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Demographics in Emerging Markets: Hope or Hype?

As investors look at the demographics picture in emerging markets, many are struck by the relatively young populations and the overall larger population sizes relative to developed markets. What are the implications of these demographic factors for household consumption in an emerging market economy? Do younger populations necessarily result in a higher growth in consumption?

In this article, we observe related theories and statistics on demographics and discuss the implications for savings and consumption in a society. Overall, we find that, while emerging markets on average are well positioned demographically to drive global consumption going forward, each emerging economy has a unique population structure and story.

Three important observations regarding demographics in a country's economy

The savings rate in each emerging market country may progress differently

The first theory we explore is often referred to as Life-Cycle Hypothesis,¹ which states that a person's propensity to save increases during his or her working years, while a person's propensity to consume is higher during youth and retirement age. Intuitively, we believe this is logical — most people add to savings during their working years and are spenders during their youth and retirement years, when they do not have a regular income to contribute toward savings. Thus, a country with a high proportion of a working-age population² will most likely have a higher-than-average household savings rate, other things being equal. On the other hand, a country with a high proportion of elderly dependents and/or a high proportion of youth dependents (often referred to as elderly dependency ratio and youth dependency ratio, respectively³) will likely have a lower savings rate.

In general, the household savings rate of a country will increase as the median age of the population increases, but beyond a certain age (which will vary depending on the country's fertility rate,⁴ retirement age, and life expectancy), this rate will start to decrease as the percentage of retirees increases. These observations are particularly interesting in emerging markets, where the average median age of the population is 24% below the average median age of the population in developed markets, as seen below.

The emerging markets' average household savings rate is also 19.0%, well above the developed markets' average of 9.7%,⁵ which falls in line with the Life-Cycle Hypothesis. Relative to developed markets, emerging markets, on average, have a higher youth dependency and a lower elderly dependency. Based on the Life-Cycle Hypothesis, as emerging market countries develop, the expected decline of the youth dependency will increase household savings rates, while the expected rise of the elderly dependency will reduce household savings rates, all other things being equal. Thus, the actual impact on the overall savings rates from the maturing of emerging markets will depend on which of these forces has a larger impact, and will also be influenced by an individual country's fertility rate, retirement age, and life expectancy.

For example, the household savings rates in countries with a higher youth dependency, such as Brazil,⁶ are likely to increase as the median age in these economies increases. On the other hand, emerging market countries with a relatively high elderly dependency and a high median age, such as China, may see declines in their savings rates in the medium or long term.

We believe the declining savings rate in China is particularly significant, given the size of its economy (already the second largest globally) and its economic growth rate of roughly 10%.⁷ As the savings rate in China declines, we expect to see a substantial, positive impact on global consumption as Chinese households will spend a larger percentage of their disposable incomes on both discretionary and nondiscretionary goods and services. In China, the household savings rate is already among the highest globally, close to 37%, indicating that there is room for increased consumption expenditures while still maintaining the relatively high savings rate.⁸

The demographic dividend will propel consumption in emerging markets

The second theory we explore when examining the implications of age structure in emerging markets is demographic dividend.⁹ This theory states that as the fertility rate and mortality rate of an economy falls over time, and as the percentage of the working-age population increases, the economic growth and productivity of this economy will also increase. The theory implies that, as an economy develops, a higher percentage of the population will be working-age, which will lead to a larger labor force and more people who are economically active.

We believe the logic of the demographic dividend is sound. As the labor force of a country increases, the productivity of its economy should also increase, all other things being equal, as there are fewer dependents to support and more working-age people who are productive, driving economic growth. In addition, the decline in fertility rates can spur an increase in the female labor supply, as well as increase a country's focus on primary education and health initiatives.¹⁰ The working-age population will also generally have higher savings rates, which will facilitate the financing of domestic investments in fixed assets and social infrastructure, further supporting economic and per capita income growth.

Historically, the labor force percentage in the emerging markets was lower than in developed markets, and, as of 2010, these percentages approached 49.6%, on par with developed markets. As seen on the next page, the labor-force ratio in the emerging markets, on average, is expected to increase even further over the next 20 years (driven primarily by India¹⁰), while the average in the G10 developed nations is expected to decline. Thus, given the growing labor forces and potentially higher economic and per capita income growth in emerging markets (based on the demographic dividend), we believe that household consumption will increase faster in these markets than in developed markets.

The demographic dividend is clearly not automatic for every developing nation, but should be most apparent in countries that invest more heavily in social and economic infrastructure and institutions. For example, economies that invest in or promote areas such as education, family planning, the participation of women in the labor force, social mobility, and fair and flexible labor markets are more likely to benefit from the demographic dividend. One example would be in Asian countries, where education is viewed as the highest social and government priority, which ultimately provides a competitive advantage for these educated labor forces to compete globally. We believe many other emerging market nations have taken steps toward making such investments in order to become competitive on a global level.

Population size matters when it comes to the magnitude of consumption

The final observation we make on demographic trends in emerging markets is that the size and growth of the overall populations in emerging markets are significant compared to the size and growth of the overall populations in developed markets. As seen below, populations in emerging markets are about five times the size of populations in developed markets, and are expected to remain at these high levels going forward. Population increases in emerging markets are expected to be ten times that of developed markets between 2010 and 2015.

Given this massive absolute population size and its projected increase, we believe that the emerging economies will be natural drivers of global consumption, as they will provide substantial numbers of consumers across different sectors and trends. We also believe that the absolute size of the populations in these markets will amplify the impact of the growing consumption trends we highlighted above.

For example, one sector that has benefited tremendously from the large consumer populations in emerging markets is luxury goods, with brands such as Tiffany & Co. and Burberry reporting emerging economies as core drivers of sales. China, in particular, is poised to overtake Japan as the largest consumer of luxury goods, with an estimated global market share of 22% and total luxury goods sales of close to $13 billion in 2010.¹¹

Thus, despite lower per capita incomes, the absolute size of the populations in emerging markets — and the populations' growing economic strength — has made these markets a significant component of sales for global corporations.

Implications for Emerging Markets

Demographics to support household consumption

Given the three observations noted above — Life-Cycle Hypothesis, demographic dividend, and absolute population size — we believe that the emerging markets overall are well positioned demographically to support household consumption growth going forward, and that these economies will play an increasingly larger role in the global economy. We anticipate that the younger populations in these countries (particularly in China and India, with their massive population sizes) will have the ability to unlock tremendous consumption potential going forward. Relative to the developed markets, where median ages are higher and population sizes are lower, we believe that the emerging markets, on average, will see increasing labor forces and, thus, increasing per capita income and consumption growth.

Each emerging economy is unique

Each emerging market economy presents a unique story, with a different demographic makeup and varying consumption patterns. For example, China, India, Russia, and Brazil — all major emerging market economies — have vastly different demographic trends.

As seen in the chart on page 11, China has what we view as an attractive de- mographic profile for the next decade, as its median age of 35.5 years is in the middle of the prime working years, with fewer youth and elderly dependents. The household savings rate in China is one of the highest in the world, at close to 37%, but this may decline as the propensity to consume increases going forward. In addition, China will likely benefit from the demographic dividend, enabling its per capita income to increase and helping to drive consumption.

India, on the other hand, has a very low median age of 26.2 years, indicating that the country is in an earlier stage of the demographic dividend, with a higher youth dependency and not as many people in the productive labor force. In India, we believe the growth in consumption will be driven more by the demo- graphic dividend rather than by an aging population consuming more of its retirement income. The absolute population size of India, second only to China globally, also positions the country to become a significant global consumer.

In contrast to the young population of India, Russia has a median age of 38.7 years, well above the average of 31.2 years in the emerging markets and closer to the average of 41.6 years in the developed markets. This indicates that Rus- sia may have moved beyond the demographic dividend, passing the relatively more attractive profile of its peers in median age. Given Russia's higher level of elderly dependency and, thus, its smaller labor force, the savings rate in Russia is 13.2%. This is well below that of both China and India, indicating that the long-term consumption growth of this economy will not be as strong as either China's or India's, all other things being equal.

Finally, when we observe Brazil, the picture is mixed. This country has a relatively low median age of 29.3 years and a higher-than-average youth dependency of 39%, indicating that the economy should benefit from both the demographic dividend and the potentially higher consumption growth rates going forward.

Given the country's history of high inflationary cycles and rapid expansion of consumer credit, however, Brazil has a very low household savings rate, currently around 6.8%. In Brazil, we believe that it is critical for government policies and institutions to promote sound household savings and consumption patterns to allow the economy to benefit fully from a demographic dividend and to realize higher consumption growth in the long term.

Global implications

We believe that higher consumption in the emerging markets has implications for businesses worldwide. For global corporations, we predict that emerging markets will continue to account for a higher percentage of revenue going for- ward as per capita incomes rise. This trend can already be seen in the consumer discretionary sector (with items such as luxury goods and cosmetics), as well as in the consumer staples sector (with shampoo and dairy products). In our view, in order to remain competitive, global corporations need to tailor their marketing and business plans further to account for the tastes and needs of consumers in emerging markets.

For corporations based in the emerging economies, we believe that many will capitalize on the favorable demographics in these markets to become significant players on the global stage. We see these businesses as having relative advantages both on the supply side and on the demand side of their markets. On the supply side, these firms have access to younger and cheaper labor, while on the demand side, the firms possess critical knowledge of local trends and business infrastructure. In our view, local corporations have already started to benefit from these advantages, as companies based in emerging markets gain market share and create shareholder value.

Ultimately, we believe that the demographic structure of emerging markets, all other things being equal, positions this region very favorably to become drivers of global consumption going forward. We see the younger populations in these countries, particularly in China and India, with their massive population sizes, as having tremendous consumption potential going forward. In this context, we see the emerging markets, on average, as having stronger household consumption growth than the developed markets, and we believe that the corporations that can foresee these demographic trends, and the accompanying economic and consumption growth from this region, will be winners.

¹The Life-Cycle Hypothesis is an economic concept analyzing individual consumption patterns. It was developed by economists Irving Fisher and Roy Harrod, and extended by economists Albert Ando and Franco Modigliani. Source: Life Cycle, Individual Thrift, and the Wealth of Nations, Franco Modigliani, 1985.

²A working-age population comprises individuals from 15 through 64 years. Source: OECD Factbook, 2007.

³The elderly dependency ratio is calculated by dividing the number of people in the elderly population (age 65 and over) by the total number of people in the working-age population (ages 15-64). The youth dependency ratio is calculated by dividing the number of people in the youth population (ages 0-14) by the total number of people in the working-age population. Source: Population Division, United Nations

⁴The total fertility rate is the average number of children a woman would bear over the course of her lifetime if current agespecific fertility rates remained constant throughout her childbearing years (normally between the ages of 15 and 49). Source: Population Division, United Nations.

⁵Emerging markets' average household savings rate is a GDP-weighted average of those emerging market countries that provide annual household savings rates: Brazil, Chile, China, Czech Republic, Hungary, India, Korea, Malaysia, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. The average is based on the five-year average savings rate for the last five years of data available for each country. The developed markets' average is a GDP-weighted average of the following G10 countries: Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, United Kingdom, and United States. The average is based on the five-year average savings rate for the last five years of data available for each country. Source: Datastream.

⁶Macroeconomic and Policy Implications of Population Aging In Brazil, Policy Research Working Paper 5519, The World Bank, 2011. [This paper discusses the implications of Brazil's age structure and its potentially higher savings rates.]

⁷IMF estimates China's 2010 GDP growth rate to be 10.5% and its 2011 GDP growth rate to be 9.6%.

⁸China's high saving rate: myth and reality, BIS Working Paper 312, 2010. [This paper proposes that various factors (including income distribution, social safety nets, home ownership, and the availability of household credit) have impacted the savings rates in China.]

⁹The demographic dividend is a theory proposing that as countries transition from largely agrarian societies with high fertility and mortality rates to more urban societies with lower fertility and mortality rates, the working-age population will grow more rapidly than its dependents, creating resources for investment in economic development and, all other things being equal, increasing per capita income growth. Source: What is the Demographic Dividend? Lee and Mason, International Monetary Fund, 2006.

¹⁰IMF Working Paper, The Demographic Dividend: Evidence from the Indian States, 2011.

¹¹China Market Research Group, March 2011.