Post 20: Demographics and Innovation

This series has made a number of predictions about innovative potential on the national level. In theory, technological improvements should result in long-term economic growth on a per capita basis. One potential concern is demographics. The size of an economy is equal to its per capita income times its population. If its population is decreasing, then the per capita income has to increase by a larger amount to maintain aggregate economic growth. A country can be a rapid innovator or adopter of technology, experience impressive per capita economic growth, but experience slower overall economy growth due to a shrinking population. In particular, all of the developed countries we identified as being in creative insecurity situations face significant demographic challenges, with the exception of Israel.

South Korea is an extreme case. Its birth rate is currently around three quarters of a child per woman. If this figure holds, then the next generation will be over sixty percent smaller than the current one. If South Korea’s birth rate persists over a long period of time, then eventually the population will decrease at over three percent per year without net immigration. South Korea would be forced to grow per capita GDP at a high rate of three percent per year, just to maintain its total GDP. This is in addition to the potential drag to the economy of supporting a high number of retirees.

Others face this problem to a less significant extent. Taiwan’s birth rate is just barely above one child per woman. Japan’s and Finland’s birth rates are closer to one and a quarter. If these numbers were to persist over very long periods of time, then they would translate to a population decrease roughly between one and a half and two percent per year, which would act as a head wind to total GDP growth.

So at what point should demographic concerns trump innovative potential from the perspective of long term economic growth? The answer is likely more art than science, and depends on a number of factors. One factor is the extent to which exports drive its economy. If a country can sustain itself on exports, then it can better withstand a shrinking consumer base. A downside of relying on exports is that you become dependent on the economies and good will of your principal trading partners. For reference, South Korea’s exports account for almost fifty percent of its GDP, while Taiwan’s account for over sixty percent. Japan has a much larger population, so its exports are only about twenty-two percent of its economy, even though its total exports are larger.

If you were to invest, you would invest in specific instruments rather than a country as a whole. You might consider buying stocks in technology companies or export companies that utilize new technologies. On the other hand, you might consider avoiding real estate, for example. A shirnking population could result in shirnking resale demand. These are examples, and proper due diligence is essential for actual investments.

Another issue is that birth rates are not static. While global birth rates have been decreasing over the past few decades, there is no reason to expect that this trend will continue over the long term. In fact, a country facing external threats may be more motivated to reverse a low birth rate to ensure its future. For example, there are signs that South Korea is starting to reverse its birth rate decline as ominous predictions have been making their way to the the national consciousness.

A country in a creative insecurity situation is also more likely to invent technological solutions in anticipation of an older, shrinking population. For example, Japan has become a world leader in robotics, in part to remain relevant in global manufacturing as its work force shrinks. Net immigration is another factor, but relying on immigrants to counteract a shrinking population population can have other drawbacks. I will discuss in more detail in next week’s post.

To summarize, while a low birth rate can act as a headwind to growth, it is only one of many factors to consider when investing. People are resilient and can overcome a variety of challenges. If there is one takeaway from this series, it is that nations facing external threats are likely to do whatever is necessary to address them.