Global growth should remain positive, but slow, and contribute to lower investment returns.
BY IRINA TYTELL, LISA EMSBO-MATTINGLY, AND DIRK HOFSCHIRE, FIDELITY’S ASSET ALLOCATION RESEARCH TEAM, FIDELITY VIEWPOINTS – 09/23/2016
When it comes to creating and adjusting a mix of investments, Fidelity’s Asset Allocation Research Team (AART) looks at how trends may play out over three different time periods: short (tactical), medium (business cycle), and the long-term (secular) outlook. While short-term trends can help investors make tactical investment decisions and the business cycle can help make asset allocation adjustments over the medium-term, looking out over several decades—the long-term secular view—can help to build your core investment strategy.
During the next 20 years, Fidelity’s AART team expects global economic growth to slow relative to the pace of the past two decades, but to remain positive. Demographics have grown less favorable for growth in much of the world, and could contribute to slower economic growth. Those demographic challenges are particularly relevant for developed economies. On the other hand, improved and increased economic complexity in many developing economies could benefit productivity growth there.
Emerging economies with higher growth rates will account for a greater component of global growth moving forward—and should help to partially offset the weaker outlooks for Japan and many European countries.
The big question: growth
Economies provide the backdrop for asset markets, influencing corporate earnings, interest rates, inflation, and many other factors that affect the returns of stocks and bonds. We believe, therefore, that long-term GDP growth forecasts should form the foundation for long-term capital market assumptions.
Today there are generally two major schools of thought about GDP growth. One group argues that the rapid growth—and associated investment returns—seen in the U.S. and other developed economies over the past two centuries may have run its course and that we are entering a long period of slower rates of global growth. The other school of thought suggests that the U.S. economy is more dynamic and will continue to grow rapidly and power global growth.
Fidelity’s AART finds both approaches lacking. Looking back at past growth or focusing on the U.S., as some analyses do, is not enough. We think that the global economic landscape is likely to look quite different over the next 20 years than the past 20 years. What will shape that landscape? Our approach looks at history to find the factors that have determined growth rates in the past, and then compares those factors in many different economies to project GDP growth for the future. At a high level, we believe the key factors to determine GDP growth are the change in the number of workers in an economy—labor force growth—and how much each of them produces—productivity growth.
Our model successfully explains about two-thirds of historical GDP in our sample of 86 countries during the past 30 years. As with any attempt to make projections, there is uncertainty in our forecasts. We acknowledge the possibility that government debt levels could have an impact on financial stability and economic growth, but we were not able to identify them as statistically significant drivers of future growth for economies in general. We continue to search for additional factors to further refine our forecasts and improve the robustness of the results.
Population growth: less positive than in the past
For GDP, the most important measure of population is the labor force. Global labor forces have been growing rapidly for decades, but that growth will slow considerably in the coming years. Many of the biggest developed economies will see an outright reduction in the number of people in the labor force. In advanced economies, aging populations will generally lead to lower labor-force participation rates, adding to the demographic challenge of weaker growth in working-age populations.
That means, compared to the last two decades, population growth will provide less support for economic growth over the next two decades.
In general, growth will be faster in the developing world—Latin America, parts of emerging Asia, the Middle East, and Africa. However, population growth is flattening or declining in several emerging Asian economies, including China, South Korea, and Thailand.
Almost all countries will experience slower labor-force growth and thus less of a direct demographic benefit over the next 20 years (see chart). But it’s important to note that any changes to immigration policies could have an important impact on these forecasts, particularly in Europe where inflows of working-age migrants have been higher than expected in recent years due to turmoil in the Middle East and Africa. This migration could help mollify the region’s demographic challenges, although the opposite effect would occur if more restrictive policies were enacted in response to migration pressures (see “Rising anti-globalization pressures could affect growth outlook”).
Productivity growth: still positive
While complex and more difficult to predict, productivity is poised to help drive GDP growth in the coming decades, according to AART. Here are four reasons why:
1. Human capital. The characteristics of a population can influence the pace of economic growth. Educational and scientific achievements are key drivers of future innovation and adoption of new technologies, and should help to power growth.
Human capital tends to be higher in the world’s wealthiest regions, such as the U.S., Japan, and northern Europe. South Korea also has a high human-capital ranking, and several emerging economies—including China, Turkey, and Indonesia—have made great strides over the past 20 years.
Age also plays a factor. Over the next 20 years, developed markets will face headwinds from an aging population, as the proportion of the population above 60 years old will rise to roughly 30% (see chart, below). In emerging markets, the population distribution will generally become more mature, but will remain healthy with a balanced foundation of younger cohorts.
Over the next 20 years, developed economies are likely to see greater productivity headwinds from aging than emerging market countries.
For example, the Philippines, Mexico, and Colombia will benefit from a maturing phase. Formerly maturing countries—such as China, South Korea, and Thailand—will be disadvantaged as their populations enter the aging phase. Already aging societies—such as Russia, Germany, and Japan—will feel the most negative effects on productivity as their demographics deteriorate further.
2. Structure. Complex economies tend to be more competitive, use technology more effectively, and have better business climates and more business-nurturing institutions.1 As a result, higher complexity typically means higher productivity. Greater variety and more sophisticated products in a country’s output signal a more complex economic structure. For example, Japan has the highest complexity ranking, while a number of African countries rank very low. Complexity should contribute slightly to higher global growth over the next 20 years, primarily due to increasingly complex emerging economies such as South Korea, Malaysia, and China.
3. Catch-up potential. In theory, less advanced economies should grow faster than more mature economies, thanks to their ability to grow off a lower base, adopt existing technologies, and catch up or converge to the higher income levels of developed countries. In practice, however, this convergence does not occur automatically but is conditional on other factors, such as the labor force and structure of an economy.
Once we account for these other growth determinants, catch-up potential has been—and will continue to be— a positive contributor to global GDP growth on an absolute basis. Many poorer economies in Asia, Latin America, and Africa will still benefit from sizable potential development gains. However, catch-up potential generally will contribute much less to global growth going forward than it did over the past two decades. After the rapid growth in recent decades of many larger developing economies, such as China, India, and South Korea, higher per capita incomes now leave less catch-up potential for the next 20 years.
GDP forecast: growth slowing
Using projections for 40 countries within the MSCI All Country World Index (ACWI), we forecast global real GDP growth of 2.1% annually over the next 20 years, compared with the 2.7% averaged during the past two decades. About four-fifths of these countries could experience slower growth, including all the developed economies (see chart, below). In general, worsening global demographics are expected to take the largest toll on the global forecast relative to past history, as almost all economies confront an inferior demographic outlook than the one they faced two decades ago. In addition, rapid gains in emerging Asia in recent decades may leave less room for industrialization and catch-up potential from low income levels than before.
Nevertheless, our forecasts indicate that global growth will still be positive. The U.S. will remain the world’s largest economy and average roughly 1.6% real (inflation-adjusted) annualized growth. Improved human capital and increased economic structural complexity could benefit productivity growth in many developing economies. Emerging economies with higher growth rates will account for a greater component of global growth moving forward—developing countries are projected to comprise about half of global GDP by 2035, compared with about one-third in 2015 and one-quarter in 1996.2 This should help to offset the weaker outlooks for Japan and many European countries.
By 2035, we estimate that three of the world’s top five economies are likely to be emerging countries, compared with just one today (see Exhibit chart). Our forecasts indicate that India will grow from the seventh-largest economy today to the third-largest.
At a high level, our long-term GDP forecasts suggest a few overarching conclusions. First, all else being equal, slower global growth should provide less of a tailwind to equity returns over the next 20 years than during the post-World War II period. Second, the geographic opportunities for growth tend to favor emerging economies, though there is significant dispersion of expected growth around the world. Third, we expect interest rates to rise over time from their current levels, but remain lower than their historical averages. In general, asset allocation strategies that can be selective across a broad, global opportunity set may have the best potential to take advantage of future growth prospects.
The long-term expectations on which these forecasts are based may deviate substantially in the short term. For more near-term observations, see Viewpoints: “September business cycle: improved cyclical trends,” which focuses primarily on cyclical fluctuations in the intermediate term.
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