By PAULA CAMPBELL ROBERTS, KEN MEHLMAN Feb 13, 2018

Global populations are aging – on this there is little debate. However, what that means for growth, investment and social cohesion has been less often discussed.

Profound demographic and technological changes are transforming the societies where we live and work globally. On the one hand, the large post-World War II generation is retiring and working age populations are shrinking in many countries. This demographic shift alone will likely translate into slower growth, lower interest rates, and subpar financial returns unless nations increase the size of their labor forces and/or improve productivity. At the same time, the Fourth Industrial Revolution is redefining key industries and the meaning of work. While nations can leverage the productivity-enhancing advances of this digital revolution or increase immigration to stimulate growth, both tactics can be controversial and disruptive. Indeed, unless there are reforms to the social contract between governments, employers and employees, immigration, technological innovation and other factors can reinforce social, economic and industrial disorder, fuel populist backlash, and build opposition to pro-growth solutions to these demographic headwinds.

In this paper, we address the economic implications of aging, the levers countries may pull to counteract these challenges and the investment opportunities that arise as a result. In particular, in this global “new normal”, which Henry McVey, KKR’s Head of Global Macro & Asset Allocation and Markets Risk and CIO of the KKR Balance Sheet, has described in prior publications, we believe investors may consider:

• Seek investment products that offer income or yield in a lower return environment. Henry McVey expects slowing working age population growth, lower rates, and full valuations to lead to lower expected nominal returns in the future. Given this view, he believes that this backdrop will continue to fuel demand for yield-oriented investments such as infrastructure and asset-based lending as well as for certain global private equity investments.
• Lean in globally to long-term themes consistent with these demographic changes like health and wellness, urban rentership, travel and leisure, digital content and media, productivity enhancing technology and the search for income yielding financial products. The aging of the population, rise of millennials and the sharing economy driven by an increasingly mobile youth cohort support these trends.
• Monitor and heed political attitudes and geopolitical risks, particularly focused on possible reactions to high levels of social, economic and technological disruption, high inequality and economic stagnation. Public distrust in key business and political institutions is high. The Fourth Industrial Revolution, radical transparency of the Internet and social media, combined with high inequality and rising immigration are producing political volatility and populism in many nations. Investors must pay attention to these factors as they may impact how well nations can develop policies to counteract the demographic economic headwind.

In the first section of this paper, we delve further into the impact of demographic shifts on the economy and investments. In particular, we look at aging and its impact on growth, consumption, urbanization and consumer preferences. Following this global review, we consider steps nations have and may continue to take to counteract these demographic headwinds, including leveraging technological innovation and immigration to build larger and more productive workforces. We then delve deeper into demographic trends in six countries— Mexico, China, U.S., U.K., Germany and Japan.

The Impact of Aging on Economic Growth and Investing

Per the United Nations, population aging – the increasing share of older individuals in the population – is one of the most significant social transformations of the twenty-first century. At a high level, we expect global population aging to result in slower economic growth, lower financial returns, lower interest rates, increased urbanization as well as shifts in consumption and housing patterns. Each of these will have important investment implications.

The median age of the population will rise in many countries globally as fertility rates – the average number of children born per woman, decline – while longevity increases, just as the massive generation born after World War II retires. Between 2015 and 2030, the global population aged 65 and older is projected to grow by more than 60% (Exhibit 1) compared to working age population growth of 14%. By 2020, for the first time in human history, people aged 65 and over will outnumber children under age five (Exhibit 2).

While Europe has historically been the oldest region as measured by the over 65 proportion of the population, Asia and Latin America are rapidly progressing through this demographic transition. Indeed while less than eight percent of Asians were aged 65 and over in 2015, that number is expected to increase to 12.1% in 2030. Europe will remain the oldest region for the next 15 years and North America will rank second oldest, with their over 65 population shares rising to 22.8% and 20.7%, respectively. By country, China‘s prior one-child policy had accelerated the aging demographic. We expect China’s elderly share to rise to 17.1% in 2030, from 10.1% in 2015. And Japan is and will remain home to the world’s most aged population with 30.3% of the population aged over 65 by 2030.1

Importantly, improved longevity and the need to fund higher retirement and health expenses have led much of this older generation to work longer in recent years. For example, in Japan the labor force participation rate has increased as those aged 55 or older are increasingly concerned about their finances.2 In the U.S., Americans on average now retire later at age 63 up from age 59 in 2002. And the official retirement age in the U.S. will rise from 65 to 67.3 However, delayed retirement (even to 75) would be insufficient to counteract the combination of the retirement of the large Baby Boomer generation, increased longevity and the decline in fertility rates since the 1950s.4

What does this mean for growth and markets? What are the relevant investment implications?

1. The Impact of Demographic Shifts on Economic Growth

Slower Growth

The long-term drivers of real GDP growth (inflation-adjusted economic growth) are labor force growth and productivity, i.e., an increase in the number of people within the productive population and the amount of goods and services each person produces. As the global retiree proportion of the population rises from 8.5% in 2016 to 12% in 2030, and global birth rates continue to fall, annual global working age population growth will slow to 0.9% from 1.5%. Holding productivity constant, demographics alone can slow GDP growth.

Compounding the impact of challenging demographics, aggregate productivity growth has also been softer in the past decade as corporate capital investments have slowed amid weak demand in a slower growing global population. However, some countries like China and India are investing significantly to increase labor productivity amid emerging demographic pressures. Indeed, over the past ten years, annual productivity growth in China has averaged 8.5% versus a more modest 0.9% in the U.S., or 0.3% in Germany.

On net, while working age and total populations are shrinking in Japan, Germany and Spain, U.S. and U.K. populations will continue to grow. Indeed, Japan’s working age population peaked in 1995 and is today 13% below peak. By 2040 it will be 31% below peak. The result has been a steady deceleration in real GDP growth in Japan – from a five-year average peak of 5.2% in 1989, to the current average of 1.2%.

In the U.S., the large, diverse millennial population — which includes a Hispanic segment with above-average fertility rates5— is an important tailwind to growth. Growth in the U.S. working age population will continue to rise, albeit at the slower pace of 0.2% year-over-year in 2030 versus 0.4% in 2015, which should be sufficient to sustain GDP growth rates of 1.5% to 2.0% over the next decade. Further, productivity gains can drive GDP above that range.

Investment Implications:

• In a slower growth environment, we caution investors to be wary of paying high valuations for investments that rely on above average GDP-per-capita growth, particularly when that nation’s working age population growth is in decline.
• Investors should reset expectations for consumption growth as well as home price appreciation as both measures are closely tied to working age population growth, which we expect to slow over the next decade.

Demographics and Interest Rates

In addition to slowing growth, population aging also lowers the natural rate of interest, which is the rate that neither stimulates nor cools down the economy.6 Monetary policymakers estimate the natural rate of interest when making decisions about raising rates to prevent inflation. Lower rates reduce yield and boost financial asset prices, which has implications for investors seeking to achieve certain return targets. Indeed the OECD has noted that over the past five years many pension funds and insurance companies have been on the hunt for higher returns as yields on safer government bonds have hit lows.7 In order to match the level of returns promised to policyholders, they have had to adjust their asset allocation strategies while continuing to maintain risk management prudence.

There are two demographic drivers of lower interest rates: increased longevity and declining population growth rates. With increases in life expectancy and longer average retirements, individuals have a greater incentive to save to fund retirement rather than to spend, particularly given current pension underfunding concerns. The overall boost to savings at the expense of current consumption puts downward pressure on interest rates. Based on the model developed by the Federal Reserve Bank of San Francisco, this negative effect dominates the modest positive impact from an increasing share of population with higher average consumption rates during retirement. Slower population growth also results in a moderation in aggregate growth in consumer spending, which also leads to lower interest rates.

Further, population aging will increase the dependency ratio, which could raise deficits and reduce public investment.8 The dependency ratio compares the number of individuals aged 0-14 and 65 and older, relative to the number of individuals who are working age. An increase in the dependency ratio means that the working age population supports a greater number of non-working individuals in the economy. A larger proportion of non-working individuals reduces the tax base and increases the demand for pension, retirement, healthcare and other services from the public sector, which would likely lead to deficit increases. Further, increased deficits could result in a shortage of public capital available to invest in areas like infrastructure or education.

Investment Implications:

• Amid lower interest rates and returns, the global search for yield in aging societies will drive continued demand for wealth management products offering income.
• Particularly in a lower yield environment where government budgets are likely to be increasingly constrained, infrastructure may become more attractive to private investors.

Increased Urbanization Globally

These demographic trends will also accelerate urbanization. India, China and Nigeria are examples of economies already undergoing a process of rapid urbanization as locals move to cities in search of economic opportunity. In addition, the large aging global baby boomer population (estimated 75 million) will continue to seek access to the services and community that cities provide. Indeed, between 2000 and 2015, the aged 60 or older population increased by 68% in urban areas versus 25% in rural areas, globally. The 60 or older population living in cities increased from 51% in 2000 to 58% in 2015, and the over 80 population living in urban areas increased from 56% to 63% over that timeframe.9 Further, in many nations the rising millennial generation favors urban living. As a result of these dynamics, many cities specifically seek to attract a large baby boomer/millennial mix.

Overall, today, more people live in urban areas than in rural areas with 54% of the world’s population residing in urban areas. Today the most urbanized regions include North America (82% urban), Latin America and Caribbean (80%) and Europe (73%). By 2030, we expect 60% of the global population to live in urban areas. While all regions are expected to urbanize further over the coming decades, most of the world’s fastest growing cities are in Asia and Africa.10

Investment Implications: As the urban proportion of the global population increases, investors may consider the following trends in infrastructure and real estate themes:

• Amid rapid urbanization, countries will need to expand urban floor space, which will require tens of trillions of dollars in investment. Higher budget deficits from increased pension, retirement and healthcare spending will hamper the government’s ability to meet the growing demand for infrastructure which may create opportunities for private investors.
• Globally, the demand for apartments should continue. A higher proportion of millennials versus prior populations will likely opt to stay in the city amid fewer tax incentives to own and lower household income growth.
• The migration of older populations to the city to meet mobility, access and community needs should persist, particularly as longevity continues to improve. This movement should drive demand for urban senior living properties.
• In the U.S., investors may consider to invest in Southern and Western cities that have been able to attract millennials. Over the past 10 years, college student migration has been highest to Texas, Georgia, Arizona and North Carolina. Housing a ordabil- ity, employment opportunities and warmer climate have driven domestic migration to cities in the South and West.

Shift in Consumption Patterns

In addition to slowing overall economic and consumer spending growth, demographic changes will also alter the mix of consumption. Consumption growth will be driven by two groups: retirees and millennials. Based on our analysis, retiring baby boomers, who wield enormous economic clout, are driving increased spending on healthcare services, senior living facilities and food at home. The youth cohort globally is driving dramatic shifts in consumption patterns including increased digital media usage and the rise of the sharing economy, which has already impacted housing, autos and apparel, to name a few categories.

This growing demographic of wealthy baby boomers is a significant driver for several major economies. Older consumers are not only the fastest-growing group in wealthy countries, but are also the richest thanks to house-price inflation and generous pensions. The over 60 population globally spends roughly four trillion U.S. dollars per year, and that number will only grow.11 Indeed, the U.S. adult population age 65 and older controls 70% percent of the country’s disposable income. Of course, wealth is distributed unevenly in this U.S. age group as the top 10% of this cohort controls nearly 75% of the total cohort’s wealth.12

On the other hand, the global millennial population accounts for about 27% of the total population and is becoming one of the world’s most important generational cohort for consumer spending growth. 58% of millennials live in Asia, and in absolute terms, India, China, the U.S., Indonesia and Brazil have the world’s largest millennial populations. This cohort will become even more important to future economic growth as previous generations retire, which has important implications for any global consumer business.13 Indeed much of future consumption growth we anticipate will be driven by Asian millennials, with U.S. millennials following thereafter.

This younger generation is highly educated and technologically savvy, but millennials earn less than prior generations at the same age. They also have very different consumption patterns when compared to other generational cohorts. For example, millennials are critical drivers of the sharing economy as they use technology to get improved service, more customization and better value.14 Indeed, millennials are generally more focused on value, experiences, sustainability and technology. Further, because they are more likely to move around given less job security and the rise of “gig” economy – where freelance workers and short-term contractors are more prevalent, they are also less likely to marry or own homes and cars. Asian millennials in particular are heavy tech consumers, over-indexing versus the global average on smartphone, PC and tablet ownership. They were also among the earliest to adopt streaming TV services.15

The U.S. will benefit from the coming of age of the largest millennial cohort (75 million consumers or approximately 25% of total) among developed countries. This population has the potential to drive significant economic growth as household formation and wage growth improve, and they inherit the wealth of their baby boomer parents. Importantly, the U.S. Hispanic population, 26% of whom are millennials, is set to grow from 18% of the population in 2015 to 22% in 2030, and have above average labor force participation, earnings growth as well as low savings rates. Taken together, growth in the over 65, millennial and Hispanic cohorts will likely drive above-average spending on healthcare, rent and food at home in the U.S.

In some countries, we anticipate some diminished consumption in areas such as autos and hotels as well as weakness in traditional single family housing. The millennial-driven sharing economy is encouraging new business models and consumer-to-consumer buying which are negatively impacting vehicle licensing rates and spending on traditional hotels. Further, amid shrinking working age population growth, countries like Japan already face a housing overcapacity problem for single family homes. On the other hand, demand for modern high-rises has increased in central Tokyo. A more specific country-by-country analysis of investment trends from demographic change can be found in the third section of this document.

Investment Implications: Invest in consumption categories that will benefit from demographic shifts, e.g., retiree spend on healthcare and grocery, as well as spending by Asian and U.S. millennials on technology and rentership.

• Healthcare – Retirees allocate more of their income to healthcare versus other cohorts. As longevity increases and the proportion of retirees rises, we expect substantial growth in healthcare spend. Amid rising costs, strapped government budgets, as well as an increased focus on self-care, lower cost approaches to healthcare and personal healthcare management solutions will increase in popularity. Additionally, the growing middle class in Asia will also drive demand for affordable healthcare.
• Rentership - We expect demand for apartments to continue as a higher proportion of millennials versus prior populations opt to stay in the city amid fewer tax incentives to own and slower income growth for a large segment of the population (in the US).
• Grocery - Globally there is an increased focus on healthy and/or higher quality food. In the U.S., both the over 65 and Hispanic populations have above average allocations to eating in. The Hispanic population also exhibits a preference for organic foods.
• Digital Content and Media – The tech savvy millennial cohorts in Asia and the U.S. will continue to drive spending on devices, content, particularly online.
• In general, there has been increased interest in supporting companies with sustainable business practices, but millennials in particular are leading the charge. We expect further growth in Environmental, Sustainable, and Governance (ESG) oriented investing as a result.

Technological Innovation Can Enhance Growth and Counter Demographic Economic Headwinds

Demographics need not be economic destiny. Nations have important tools to stimulate growth in spite of less favorable demographics. One standard approach to stimulating growth is to enhance productivity via technological advances. And today, we are in the midst of a global technological revolution. Historically, technological innovation has enhanced economic growth and improved quality of life for populations around the world. The First Industrial Revolution used water and steam power to mechanize production. The Second used electric power to create mass production. The Third used electronics and information technology to automate production.

We are now in the middle of the Fourth Industrial Revolution - the digital revolution, which is characterized by a fusion of technologies which are blurring the lines between the physical, digital, and biological spheres.16 Like the revolutions that preceded it, the Fourth Industrial Revolution, e.g., emerging technologies such as artificial intelligence, robotics, autonomous vehicles, 3-D printing and nanotechnology, are enhancing quality of life, longevity, learning, community and raising living standards.

However, like in prior industrial revolutions, we are also likely to experience increased economic, social and technological disruption during the transition years. Each technological revolution has resulted in a redefinition of the meaning and practice of work, the displacement of workers and the disruption of industries and communities. This is particularly true for this Fourth Industrial Revolution. A recent study by the McKinsey Global Institute estimated that 10% to 50% of job tasks in the U.S. could be automated using existing artificial intelligence and robotic technology. In about 60% of the 800 occupations surveyed, at least 30% of activities could be replaced by software, with some jobs (such as driver, retail worker and fast-food employee) becoming entirely obsolete.

While new jobs and industries have been and will be created, the transition will likely be disruptive and add tremendous uncertainty and economic instability into the lives of millions of citizens and communities. Absent comprehensive retraining programs or the development of a new social contract with workers, the Fourth Industrial Revolution is likely to perpetuate job disruption which could increase social and economic disorder—particularly in regions that were home to the industrial economy. Indeed, much of our social safety net was created after World War II for an industrial society where people worked for much of their lives in the same company or industry. However, lifetime employment for a company that also provides healthcare, retirement and training is less applicable for millions of workers today. Just as many nations reformed their policies and societies during the transition between the agricultural and industrial eras, the development of reforms that provide worker training, ensure health care and retirement and broad based economic opportunity will be critical to mitigating tensions in this new era.

An example of the scope of this challenge is the transformation of U.S. manufacturing as machines have taken the place of labor.17 Manufacturing employment has declined considerably, even as manufacturing output – the value of goods and products manufactured in the U.S. – has grown strongly. China’s absorption of manufacturing explains only part of the story. Technology has been the dominant driver of the decline in manufacturing employment in the U.S. Indeed, for decades there has been a structural shift in advanced countries away from production, driven by two core factors: increased demand for services as per capita income increases, and increased technology-driven productivity in the industrial sector which reduces the demand for labor.

The high point for American manufacturing jobs was 19.4 million in 1979. Since then and through several downturns and recoveries the numbers have drifted down by approximately 36%. But, this is not just a U.S. story; manufacturing employment has declined by 25% in Germany, 33% in France and Sweden, 34% in Japan and 49% in the U.K.18

One key element of this new social compact must be to update retraining programs to support workers following job displacement, which have become all too common. In France, slightly more than one percent of GDP is devoted to spending on labor market adjustment programs versus 0.1% in the U.S., where the labor market is most volatile. Compared to France, nearly triple the proportion of displaced workers in the U.S., remain unemployed in the following year. Also perhaps more important than spending, many training programs are antiquated. Some were designed for an industrial versus digital era and do not assume a need for continuous learning. The result is that a high proportion of displaced workers in the U.S. remain unemployed a year after a displacement occurs. Even once workers gain employment, earnings do not recover to prior levels even after five years.

Investment Implications:

• Countries with shrinking working age populations are likely to prioritize productivity-enhancing technologies such as robotics or artificial intelligence, which may present opportunities for investors. Investors should take note of nations with high productivity growth as such investment will be supportive of broader GDP growth.
• Increased capital intensity of production and employers seeking to substitute routine, repetitive tasks with technology will drive continued job dislocations at the mid-to-low skill level, e.g., drivers, retail workers and fast-food employees. Job losses have significant impacts on the employees and their families, as well as demand for goods and services.

  Exhibit 20

  The Rise In the Share of Foreign-Born Populations Is an International Phenomenon Among More Developed Countries

  

  Data as at 2015. Source: United Nations International Migration Report.

2. Immigration as a Double-Edged Sword

Another tool to lessen the demographic drag of an aging population is to increase immigration and attract new workers. Indeed, the rise in the share of foreign-born populations is an international phenomenon among more developed countries. International migration reached 243 million in 2015, up from 172 million in 2000.19

While empirical research suggests that the net impact of immigration is positive on the economy, rising flows may have disparate short-term impacts on growth, wages in some areas, employment and fiscal spending. And those short-term impacts may not be evenly distributed. Communities with large populations of lower-skilled workers may face more temporary challenges from high levels of immigration. Amid the existing disparities in economic opportunities that persist across the world, it is no surprise then that increased migration has become a major policy issue, and one that will likely endure. Further, the recent European migrant crises increase the complexity of immigration in the public discourse. Challenges will be particularly acute in nations and regions less effective at assimilating large immigrant populations.

Just as nations need to develop effective programs to help workers transition into the Fourth Industrial Revolution, successful immigration too will entail policy optimization. To harness the benefits of immigration, it is critical for governments to: ensure that native workers have access to high potential employment opportunities, attract the right mix of immigrants that support the country’s economic and social needs, adopt policies to welcome and absorb these newcomers, and make sure borders are protected.

In the U.S., the proportion of the immigrant population has increased significantly—from 10 million (about five percent of the population) in 1970 to 45 million (about 14% of the population) in 2015 while the native-born population increased by only about 20 percent over the same period. Now, roughly one in four Americans is a first or second generation immigrant.

Economic Growth

Immigration has been integral to economic growth in the U.S. – helping the nation to avoid some of the stagnation issues facing economies like Japan, which has a shrinking workforce. The infusion of high-skilled immigrants has boosted the nation’s capacity for innovation, entrepreneurship, and technological change. Research also suggests that immigrants increase patenting rates, which ultimately contributes to productivity growth. At mid and lower skilled levels, immigrants have supported industries such as construction, which now faces labor shortages and wage pressure amid immigration constraints.

Immigrants also contribute to consumer demand for products, services and housing, which in turn further supports economic growth. In general, the prospects for long-run economic growth in the United States would be considerably lower without their contributions.

Wages and Income Inequality

When measured over the long term, the overall impact of immigration on the wages of native-born Americans has been small. However, dynamics differ for lower-skilled versus higher-skilled workers. An increase in the supply of lower-skilled immigrant workers tends to put downward pressure on wages for the native-born population without a high school degree as well as for existing immigrant populations. In the past four decades in the U.S., a disproportionate share of immigrants has had relatively low education. The result has been an increase in income inequality as depicted by the analysis below compiled by the London School of Economics.20

However recently, immigration flows have shifted towards high skilled migrants to the United States. As Exhibit 24 shows, H1-B and other visa programs have contributed to a rapid rise in the inflow of professional foreign-born workers, which has positive wage effects. In addition, the knowledge and skills transfer that occurs as a result of interactions among workers and skilled immigrants leads to an increase in productivity.

Despite the many benefits of immigration, history shows periodic backlashes following long periods of wide scale immigration. We caution investors to take note of countries where inequality is high, assimilation is low and immigration is increasing. We plot a handful of these countries against those dimensions and several of the countries in the upper, right high risk quadrant have already experienced significant political backlash/disruption, e.g., the U.K. or the U.S.

Employment

While immigration may not significantly impact the employment levels of native-born workers as a whole, there is evidence that there may be significant impact at lower and middle skill levels. For one, immigration may reduce the number of hours worked by native teens (though not their employment rate). Moreover, as with wage impacts, there is some evidence that recent immigrants reduce the employment rate of prior immigrants.

With respect to the workforce, immigrants have been key drivers of labor force growth. Over the past 20 years, the foreign-born portion of the labor force in the U.S. has risen to a peak of 16.9 percent from 11 percent (Exhibit 26). And immigrants and their children will account for the vast majority of future net workforce growth as fertility rates decline and the median age increases in the native-born population.

Immigration may also help to increase labor market efficiency. To be sure, evidence suggests that immigrants locate in areas with relatively high labor demand and are more willing than natives to relocate in response to labor market shifts. To the extent that immigrants flow disproportionately to where wages are rising and local labor demand is strongest, they help equalize wage growth geographically, thereby making labor markets more efficient.

Fiscal Spending

The fiscal impact is also nuanced. According to the London School of Economics, first generation and lower-skilled immigrants may initially earn and contribute less to the tax base, but the children of those immigrants become the strongest economic and fiscal contributors in the population.21 To be sure, immigrants themselves are often at a disadvantage due to restricted access to federal benefits. However, today’s immigrants have more education than earlier immigrants and, as a result, are more positive contributors to government finances.

The ultimate impact and resultant implications of immigration will depend on both the context of the receiving country as well as the profile of the immigrant.

Investment Implications:

• Immigration of lower-skilled workers to countries facing high and rising inequality may result in wage compression, job losses and political backlash – particularly in countries that are less effective in integrating immigrants. We caution investors to monitor geopolitical and social developments in the U.S., U.K., Germany, and Mexico.
• Immigration of higher-skilled workers has the potential to drive innovation, productivity improvements, improved economic and wage growth.

3. Global Investment Themes in Six Countries

Based on the trends discussed in the above section, we have identified seven global investment themes emanating from demographic changes. These themes fall into the following buckets: Healthy Living, Digital Content and Media, Urbanization and Rentership, Travel and Leisure, Productivity-Enhancing Technology, Education as well as Financial Services. The Global Macro & Asset Allocation as well as Global Public Affairs teams at KKR outline country-specific demographic trends and specific investment thoughts for six countries – Mexico, China, U.S., U.K., Germany and Japan.

Mexico

According to Brian Leung, who covers Latin America for the Global Macro & Asset Allocation team, Mexico has one of the more compelling demographic stories in the Western Hemisphere. It currently has one of the youngest populations in the world (with a median age of just 28 versus 38 for the U.S.22). Its working-age population is projected to keep growing for the next 30 years and its dependency ratio should keep improving over the next 15 years. Credit penetration is in its infancy and overall household leverage is very low at 19% of disposable income (versus 110% for the U.S.). On the other hand, the labor market has struggled. Inequality remains high, labor productivity is among the lowest in the world, and real wages have stagnated recently due to high inflation.

Neil Brown, the Director of Policy and Research for KKR’s Global Institute, highlights that structural reforms shepherded by the current government with support from mainstream opposition can amplify demography-led opportunities. For example, telecommunications prices are rapidly decreasing and service is improving to enable the digital economy, media, and e-commerce. Mexican industry is also starting to see the benefit of low-priced U.S gas to cut high power costs and domestic investment, which will support advanced manufacturing. Moreover, despite current risks on NAFTA renegotiations, over time Mexico’s inter-connectedness with the U.S. through the economy and culture has been a tailwind compared to other emerging markets. Nonetheless, growing popular disenchantment – driven by inequality, corruption, and a worsening security situation – is stoking populism, and those factors have resulted in a drag on foreign investment in some regions of Mexico.

China

Frances Lim, who leads our Macro effort in Asia, highlights that China has an extremely large and rapidly aging population. The one child policy, which was phased out in 2016, has accelerated the aging demographic and also skewed its population towards more males than females. Vance Serchuk notes that China’s large and rapidly aging population is particularly challenging given less robust safety nets as well as smaller families because of the one child policy.

China’s working-age population peaked in 2014, but unlike most advanced economies, which are small open economies, China cannot solve its labor shortage by inward migration as it accounts for 19% of world population. China also accounts for a third of global growth and it already accounts for 10% of global private consumption.24 The larger and older it grows, the less it can rely on exports or migration to solve its demographic headwind. As such, it is imperative that China continue on the path of productivity enhancing measures to maintain growth at a reasonable pace. That said the big offset to its shrinking labor force is urbanization and its growing middle income consumer, which should dampen the deceleration in growth for now until urbanization gets closer to 75%.

Investment opportunities are detailed in the table below.

U.S.

While the U.S. has an aging population, declining fertility rates and a rising dependency ratio, the large millennial population will mitigate some of the economic headwinds arising from the retiring baby boomers. Growth in the working age population is set to slow to 0.2% year-over-year in 2030 from 0.4% year-over-year in 2015, but should be sufficient to sustain GDP growth rates of 1.5%-2.0% over the next decade. Further, productivity gains can drive GDP above that range.

In addition, increases in the over 65, millennial, Hispanic and Asian cohort proportions of the U.S. population will also create opportunities:

• The over 65 population will increase from 14.9% of the population in 2015 to 20.6% in 2030 and older Americans hold the majority of U.S. household wealth, have rising incomes, longer life expectancy, higher labor force participation rates and exhibit stronger spending growth than millennials.
• Of course, the U.S. will also benefit from the coming of age of the largest millennial cohort by country (75 million consumers or 25% of total) among developed countries.
• The U.S. Hispanic population, 26% of whom are millennials, is set to grow from 18% of the population in 2015 to 22% in 2030, and have above average labor force participation, earnings growth as well as low savings rates.
• The Asian population in the U.S. is expected to increase from 5.5% of the population in 2016 to 6.7% in 2030. This cohort is among the wealthiest cohorts and has experienced the fastest pace of income growth.

Shifts in immigration patterns may create challenges for some industries, while yielding opportunities for others. Immigration rates have declined in recent years and the composition of workers has shifted towards higher skill levels and Asia. The impact will vary by industry, but sectors such as construction that have relied on low-skilled immigrant labor certainly face risks. On the other hand, an increase in skilled labor can improve productivity and economic growth.

Sectors facing secular tailwinds include: healthcare, rental and senior living properties, food at home, telecom and media, entertainment, health and wellness and personal care. Sectors warranting caution include: autos. More details are in the table below.

We also highlight areas of caution. Demographics and a shift in preferences are driving vehicle licensing rates lower which will continue to threaten traditional business models, particularly with the diffusion of autonomous vehicle technologies. Demographics and the sharing economy are also driving licensing rates lower. Ridesharing may lead to further softening of new auto demand as the large millennial and Hispanic cohorts prefer used cars. However, the penetration of new car technology has the potential to mitigate some of these trends.

U.K.

Aidan Corcoran, who leads our Macro efforts in Europe, notes that the working age population in the U.K. will continue to grow over the next decade albeit at a slower pace. Overall, U.K. population growth remains positive, but – importantly for investments exposed to younger consumers – growth of younger cohorts is turning negative. Employment growth in the U.K. has been strong, but recent growth has been tilted to immigrant laborers and the “gig” economy. Elevated shelter costs are driving pent-up housing demand, visible in the rising number of adults per household.

Our European Public Affairs lead, Ludo Bammens, points out that increased immigration, along with the economy, were the two most prominent drivers of the polarized Brexit vote. On the one hand, densely populated urban areas with large youth cohorts voted overwhelmingly to remain in the European Union.27 There was a sharp increase in the number of younger people voting, according to analysis from Ipsos MORI. Their assessment was that almost two-thirds (64%) of young people (18-24) voted in the 2017 General Election, the highest for a quarter of a century and has resulted in this traditionally low participation age group now voting at a level comparable to the 25-34 and 35-44 age groups. On the other hand, older cohorts with generally lower average income and education levels voted to Leave, which as we now know was the winning referendum vote in the end.

In recent years, locations that have been reliant on international inflows, e.g., London, have seen domestic outflows within the U.K. In fact, U.K.-born residents have also had net outflows from the U.K., even amidst strong overall net immigration to the U.K. The evolution of these flows will be one of the key outcomes of Brexit for investors, and this is something we are watching very closely.

Below is a summary of the core investment themes we’ve identified for the U.K.:

Germany

Aidan Corcoran cautions that demographics in Germany are becoming less supportive of growth. Save for the recent rise in immigration, long-term population growth trends in Germany are negative and getting worse and will likely be a headwind for investments that are linked to the absolute level of population. Importantly for investors, labor force growth is positive and employment rates are the highest in Europe.

German household formations are still in positive growth, but do not bank on any cyclical uptick. Discretionary spend has lost wallet share in Germany over the last decade, across almost all categories. Health and education spend has been resilient or gained share across all age groups. Other bright spots include communications spend by those sixty years old or older. German wallet share evolution has been remarkably stable in recent years, highlighting Germany’s overall macro stability, which is attractive to investors at this point in the cycle.

Ludo Bammens identifies migration as the decisive factor in recent elections. Further, the critical median voter is already of retirement age which has impacted the political agenda. The major parties are increasingly catering to pensioners and their interests by promising stable pensions, increasing pensions for specific groups, and limiting prescription co-payments for retirees. In the short term, Ludo expects to see pressure to increase funding (out of the general budget and/or from individual contributions of the working population) for pensions and social security systems, and mid-term a gradual decrease in benefits for future beneficiaries.

Core investment themes are detailed in the table below:

Japan

Frances Lim notes that Japan is home to the world’s most aged population and presents an example of what may lie in the future for countries like Germany and Spain. Japan’s total population peaked in 2011. By 2050 the population will shrink by 20%, and by 2065, it will be 31% below its highest point. Japan’s working age population peaked even earlier in 1995 and is now 12% below that level. By 2040 it will be 31% below peak. Between 1997 and 2009, nominal GDP in Japan fell 8.4%. The massive stimulus program in Japan has only brought nominal GDP back to 1997 levels. In other words, over the past 20 years, Japan’s economy has not grown.

So what does an aging economy really look like? Prisons have been converted into nursing homes. Adult diapers outsell baby diapers. Longevity has increased and social security costs are high. A fast-shrinking working age population is struggling to support a large, growing older population.

Vance Serchuk, who is the Executive Director of the KKR Global Institute, highlights that that the number of foreign workers in Japan has actually already started growing in recent years and the Japanese government is now considering an increase in immigration to offset the effects of its demographics. Less than two percent of the population is of foreign origin, a proportion far below that of other rich countries.

Given the aging population, urbanization, a tech savvy youth cohort, investment opportunities exist in TMT28, healthcare, urban infrastructure, digital technology, food and beverages, senior living, leisure and wellbeing, productivity enhancing technology and financial services (low-risk yielding). See additional details in the table below.

Conclusion

Globally, demographic change is producing a slower growth, lower rate, government budget constrained environment. We suggest investors lean into seven long-term secular trends being enhanced by aging in key markets (U.S., U.K., Germany, Japan, China and Mexico):

• Healthy Living
• Travel and Leisure
• Digital Content and Media
• Urbanization and Rentership
• Productivity-enhancing technology
• Financial Services
• Education

That said, we are cautious about paying high valuations for investments that rely on GDP-per-capita growth in nations where working age population growth is negative, e.g., autos. An aging and shrinking population, coupled with the growth of autonomous vehicles, is likely to result in a smaller, less specialized domestic market for automobiles and greater emphasis on exports.

Finally, we note that nations where both income inequality is high and/or rising and immigration is increasing without commensurate efforts to train workers, update healthcare and pension policies and assimilate new citizens could present greater geopolitical risk. Indeed, in the coming decades, nations will attempt to counteract the profound effects of population aging via technological innovation, immigration, as well as other tools. Without reforms that offer workers opportunity and security relevant for this disruptive era, and smart policies to assimilate immigrants, these solutions could in the short term enhance social and economic disruption and risk political backlash.