Investment report: Population boom—and bust

As the world population reaches 7bn, poor countries worry that they have too many people and rich countries worry that they will have too few. [See Bronwen Maddox’s cover story] From an Olympian perspective there seems to be an obvious, if only partial solution to this problem. But this solution has almost no chance of being implemented and, if anything, the tide is running against increased migration. This state of affairs tells us that the issues of world population and its investment implications are not entirely those of pressure on resources but are at least partly questions of technology, politics and social organisation.

Two overarching themes presently preoccupy the minds of investors. Rather grandly known as the “debt supercycle” and the “commodities supercycle,” they both have population woven into their fabric. The debt supercycle is mostly a rich world affair. It is rooted in the inability of the baby boomers to act their financial age and in the extravagant social security and pension promises made by their governments when life expectancy was lower and growth higher. It is deeply implicated in such matters as the failure of private pension provision, the need to reduce government deficits and in the crisis in Euroland. The further one looks into the future the clearer it is that, by the time financial claims of one sort and another have been added to the manifold promises made by governments, that there are more raffle tickets than prizes.

The commodity supercycle, on the other hand, is a self-serving fantasy got up by the promoters of mining stocks. Supposedly, as the world population expands and grows richer, there is a relentless rise in the price of commodities. If this is indeed the case it must be something which lies in the future since it certainly does not lie in the past. Both conditions have been met over the last century with only cyclical fluctuations in commodity prices. This is dangerous ideological territory. The ideas which inform the commodity supercycle are very close to those which inform the climate change debate, a subject considered by many to be so serious as to permit only affirmation.

No climate change denial is here real or implied. The proposition is more modest: that investors have conflated cyclical phenomena, the usual ups and downs of demand and prices, with profound and long-lasting change. They have sold short the power of human ingenuity and underestimated the role of incentives, in particular, a change in prices, as a spur for finding new or better ways of doing things. It is this that has so far frustrated the Malthusian vision of a world in which a growing shortage of natural resources threatens disaster.

Almost all arguments of this type respond to problems of the time, whether deforestation caused by fuel demand in areas of Europe during the middle ages, or the limits on growth supposedly imposed by the rise in the population of horses and the mounds of dung they produced in 19th-century London. Most recently, the rise of China has created demand for resources which has outstripped supply. Whether this is temporary or permanent is the question. In the past, however, there has been a response, albeit a lagged one. It has been through advances in technology, from crop rotation to genetic engineering, that the world has been able to grow to, and support, its current level of population.

In their book Water Wars: Coming Conflicts in the Middle East John Bulloch and Adel Darwish describe the river Jordan as a “short, mildly brackish stream.” When, in 1862, the English novelist Anthony Trollope visited the purported site of Christ’s baptism he was urged not to risk bathing in the angry torrent (he did anyway). Since then, the population of the area has grown enormously and the river has been diverted for irrigation. While this might appear a clear case of resource depletion, the truth is somewhat different. The cheapest and simplest form of irrigation, surface irrigation, where water is diverted along open conduits, is about 35 per cent efficient—less in very hot conditions. Sprinkler systems are about 65 per cent efficient and the most expensive type of all, drip feed, is about 90 per cent efficient. It was recently estimated that, worldwide, about half the total crop is grown on about 15 per cent of the irrigated land, mostly in rich countries. Not surprisingly surface irrigation is the most common type in poor countries while the most expensive and sophisticated computer controlled drip-feed systems are found in the greenhouses of the Netherlands.

What is required for change are powerful incentives for those who have the resources, wealth and knowhow to effect that change. Raw commodities typically make up only a small part of the consumption of rich countries, meaning that price changes which make a lot of difference to poorer consumers do not translate into a call to arms to the wealthy. If that changes, there is a powerful response. When in 1999 the oil price hit $10 a barrel there was little incentive to look for more. By the time the price hit $100, exploration was in overdrive, as was research into substitute technologies. It may be that we have reached the limits of human ingenuity and that the problems are now so overwhelming that no solution will be forthcoming. It is plausible that 20 years hence milestones such as mapping the genome, with its promise of superior crop varieties, and research into battery technology, which bridges the gap between expensive oil and plentiful and clean natural gas, will have marked the way.

The low birth rates of the rich world have translated into different challenges. Probably no other factor separates the priorities of the rich and the poor countries more than birthrate. It has taken the rich countries a long time to figure out the implications. For Japan, for example, a country in the vanguard of the ageing economies, “Malthusian” pressures on space have given way to something different. High property prices, the consequence of a rich and growing population, have given way to two decades of falling prices. In Tokyo, demand has held up but in the provinces more and more buildings are deserted. At the same time demand for healthcare has risen, creating pressure on a different set of resources.

Looking back, technological change and population growth have marched hand in hand, both contributing to output. As the labour force has shrunk, productivity growth has done the economic heavy lifting on its own. The result is lower growth. Saving economic output for future use is as difficult as storing other types of energy. Contrary to popular belief, a savings vehicle is not a battery which is charged by one’s exertions to be drawn down at some future date, but rather a claim over future output. As that level of future output falls relative to expectations, it becomes increasingly clear that the total of promises, including those made by the government in the form of pension and social security promises and those represented by private financial contracts, will not be met.

Structures such as final salary pension schemes or life assurance, which relied on a supply of new entrants at the bottom so that early joiners could get out at the top, have buckled as population growth has slowed. The problems in public-sector finances, slower to be recognised, have now arrived. The resulting debt crisis pits one section of the population against another or, if the financial liabilities are external, one country against another. This is happening with Greece and Germany. There simply is not enough output to satisfy both groups. Both sides feel betrayed and the results can be seen in the eurozone debt crisis and in the protests against pension reform in Britain.

Governments draw up their financial statements in a way that would be illegal for a private venture in many jurisdictions. Typically, no allowance is made for promises which have been made but where the bill arrives later. Consequently, current levels of government debt, though high, actually paint a flattering picture. Unfortunately the personal sector has pursued its own version of the same strategy. Twenty years ago it was assumed that the baby boomers would start saving for retirement as they reached middle age. Not a bit of it. The generation that trusted no one over 30 has continued its youthful borrowing habits into its late fifties. It is only the recent fall in house prices that put this process in reverse and consumer debt has fallen, reversing a trend of decades.

As the world’s population rises, investors face a polarised set of choices. As populations shrink, economies of the rich world are becoming increasingly sclerotic while, from an investor’s point of view, they retain the attraction of having strong institutions. The developing world, however, does face Malthusian pressures on resources. Happily some of these do yield to investment and technology transfer, indeed the growth of the last decade has lifted many millions out of poverty. On the other hand, investors like strong property rights and the rule of law. It is no accident that the Muslim world, where birth rates are high, living standards low and the population is young, tends to veer between instability and authoritarianism.

Migration demands assimilation, particularly if there is generous social provision. Japan tightly restricts immigration. The US insists on assimilation and can fill its green card quota with PhDs. Europe is undecided, but would do well to pay attention to Milton Friedman’s observation that “Free markets allow you to co-operate with people whose values you don’t share.”