2: Comparison of Australian Asset classes ASX.com.au
Property and the baby boom, with immigration.
In addition to shares doing remarkably well since 1956, so has property. Australian property prices in Sydney and Melbourne are among the highest in the world, comparable to Hong Kong, Singapore, New York and London. Sydney and Melbourne also experience population booms from both births and immigration. In 1985 a typical three bedroom family home cost 3-4 times annual incomes. Today it is more like 10-15 times annual incomes. Inflation adjusted property is now much more expensive than in the past. Part of this expansion may be linked to larger families, having more children, who then go on to form new households and require a new house.
Australians seem to exhibit a behavioural finance bias toward property over other asset classes. While Australians with Superannuation will have exposure to equities as an asset class, outside of super shares ownership is not high and exposure to bonds is muted compared to property. This bias may be challenged if Australia experiences a slowing in population growth, a slowing in in consumer demand, and a lack of fundamentals to support valuations with abysmal yields.
Figure 3 Australian House prices 1960 to 2016.
Changing demographics and fragility of asset prices.
The birth rate required for a population to remain stable, that is, to not decline, is 2.1 live births per woman. The 0.1 is to account for mortality and people that do not reproduce. Higher than 2.1 the population grows, and lower it shrinks. The lowest birth rate in the developed world is Japan at 0.7. Italy is not far behind. Japan experienced an economic miracle following World War 2. Japan had a baby boom and crazy property and equities prices. This continued until eventually reality collided with the bubble and there was the crash of 1990. The Japanese asset bubble was one of the biggest bubbles in the world and Japanese asset prices still have not recovered even close, over 30 years later.
Figure 4 Nikkei 225 1984 to 2011.
It should be noted that Japan does not have an immigration program and so the effects of low birth rates have not been mitigated with short term GDP boosts from immigration.
Australia is higher population growth and birth rate than other developed countries at 1.7, however it is falling. The only reason the Australian population is growing is from record high levels of immigration. Net migration is 300,000 p.a for a population of 25,000,00 meaning growth of 1.2% of the population per annum attributable to immigration. The example of Japan can serve as a warning to other developed countries what can happen when the economic growth accelerator of a baby boom comes to a crashing halt, without immigration to keep things afloat.
Figure 5 Comparison of population growth at 2017. Source NAB.
In the chart above we see that Australia has a higher population than many other developed economies. However I the chart below we see that much of this growth has been from record high immigration.
Figure 6 rolling average Australian population and immigration.
With high immigration and a high population of baby boomers, further supported by favourable government polices, Australia had a property boom from 2000 to 2017. Increased demand for material goods and housing, leads to more produced but also higher prices as supply lags demand.
In 2019 the Reserve Bank of Australia (RBA) cut official interest rates to new record lows. In 3Q2019 we see signs of a property recovery after about a 12 month slump in 2018-19. However this recent temporary bounce is not sustainable.
With a stagnant share market with high valuations, record high property prices and low bond yields, some economists refer to the current macro global conditions as “the everything bubble.
The risk now is that if the immigration sugar hit to keep things afloat was slowed, and economic reforms were not undertaken to boost productivity, and monetary policy was not so loose to continue to boost asset prices with unsustainable liquidity then things are not sustainable and actually fragile.
Macro Hedge fund manager Raoul Paul of Real Vision argues that demographic decline is a serious issue. His thesis is that the pensions pyramid schemes of Europe and other developed economies cannot possible be sustained and that government pensions are unfunded from revenues that will not flow in from taxpayers that are not being born. In adding to this, there is analysis from Douglas Murray that “guess what, immigrants get old too you know” and that the short term fix will not correct the longer term issues of a lack of babies being born to grow up and pay into the system, and to also demand jobs, houses, shares, bonds and everything else a growing economy requires.
High birth rates and population growth from births and
immigration are stimulatory to economic growth and asset prices. However this
source of growth requires birth rates above replacement rate, and/or high
immigration to be sustained. The post WW2 baby boom ended and has not been
repeated since. Currently high asset prices cannot be sustained in the absence
of either a new baby boom, or an economic miracle from radically improved
productivity. Prices continue to be high supported by loose monetary policy and
excessive liquidity however these are central bank and government policies that
can be reversed. Therefore currently high prices for shares and property are