Demographics, productivity, debt and future economic growth

The central banks will not be able to keep inflation at two percent in the long term. This is supported by two obvious trends. This is a good sign for investments such as shares.

Since 2020, our core thesis for the next decade has been that inflation will no longer fall to the comfortably low average of 1.5% p.a. seen since the mid-1990s. The main reasons for this are

1. future weak population growth, which is gradually turning into a decline (demographics)

2. future low productivity growth, which together with demographics is the cause of point 3:

3. the - unlike after 1945 - weak economic growth in the future (= population growth or growth in the potential labor force + productivity growth). At that time, the economy and thus tax revenues grew so strongly that the barely growing national debt in relation to national income declined sharply. As a result, the inflation of the 1970s could be combated through high interest rates. The extremely high level of debt in most countries now deprives central banks of the opportunity to combat inflation appropriately by offering savers attractive interest rates above the inflation rate (see Figure 1 below, which also shows the USA as an example for other industrialized countries).

Details on point 3 in particular, as well as other causes of inflation, are described in the January 2022 Capital Market Outlook, which you can find here . This time we are examining the future development of points 1 (demographics) and 2 (productivity), the two components of real economic growth. We want to find out whether a decline in government debt as a percentage of national income is possible, as was the case between 1945 and 1970 (see above), when no debt was reduced but the economy grew strongly. In Figure 2 below, using the USA as an example, you can see that economic growth consists of real, i.e. inflation-adjusted per capita growth (corresponds to productivity growth) and population growth. The green line - population growth - must be added to the growth in per capita income. The result is then real economic growth.

Figure 2 shows that real per capita income in the USA grew at around 2% p.a. for decades until the Great Depression of 1929 and from the Second World War until 2005. Since then, average growth has fallen to 1% p.a. Population growth gradually fell from 2.5% to 1% p.a. from the late 19th century until the Second World War, then rose again to just under 2% p.a. by 1960 ("baby boom") and is now only 0.8% p.a.. Accordingly, real growth in the US economy has fallen in the last 50 years from an average of over 4% in the period from 1950 to 1970 to less than 2% from 2000 to 2020 due to declining growth in productivity and population.

Figure 3 below uses the example of Germany over the last 30 years to show that, as in the USA, real economic growth has been gradually declining for decades despite a sharp rise in the number of workers since 2005.

Since then, average real economic growth has been 1% p.a., but the labor force has grown at a rate of 0.8% p.a., which means that individual workers have only become 0.2% more productive. In other words, without the unusual and unsustainable increase in the labor force, the economy would only have grown by 0.2% p.a. over the last 15 years.

However, a look at the data on population development shows that not only is no further growth in the number of workers to be expected in Germany in the future, but also a long-term decline. Average population growth rates have been falling since 1970, with only the UK and Italy showing a slight countermovement in the last 20 years (Figure 4a). However, this is likely to be due to migration, as the fertility rate, i.e. the number of children per woman, has fallen sharply everywhere since the 1960s ("Pillenknick") and has not reached the minimum value of 2.1 required for a stable population in any major industrialized country for almost 30 years (Figure 4b).

These figures mean that in the next generation, i.e. in 30 years, there will be 14% fewer young people in France, 27% in Germany and even 36% to 40% fewer in Japan, Italy and China (see Figure 5a). As a result, demographic trends will reduce future real economic growth in France by 0.5 percentage points per year, in Germany by 1.05 percentage points and in Japan, Italy and China by 1.5 to 1.7 percentage points (see Figure 5b).

Without migration - 400,000 immigrants per year is a politically unrealistic figure for Germany - the potential workforce will therefore shrink everywhere and, in view of the generally weak productivity growth, so will the overall economic output. In the long term, Germany would have to expect annual real economic growth of -0.85% p.a. (= 0.2% - 1.05%).

The ageing of the population creates yet another problem. Figure 6a shows the impact of demographics in the years 1970 to 2010 (blue bars), when the entry of baby boomers into the workforce, increased female employment and the opening up of China and the former Eastern Bloc reduced annual inflation in 22 countries by an average of 2.9 percentage points p.a., because the growing number of workers worldwide resulted in lower wage increases. The orange bars show the expected increases in annual inflation rates up to 2050 (average value up to 2050: +3.4% p.a.), because the number of workers is now starting to fall everywhere and higher wage increases are to be expected as a result.

In addition, the number of older people is increasing. Their expenditure on healthcare services is particularly high without being covered by a corresponding income (example USA: income and expenditure of US Americans as a function of age, Figure 6b).

The difference will have to be covered by the states, particularly in the democracies, whose debts will continue to rise as a result. There can therefore be no question of the frequently expected deflation due to the ageing population. After all, this analysis comes from the Bank for International Settlements (BIS) in Basel, the Bank of Central Banks - an address that is beyond reproach - as well as from statistics from the UN and the USA.

This raises the question of whether productivity, i.e. output per worker, can compensate for the shrinking potential workforce through steady growth. Let us first look at the past. After stable positive growth before the First World War and several slumps due to the two world wars and the Great Depression, productivity growth was very high after the Second World War until around 1970 (see Figure 7a).

There we do not show productivity per worker, but per capita, because increasing productivity per worker, for example, can be negated by falling working hours or an increasing proportion of non-working people. What is relevant is the productivity of the population as a whole, as it has to finance the state and its debts. In addition to the reconstruction of parts of Europe and Japan, which led to a sustained boom in these countries, the spread of new industries such as car manufacturing (outside the USA, where the car boom had already begun 30 years earlier) and petrochemicals as well as the increasing number of academics were responsible for the rise in productivity up to around 1970.

After that, even the growing use of computers could not prevent the gradual decline in productivity growth, leading the American Nobel Prize winner in economics Robert Solow to state in 1987: "You can see the computer age everywhere but in the productivity statistics". The internet was only invented a few years later, but has not solved the productivity problem either; it is possible that many modern technologies are not productivity-driving basic innovations (computer games, crypto "currencies", air cabs as opposed to telephones or cars). The addition of declining population growth and productivity growth has thus resulted in declining real economic growth for over 50 years, including in China for some years now (see Figure 7b).              

In addition to the growing proportion of people of retirement age (and possibly the declining number of basic innovations, a topic we will address shortly), the following factors are responsible for the weak productivity growth:

• Education
• Welfare state
• Regulation
• Monopoly formation

Wasting capital is always the cause when, over a long period of time, debts increase faster than the income from which they have to be repaid and interest paid. This can be a dual-income private household that rents the penthouse apartment, leases the two SUVs and finances vacations and weekend trips with loans. If something goes wrong (illness, divorce, etc.) or the income growth is insufficient, there is a risk of personal insolvency at some point. In the case of companies, decline is triggered by bad investments, high costs, an economic crisis or innovative competitors (Apple / Nokia). Because the debts of poorly performing companies and private households are wiped out by bankruptcies, debt growth remains moderate (see Figure 8a). In the long term, household and corporate debt can only rise somewhat faster than national income if borrowing costs (= interest rates) are sustainably low, as has been the case in the last two decades (see Figure 8b).

However, the situation is completely different for the state, which can expand its debt at will (see Figure 8c) because the central bank, which is ultimately the state's lender, always steps in when necessary (see Figure 1). In the past, extremely high levels of government debt were only common after major wars. Since 1980, the modern welfare state has set global government debt records in peacetime for the first time in history). A particularly bad example of government waste of capital in Germany was the introduction of the skilled workers' pension. Not only is it antisocial because workers at risk of ill health (construction workers) can only rarely reach the 45 years of contributions required for this, but it also damages the state and the economy financially in two ways. The economy lacks urgently needed experienced skilled workers and the state has to forgo their taxes and social security contributions and pay higher pensions.

In the corporate sector, low interest rates, which are a consequence of the government's waste of capital (see Figure 1), are already giving rise to the phenomenon of zombie companies, which earn no money, have little financial leeway to service loans and are therefore unable to invest anything on a net basis. Studies by the ECB show that their share grew from 12% in 2006 to 18% in 2019 and their productivity is below average, a logical consequence of the lack of investment. These companies can only stay afloat because of low interest rates; however, they tie up workers and capital that would be better off in more productive companies (source: "Now there are zombies after all, according to the ECB" in: beyond the obvious, June 15, 2021).

All major capital wastage by companies and private households over the past 40 years has been the result of investments desired by the state, which were made palatable to investors through tax benefits or other government regulations. The most loss-making event in Germany was the massive promotion of real estate purchases in the five new federal states from 1990 onwards. 50% of the investment was immediately tax-deductible for buyers, which was irresistible for high earners at the top tax rate of 56% at the time. Due to the high demand, the properties could be offered at very high prices, often at rental yields of less than 3%, which, with mortgage interest rates of over 9% at the time, triggered such high losses for numerous investors that Germany was the "sick man" of Europe until 2006. Other loss-making examples in Germany were film funds or ship funds to promote the respective industries. In the USA, the easing of lending conditions for residential real estate loans was the cause of the subprime crisis, which was followed by the global financial crisis after the collapse of the US investment bank Lehman Brothers in the fall of 2008.

Education was an important driver of productivity from 1900 to around 1970. During this period, the proportion of high school graduates among all students of the same age in the USA rose from 6% to 70% (see Fig. 9). In the 50 years that followed, there was a further increase to 86%, but the increase is only slight and will soon come to an end.

A high proportion of workers with a good education in mathematics and science should help with the mass use of robots to increase productivity in industry (see Figure 10a) as well as with digitalization in other areas.

In addition, companies have recognized the importance of the use of robots in dealing with the foreseeable shrinking of the labor supply (Figure 10b). There is a correlation between the number of births per woman and the use of robots, 63% of which can be explained by the birth rate, which is extremely high in the two countries with particularly low birth rates (South Korea and Singapore), for example, and low in France, which is still quite stable demographically. Unfortunately, the successful efforts of a number of Asian countries to achieve a high level of mathematical performance among the next generation are not being emulated in this country, although they would be a promising approach to mitigating the consequences of low demographics and productivity.

Another cause of the productivity weakness is the welfare state. At first glance, it can indeed significantly reduce the inequality of income distribution (see Figure 11a); redistribution in Germany reduces the Gini coefficient from an above-average 0.52 to a very low 0.3 (a value of 1 means that one inhabitant earns the entire income, the others earn nothing, 0 means that everyone has the same income). However, quite a lot of effort goes into this. The welfare state devours almost 30% of national income and is only successful on the income side, but not on the wealth side, where the Gini coefficient in Germany is very high at 0.82 (see Figure 11b).

This is not so much because there are a particularly large number of super-rich people in Germany - in this respect we are no different from other European countries - but because the poorest 40% of Germans are far below the eurozone average in terms of net wealth and are therefore practically assetless (see Figures 12a-b).

The reason for this, in addition to the low prevalence of property ownership and the unprofitable funded pension products (Riester pension, life insurance), is the extremely high marginal tax and social security contributions on low incomes and the loss of social benefits if certain income thresholds are exceeded (see Figure 13).

For a single parent with one child, this marginal burden is 80% for an annual income of €10,000 and then rises (!) to 100% for an income of €20,000, to then lie between 46% and 52% from €30,000 and fall to 44% from €80,000. Only then is the marginal tax burden slightly lower than that of a high earner with an annual income of €10 million who has to pay 48% of a salary increase.

Nowhere else in the world do top earners have such a high marginal burden as German low earners, which explains their lack of wealth.

With 80 - 100% marginal employment, the incentive to take up work is extremely low, so that the proportion of workers in the total population is kept artificially low by the wrongly constructed welfare state, which has a productivity-reducing effect. However, a fundamental reform of this strange "welfare" system is no more on the political agenda than an education reform.

Excessive state regulation of the economy is a major productivity killer. After the Second World War, there was a general shortage of goods in devastated Germany. As a result, there were countless laws detailing the distribution and prices of the few goods that were produced. The abrupt abolition of this regulation in 1948 triggered the well-known "economic miracle" in Germany. The initial spark for this was a major "naughtiness" on the part of Ludwig Erhard. He was already responsible for economic policy in the western occupation zones when, in June 1948 - one day before the currency reform - he announced on the radio that compulsory economic management and fixed prices had been abolished. His initiative was not coordinated with the Americans. General Lucius D. Clay accused Erhard of changing Allied regulations on his own authority. Erhard's response to this was as dry as it was bold: "I didn't change them, I abolished them." (Source: Westdeutsche Zeitung 2009). This was the most successful deregulation in German history.

The last attempt at significant deregulation in Germany was made by Professor Kirchhof from Heidelberg, whom Chancellor Merkel later wanted to appoint as her finance minister in 2005. Kirchhof wanted to drastically simplify the extremely complicated German tax law with a uniform income tax rate of 25%, a tax-free allowance of €28,000 and the abolition of all tax-saving models. This intelligent and sensible reform was no longer acceptable to Germans at the time; the idea came to nothing. To combat global warming - which is both right and necessary - a large number of regulations are once again considered sensible, an inefficient and inflation-driving approach compared to focusing on a CO2 tax as the only regulation (see Capital Market Outlook from August 2021, which you can find here ).

Finally, we would like to describe the productivity-reducing factor of monopoly formation using an impressive example from the model country of free capitalism, the USA. In recent decades, the volume of company mergers in the USA has risen sharply (see Figure 14a). As a result, there was less competition for companies and prices could be increased (source: Michael Vita, F. David Osinski: John Kwoka's Mergers, Merger Control, And Remedies: A Critical Review, 2018, p. 5). This development had particularly fatal consequences for the American healthcare sector. Adjusted for inflation, per capita healthcare costs rose to the highest level in the world, but life expectancy is significantly lower than in other industrialized countries, which achieve better health and therefore longer life expectancy with much less money; capital is therefore used more productively outside the USA (see Figure 14b).

With the exception of the formation of monopolies, where there are only political efforts to weaken the monopoly position of some companies in the technology sector (Facebook, Google, ...), the other productivity killers - waste of capital, too little education in mathematics and science, a sprawling welfare state and excessive regulation - are politically desired. There is no sign of a turnaround. Economic growth will therefore continue to weaken in the long term and it will not be possible to reduce government debt, which will rise in relation to national income for demographic reasons. The central banks in the USA and the eurozone will therefore not be able to raise interest rates high enough to combat inflation effectively and limit it to 2% in the long term. This means that the return expectations for equities, investment funds, residential real estate and gold remain significantly higher than those for fixed-interest investments.