In brief
- A big debate is under way among investors: will demographic change provoke structurally higher inflation in the coming years?
- A permanent "worker shortage" could emerge, while retired people could spend down their savings
- But improved health care could expand labour supply, while uncertainty about the future could increase savings
Introduction
Better health, and longer life expectancies, are self-evidently good things. Metrics such as the Human Development Index and the Sustainable Development Goals give these objectives pride of place. Generation Investment Management places high value on human health in our definition of sustainability and mission: “We seek transformational change to drive to a net zero, prosperous, equitable, healthy and safe society.”
Improvements in human health, however, may also have profound economic and financial consequences. In this Insights piece, the second of a three-part series, we explore the potential interactions between better health -- and thus longer life expectancy and demographic change -- and inflation. Could a healthier world be a more inflationary one? This is rapidly becoming a fierce debate.1
Below we explore four potential interactions between human health and changes to inflation.2 We do not offer forecasts let alone definitive predictions. Instead we merely try to set the scene for the debates that are likely to dominate in the years to come.
Hypothesis 1
Longer life expectancy means more retired people. A structural “worker shortage” will emerge. This will be inflationary.
Arguments for:
Populations are rapidly ageing. Over the next 20 years the share of the rich-world population over the age of 65 will rise by half, while the share of people over the age of 90 will double (see chart 1). The “dependency ratio” -- a comparison of the number of retired people to economically active people -- will therefore deteriorate.
Chart 1: Share of total population over given age thresholds, high-income countries
Source: UN, World Population Prospects
People normally think of a higher dependency ratio in terms of its impact on healthcare or pension spending. But it could also have inflationary consequences. Retirees will still be buying goods and services (such as food, health care and heating), but they will not be supplying them (because they are not working). Therefore, overall demand for labour will grow relative to overall supply. This, according to some theories, will push up wages, largely because workers will recognise they are in short supply and thus bargain harder. This thesis has been explored widely, with some economists arguing that it will lead to a period of structurally higher inflation, as wage growth is passed on to consumer prices.3
Arguments against:
One important question, however, is whether one extra older person necessarily means one extra retired person. Is that assumption valid? Perhaps not. Across the rich world in recent years, people have actually been spending a smaller share of their overall life in retirement. More and more governments are coming to realise that they cannot afford to have perfectly fit, healthy people in retirement for many decades. They are thus raising pension ages (see chart 2).4 This will help to support the dependency ratio in the years to come.
Chart 2: Average age of retirement, OECD countries
Source: Generation analysis of OECD data
Many older people may also not choose to retire, especially if they work in knowledge-intensive jobs such as research or investment, which are not physically taxing. According to one estimate from the UK, someone in their late 60s who has a degree is now more likely to be in the labour force than a 16- to 24-year-old with no qualifications.5 The upshot is that dependency ratios are likely to deteriorate, but perhaps by a lot less than some people expect. The inflationary impact will thus be smaller than some of the more doom-mongering researchers predict.
Hypothesis 2
Better human health will expand global labour supply, since more people will find it possible to work. This will be disinflationary.
Arguments for:
Across the developed world, approximately 70% of the working-age population is currently in a job.6 This is high by historical standards, but it is still remarkable that three in ten people of working age are not actually working. Almost all of these people have very good reasons to be in this situation. Some are looking after family members; some are studying; others are looking for work. Many people, though, are living with long-term physical and mental disabilities, which limit their potential to work.
A study by the OECD in 2016 found that chronic diseases lead to the premature death of more than 550,000 people aged 25 to 64 each year in the EU, resulting in the loss of some 3.4 million potential productive life-years.7 In Britain one-quarter of economically inactive people of working age are long-term sick (see chart 3). The opioid crisis in America could be the biggest reason why labour-force participation in that country is unusually low by rich-country standards. Efforts to improve people’s health could therefore make a massive difference -- not just to those people’s day-to-day lives, but also to the economy.
Chart 3: Reason for economic inactivity, share of total, UK
Source: Generation analysis of Office for National Statistics data
Nowhere could this trend be more profound than in the developing world, where large numbers of people die each year from preventable diseases. Efforts to eliminate diseases from malaria to tuberculosis are a matter of urgency and must be addressed no matter the economic cost. But they could also have economic benefits, bringing more countries into the global trading system and expanding the global labour force. That process, in turn, would be disinflationary.
Hypothesis 3
A world with more retirees means more “dissaving” -- i.e., spending down savings that have been accumulated during working lives. This will be inflationary.
Arguments for:
The “life-cycle” hypothesis is a basic economic theory. Briefly, it says that people save during their peak earning years (middle age) then spend down those savings when they are old. The implication of this theory is that a world with a greater number of older people will mean more spending relative to saving.
If that theory is correct, it would have potentially large inflationary implications. Inflation could be higher because higher overall spending will create more supply constraints. For complex reasons related to monetary policy, an economy with more spending relative to saving is likely to have a higher structural level of inflation.
Arguments against:
The case of Japan calls this narrative into question. The number of retirees in Japan is booming, but in 2019 (the latest available cross-country data) the overall household-saving rate was 5%, well above its level in the early 2010s.8 That is, there is little evidence of large-scale dissaving, even as the number of people in later life grows rapidly.
Meanwhile, in America, in the months before the pandemic economists were puzzling over why the household-saving rate was increasing, not declining.9 It is also worth pointing out that in the 1990s lots of people believed that a wave of dissaving was about to happen as the population aged (the theory was known as the “asset-market meltdown” hypothesis).10 In fact the opposite took place.
How can saving rates be rising, even when there are more people in retirement? One potential reason is that older people are actually quite cautious with their money. Rather than splurging everything on cruises and golf lessons, they may want to save money in case they live until they are over 100 years old. They may also want to pass on as much as possible to their descendants. That brings us to hypothesis 4.
Hypothesis 4
In anticipation of living longer, people of working age will save more. This will be disinflationary.
Arguments for:
Consider the plight of the millennials. More of them than ever can expect to live for 100 years or more. But few of them expect, by the time they reach retirement, that there will be any money left to pay them a decent pension or to give them good health care. This is hardly an irrational fear, even if it may be exaggerated. Many public and private pensions have made commitments to future retirees which are completely unfunded.11
The sensible response for today’s working-age people is to increase savings now, thus ensuring a pot of money for retirement. At an aggregate level, the consequence of this is to increase the global stock of savings. Perhaps this is already happening. At a global level savings are not easy to measure, but this datapoint from the World Bank gives a sense of the scale of what is happening. Higher gross savings are likely to reduce inflation, all else equal.12
Chart 4: Gross savings as share of GDP, global
Source: Generation analysis of World Bank data
Conclusion
In sum, there are many reasons to believe that more sustainable healthcare outcomes will exert large impacts on inflation, largely through their impact on demographic structure. The question of which effects will dominate, though, is hard to predict. Perhaps we will enter a world of structural labour scarcity and thus inflationary wage spirals. Alternatively, we may merely see a continuation of what was happening before the pandemic: uncertainty over the future provoking high saving rates and thus secularly low inflation.
In the next and final part of our series, we consider the relationship between “fairness” and inflation.
- Auclert, Adrien, Hannes Malmberg, Frederic Martenet, and Matthew Rognlie. Demographics, wealth, and global imbalances in the twenty-first century. No. w29161. National Bureau of Economic Research, 2021; Goodhart, Charles, and Manoj Pradhan. The great demographic reversal: Ageing societies, waning inequality, and an inflation revival. Springer Nature, 2020; Juselius, Mikael, and Előd Takáts. "The enduring link between demography and inflation." (2018).
- There are other related themes that we do not explore here. One relates to the fact that healthcare expenditure takes up an ever-growing share of GDP, and that healthcare inflation tends to be higher than overall inflation. However, our judgment is that this effect is likely to be small. Another relates to the inflationary impact of pandemics, which may be becoming a more frequent occurrence. However, we felt this was perhaps too speculative at this stage.
- Goodhart, Charles, and Manoj Pradhan. "Demographics will reverse three multi-decade global trends." (2017).
- Note that this follows a long period where retirement ages were declining.
- https://www.economist.com/britain/2016/02/04/shades-of-grey
- https://www.oecd.org/newsroom/employment-situation-oecd-first-quarter-2019.htm
- https://www.oecd.org/newsroom/europe-paying-a-heavy-price-for-chronic-diseases-finds-new-oecd-ec-report.htm
- https://data.oecd.org/hha/household-savings.htm
- https://www.marketwatch.com/story/heres-the-reason-americans-are-saving-so-much-of-their-income-2020-02-18
- https://www.oecd.org/finance/private-pensions/41668643.pdf
- https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2020/06/the-state-pension-funding-gap-2018
- This is part because of lower consumption, and partly because it pushes down interest rates. Very low interest rates go hand in hand with low inflation because it makes it difficult for central banks to cut their policy rates deep enough in order to reduce real interest rates and thus raise inflation.
Important Information
The ‘Insights 09: Is a sustainable world an inflationary world? Part 2 of 3: Demographic Change' is a report prepared by Generation Investment Management LLP (“Generation”) for discussion purposes only. It reflects the views of Generation as at February 2022. It is not to be reproduced or copied or made available to others without the consent of Generation. The information presented herein is intended to reflect Generation’s present thoughts on sustainable investment and related topics and should not be construed as investment research, advice or the making of any recommendation in respect of any particular company. It is not marketing material or a financial promotion. Certain companies may be referenced as illustrative of a particular field of economic endeavour and will not have been subject to Generation’s investment process. References to any companies must not be construed as a recommendation to buy or sell securities of such companies. To the extent such companies are investments undertaken by Generation, they will form part of a broader portfolio of companies and are discussed solely to be illustrative of Generation’s broader investment thesis. There is no warranty investment in these companies have been profitable or will be profitable. While the data is from sources Generation believes to be reliable, Generation makes no representation as to the completeness or accuracy of the data. We shall not be responsible for amending, correcting, or updating any information or opinions contained herein, and we accept no liability for loss arising from the use of the material.