Global Trend

The Graying Planet Revisited

Fbor anyone seeking to understand the future and exploit that knowledge to his or her own advantage, there is no greater truth than the saying, ���Demography equals destiny.���

More precisely, it���s the intersection of demography, technology, and psychographics that determines precisely what���s going to happen. However, demography is by far the most powerful and most predictable of these factors. And today, demography is pointing toward wrenching changes that will redefine our basic assumptions about employees, consumers, and investors.

The most significant change is that the aging of the Baby Boom generation will result in a labor shortage that threatens to bring the economy���s growth to a screeching halt. In the United States, conventional wisdom says this will lead to real GDP growth of just 2.4 percent and 7 to 8 percent nominal equity returns from 2011 to 2030. That���s much lower than pension plans need to meet people���s expectations for retirement, as we will discuss in Trend 5 this month. Worse yet, Europe and Japan aren���t expected to even come close to these numbers.

The Trends editors foresee three possible solutions. But, before we discuss these, let���s take a realistic look at the greatest problem of our era.

As Peter Drucker points out in Management Challenges for the 21st Century, modern businesses and governments have consistently made every decision based on the assumption that populations will always grow. This principle has held true for more than six centuries, but now it is abruptly beginning to reverse. Before long, there will be fewer workers, and fewer consumers, in the world���s wealthiest nations.

Why is this happening? To maintain a stable population, a country must produce a birth rate of 2.1 children per female. The EU birth rate in now 1.8, and it is just 0.8 in Japan.

During the two decades from 2005 to 2025, the working-age population will decline steadily in Europe and Japan, according to UN estimates. Worse yet, the decline will accelerate in the following 25 years, between 2025 and 2050. China will experience workforce growth through 2025, but thereafter, even China���s numbers will turn negative.

And, even if we could increase birth rates today, it wouldn���t pay off for the economy for roughly 20 years. This is critically important because relative economic performance depends on two factors: the size of the work force and its productivity.

Fortunately, the expectation of imploding growth in Europe and Japan contrasts sharply with continued growth in the U.S.working-age population throughout the next 50 years. The growth of the U.S. population is a product of a birth rate just above the replacement level, coupled with positive net migration. Europe and Japan both have birth rates below replacement, and negligible net migration. But, even for the United States, this trend poses challenges.

Based on UN population data and conservative projections for productivity increases, the U.S. economy will grow 2.4 percent per year through 2025, as compared to its 3.1 percent growth rate in the 1990s. However, applying the same assumptions to Europe, we get a 1.4 percent annual economic growth rate. And, Japan lags further behind with an annual growth of just 0.6 percent. This means that the power of the United States will continue to grow relative to the rest of the world.

When we examined this trend in May 2003, Trends was one of the first to focus in on the multifaceted implications of ���The Graying Planet.��� Since then, new data has become available that permits us to update and refine our outlook for the second and third decades of the 21st century.

Based on assumptions provided by the U. S. Bureau of Labor Statistics, when Baby Boomers start retiring in 2010, annual labor force growth should slow from 1.2 percent to 0.6 percent. And it will continue to decelerate to just 0.2 percent between 2015 and 2020, before recovering to 0.3 percent between 2020 and 2030.

Looking out longer term, labor force growth during the next 50 years is expected to average just 0.6 percent, about one-third of the 1.6 percent average annual pace of the past half-century. As managers and investors, we are used to worrying about the supply and cost of capital and related issues, such as the budget deficit and the current account deficit.

But, abundant labor has been pretty much taken for granted ? rather like abundant water. Perhaps the last time American business faced a peacetime labor drought was during the economic boom of the 1830s, before a depression reduced labor demand and an influx of immigrants from Germany and Ireland increased the supply.

According to a report from the Urban Institute, entitled

���Economic Consequences of an Aging Population,��� ���Over the next 40 years, the share of prime working-age adults will decline from about 59 percent of the population to about 56 percent. The share of older adults (65 and older) will increase from just over 12 percent to almost 21 percent of the population.���

This isn���t just a long-term problem. It is an urgent situation that demands our attention now. In fact, we could begin feeling the effects as soon as 12 to 18 months from now.

In a recent Investment Strategy Commentary titled ���Where Have All the Workers Gone?��� Mary Farrell and Mike Ryan of UBS Financial Services remind us that, ���Although the slowdown does not start until 2010, if economic growth remains strong, U.S. businesses could experience a much tighter labor market within a couple of years. We may soon find ourselves in a labor market similar to that of the late 1990s. Today the unemployment rate is 5.1 percent, which is low by historical standards and just slightly above the cyclical troughs of the late 1970s and late 1980s. Unemployment could fall below 5 percent by 2006.���

Worse yet, although growth in the overall number of workers will simply decelerate sharply, growth in the population of young, well-educated, tech-savvy, top-quality labor may grind to a halt, leading to the convergence of three trends we���ve examined in prior issues:

- Slower overall labor
force growth.
- An older labor force.
- The skills gap.
First, consider slower growth in the overall labor force. As we���ve already noted, growth is estimated to slow from a 1.2 percent annual rate between 2004 and 2010 to a 0.6 percent annual rate for 2010 to 2015, and just a 0.2 percent rate for 2015 to 2025.

Forecasters assume that the main cause will be Baby Boomers retiring, but another important assumption is a leveling off of women���s labor force participation. According to a Bureau of the Census report entitled, ���Women in the United States: A Profile,��� from 1950 to 1990, the proportion of working-age women who were in the labor force nearly doubled, from just 30 percent to 57 percent. However, according to the March 2000 ���Current Population Survey,���4 from 1990 to 2000, the proportion went up only slightly, from 57 to 60 percent. And, estimates indicate that it���s held steady, since then.

Second, consider the graying of the workforce. The prime-age workforce, consisting of workers aged 25 to 54, is growing far more slowly than the total labor force. These workers are considered the greatest contributors to economic growth, according to the UBS report. By contrast, workers under age 25 are less experienced and less productive because they are still learning their jobs, while workers over age 54 tend to fall behind their younger colleagues on technical skills.

Between 1980 and 2000, the prime-age labor force grew by 35 million, or 54 percent. From 2000 to 2020, the growth slows dramatically, to just 3 million people, or 3 percent. And, prime-age workers��� share of the over-25 labor force will drop from 85 percent in 2000 to just 75 percent in 2020.

Finally, consider the skills gap. In the 1960s and ���70s, the Baby Boomers who entered the workforce were better educated than the workers they replaced. But more recently, new workers are only at the same educational level as retiring workers. At the same time, immigrants who are joining the U.S. workforce are less educated, on average, than American-born workers.

What this means is that the big gains in productivity that U.S. businesses have enjoyed, due to increased education, are likely to level off, because today���s workforce is only slightly smarter than yesterday���s.

Consider that between 1980 and 2000, employers were able to capitalize on a 107 percent increase in the number of workers with college degrees. But over the next two decades, the number of college-educated workers will rise only 30 percent, according to estimates.

So what does all this suggest for economic growth? In the past decade, real GDP grew 3.3 percent. This is in line with its 50-year average growth rate. But, based on the assumptions we���ve discussed, real GDP growth should slow to 3 percent in the next decade, which is half before and half during the ���labor drought.��� And it will probably slow more, to just 2.3 percent, between 2014 and 2024. As for nominal GDP, growth should decline from 5.5 percent in the 2003-2010 period, to just 4.4 percent between 2014 and 2024.

Under this scenario, lower GDP and profit growth would lead to below-average equity market returns during the next 20 years. UBS estimates that the annualized nominal equity market return will be from 7 to 8 percent for the next 20 years. That���s fully 250-300 basis points per year lower than the 10.4 percent nominal annualized return generated by large-cap stocks since 1926. UBS arrived at this conclusion based on two valuation frameworks: a classic multi-stage dividend discount/earnings multiplier model and an earnings-yield spread analysis.

The pain will not be spread evenly: Shareholders and managers will be hurt more. On the bright side, the labor shortage caused by The Graying Planet trend should boost average wages, as employers bid up an increasingly scarce resource.

At the local level, the economies of certain states can be expected to stagnate or even shrink, along with their workforces. For investors in municipal bonds, this presents a risk of ratings downgrades and ? to a far lesser extent ? actual defaults. Rating downgrades can reduce the price and liquidity of bonds. According to UBS, these risks are highest for certain types of municipal bonds and for issuers in the following states: Alabama, Iowa, Nebraska, North Dakota, Ohio, South Dakota, West Virginia, and Wyoming.

If these assumptions actually materialize, the implications for our immediate future are discouraging. For example, 2.4 percent real GDP growth and the implied 7 to 8 percent equity returns for the next 20 years won���t be sufficient to meet the retirement income needs of the Boomers and assure a high standard of living for the Xers and their children.

It is difficult for most people to appreciate the difference between the forecasted 2.4 percent real average GDP growth rate over 20 years and the 3.3 percent rate we���ve experienced on average since 1955. However, assuming that you have a real income in 2005 dollars of $100,000 per year, the 2.4 percent rate implies it would grow to $161,000 in 20 years.

On the other hand, the 3.3 percent growth rate would grow it to $191,000, a 19 percent difference. That 19 percent difference will make a huge impact in our ability to fund the needs of all Americans. And depending on how well we manage fiscal and monetary policy, it could even lead to a rolling recession, lasting from 2011 to 2023, as Harry S. Dent. Jr. has repeatedly forecasted.

However, the situation is not as bleak as it seems. The Trends editors have identified three developing trends that point to a more optimistic outlook. These trends are:

- Delayed retirement
- Selective immigration
- Off-shoring

Let���s start with delayed retirement. As revealed in a June 27, 2005 BusinessWeek cover story, one of the crucial behavioral shifts in the labor force, that the Trends editors anticipated as far back as 1989, is now beginning to emerge, just in time to make a difference.

Today, 20 percent of men aged 65 and over are still in the workforce. There are several reasons for this: Retirement plans were hurt by the stock market downturn a few years ago. Mandatory retirement policies were outlawed by Congress in 1986. And there���s been a radical shift in attitudes toward age and work. Many people in their 60s do not consider themselves to be ���old,��� largely because they are more physically fit and mentally sharp than workers of previous generations who routinely retired at 65.

Also, as BusinessWeek points out, it is actually an advantage for older workers that skills become obsolete so rapidly in the modern workplace. In the past, companies considered the training costs for older workers a poor investment; but today, when knowledge becomes out of date in a year���s time, it is just as cost-effective to train a worker at 65 as it is to train one at 25.

These older workers remaining in the workforce can make a big contribution the economy. How big? They could add 9 percent to the GDP by 2045. According to an analysis by BusinessWeek, that���s a $3 trillion a year boost to economic output, in today���s dollars. It would also contribute to the solvency of Social Security in two ways: With more people in the workforce at older ages, FICA tax revenues would grow. And, at the same time, Social Security would have to support fewer retirees.

What can be done to tap the productivity potential of these older workers? First, companies and government need to introduce more flexibility into pay and retirement systems, to create more options as workers age. Consultant Ken Dychtwald, author of Age Wave, recommends the example of Deloitte Consulting LLC, which encourages highly valued older employees to stay by designating them ���senior leaders��� and giving them incentives such as flexible hours, the option to work at home, and opportunities for mentoring and research.

It���s also important to change Social Security to reflect the fact that people are living longer. The program should be designed to encourage people to continue working as long as they can remain productive, and only support people after they can no longer work. Therefore, we expect the retirement age to be increased gradually to the age of 70 or even higher. But, because some people will not be physically able to work into their later years, Social Security disability benefits will need to be made more accessible.

The second solution is to compensate for the worker shortage via selective immigration. In 2002, about 1 million ���legal immigrants��� and half a million ���undocumented immigrants��� entered the United States. And, as economists have found, most of these immigrants fill only the jobs that American-born workers do not want, or are unqualified for.

This means that we can���t look to the immigration system to solve the need for skilled workers unless changes are made to the immigration policy. As we���ve pointed out in previous issues of Trends, the U.S. is doing an excellent job of educating foreign-born students, but is failing miserably at keeping them to fill crucial positions in the labor force.

American higher education is the envy of the world. At American colleges and universities, foreign students receive 40 percent of the advanced degrees in chemistry and biology, 50 percent of those in math and computer science, and 58 percent of those in engineering, according to figures from The National Science Foundation.

The U.S. government will need to revamp its immigration policy to encourage more of these highly skilled foreign workers to join the American workforce.

The third component of the solution is off-shoring, also known as international outsourcing. Since we originally identified this as a positive trend for the long-term standard of living in the United States, a backlash has developed in some circles owing to the short-term pain it causes for some kinds of American workers.

However, as the labor shortage hits home, the Trends editors forecast that this controversy will come to an end. The benefits to the economy will become clear, and the threat to American workers will disappear because they will have their pick of an abundance of jobs.

But there are limits to outsourcing. UBS economists estimate the gross number of jobs ���lost��� by the U.S. in 2002 and 2003 was 400,000 annually, or only one quarter of one percent of the labor force. Companies are not likely to keep up this pace, because once they relocate a call center to India, they cannot do it again the following year.

Also, the demand for outsourced work has increased wages in India and other countries. As the costs of outsourcing work goes up, the incentive to send work overseas goes down.

In addition, some jobs simply can���t be outsourced. Jobs in construction, restaurants, nursing, transportation, vehicle maintenance, retailing, management, and primary education require face-to-face contact and can���t be performed from a distance. Nevertheless, in upcoming issues, we���ll examine some exciting trends that demonstrate why geographical barriers are likely to fall quicker than most experts expect.

Based on the aging population trend, and the three trends we���ve considered as parts of the solution to the coming labor shortage, we offer the following 10 forecasts:

First, the shortage of skilled workers will threaten the growth plans of most companies, unless they start adjusting to this new world, now. It will be most critical at two broad categories of companies: (1) high-skilled service organizations, including high-tech firms, securities brokers, and hospitals; and (2) mass service businesses, including warehouses, retailers, and hotels.

Second, mass service businesses will not be hurt as badly because they can compensate by cutting back on employees and focusing on self-service. For example, restaurants can switch from table service to buffets, and hotels can require customers to book their rooms on-line. Plus, these businesses already depend on immigrants to fill many jobs, and they can supplement the work force with less-skilled aging Boomers who aren���t ready or able to retire.

Third, high-skilled service organizations will face a more severe labor crunch because they are hurt by all three dimensions of the labor drought: slower labor force growth, the graying of the labor force, and the skills gap. Firms in these industries absolutely need skilled, credentialed workers, such as nurses, accountants, engineers, lawyers, traders, and managers. Neither unskilled immigrants nor most semi-retired baby boomers are qualified for these jobs, which require up-to-date knowledge of the relevant discipline itself and of the latest technology. Where possible, these firms will resort to off-shoring to find skilled workers. Beyond that, new policies will be enacted to increase the number of skilled immigrants. Specifically, this means expanding the H-1B visa program, and proactively recruiting the best and the brightest from the foreigners now attending our top universities. Despite this, these firms will likely face severe competition for increasingly scarce and costly talent.

Fourth, the shrinking labor supply will be good news for workers��� salaries. As Boomers retire, they will create many senior level job openings for members of Generation X, now in their 30s. Companies will face a shortage of well-qualified job candidates because there were 14 percent fewer births per year during 1965-75 than there were during the baby boom. Many two-career couples will have high incomes, in the $150,000-500,000 range. This will reinforce the Mass Affluence trend discussed in prior issues.

Fifth, while the aging population will result in a larger number of retirees who will live longer than in previous generations, the better health and longevity of seniors will also mean that people will postpone retirement and work later in life. For example, for each two years��� increase in life expectancy, the actual retirement age is also likely to increase by two years. According to conservative estimates by the Urban Institute, delaying retirement in this way would raise the labor supply by 4.4 percent. This will be encouraged by raising the Social Security retirement age, by the higher wages previously discussed, by creative work arrangements like telecommuting, and by concerns over the security of pensions to be discussed later in the context of Trend #5.

Sixth, people will eventually retire, but fortunately the increased costs of supporting the older population will be largely offset by the lower costs of supporting a smaller number of dependent children. Over the next four decades, the share of the population aged 19 and under will fall from 29 percent to 23 percent, according to estimates by the Urban Institute.

Seventh, 3-3.3 percent average GDP growth in the United States will be possible by combining technology-based productivity enhancement with the three workforce growth trends we���ve been discussing. Wise management of deferred retirement, selective immigration, and proactive off-shoring will enable a real workforce growth rate of 1.2 percent per year over the next 20 years, rather than the 0.6 percent consensus. The balance of GDP growth will come from 1.8 percent to 2 percent productivity growth created by new business models, stream-lining of existing business processes, and dramatically new technologies which will drive the creative destruction of whole industries. Low marginal tax rates and a very high global savings rate will provide the needed capital. The exponentially rising rate of human knowledge acquisition will provide the rest.

Eighth, the U.S. economy will continue to be the envy of the world, acting as the managerial, intellectual, and financial hub of an increasingly globalized system. New business models will increasingly integrate the billions of worker/consumers in China and India into the global economy. While technology will cause certain labor-intensive business processes to be largely ���off-shored,��� U.S.-based multinationals will continue to dominate the global economy. Their dividends and capital gains will accrue largely to U.S. investors. More importantly, cutting-edge new industries like biotech and nanotech will continue to grow and emerge here. Why? Because America is unique among the world���s larger economies in its lack of opacity and in the fertility of its entrepreneurial soil. No other major economy can match the United States in terms of its attitude toward risk, its openness to new ideas, and its ability to attract and hold talent. Furthermore, America���s unique political and economic resiliency makes it a safe haven for investors worldwide. For the most part, government policy trends over the past two decades and going forward steadily increase this competitive advantage.

Ninth, community colleges and other educational institutions will need to refocus their training programs, so graduates learn skills that local employers actually need. Most likely, government will have to bear this burden, because companies are reluctant to invest in training employees who may go to a competitor. For mass services, advances in automation will help make the handicapped and the functionally illiterate employable.

Tenth, the labor shortage will give industry leaders an unexpected barrier to entry against new competitors and a powerful way to protect their profit margins. For example, because there aren���t enough pharmacists to go around, Walgreen���s and CVS employ most of this scarce labor supply, which makes it almost impossible for rivals to enter the market. Similarly, there aren���t enough truck drivers, so big companies like JB Hunt and Heartland Express are able to increase salaries to attract the most qualified drivers; then they pass the higher costs along to clients and increase their profits. Similarly, the labor drought should also give ���mom-and-pop��� stores a new competitive advantage. Firms owned and staffed by family members may be harder to compete with because they have a supply of capable and motivated workers. On the other hand, midsized domestic firms will have a tougher time competing against multinationals, which can minimize labor costs through ���internal outsourcing.��� As global firms become even more digitized and communication costs plummet, they can locate every corporate function in the region with the optimal workforce in terms of cost, skills, and proximity to markets.

References List :
1. Management Challenges for the 21st Century by Peter Drucker is published by HarperCollins Publishers, Inc. ��� Copyright 1999 by Peter F. Drucker. All rights reserved.2. To access the report ���Economic Consequences of an Aging Population,��� visit the Urban Institute website at: www.urban.org/urlprint.cfm?ID=72473. To access the report ���Women in the United States: A Profile,��� visit the U.S. Census Bureau website at:www.census.gov/prod/2000pubs/cenbr001.pdf4. To access the March 2000 ���Current Population Survey,��� visit the U.S. Census Bureau website at:www.census.gov/prod/2000pubs/tp63.pdf5. BusinessWeek, June 27, 2005, ���Old. Smart. Productive.��� by Peter Coy, with Diane Brady. ��� Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.6. ibid.7. The Age Wave: How the Most Important Trend of Our Time Can Change Your Future by Ken Dychtwald with Joe Flower is published by J.P. Tarcher ��� Copyright 1989 by Ken Dychtwald. All rights reserved.