Macro Moments Weekly: Lesson from Asia—birth of a new social contract?

Key takeaways:

1. Demographic decline is the defining economic challenge. Falling birth rates across Europe, Asia, and the Americas are undermining the growth that social market economies depend on—and immigration, once the conventional fix, is no longer politically viable.
2. Japan is the cautionary tale. Productivity gains alone weren't enough to offset population aging; decades of stagnation, rising debt, and policy paralysis followed—with meaningful reform only arriving once crisis became undeniable.
3. Innovation-led growth is the viable path forward. South Korea and Taiwan show that economies with ultra-low fertility can still thrive through high-growth, export-driven industries—and investors have a critical role to play in directing capital toward the productive assets that make this possible.

A client asked me this week: ‘Do we have to always grow? Is economic growth a necessity?’ After a decade and a half of no growth in his economy (Germany), it felt like an obvious question.

We in the markets by profession look for and price growth and price potential by valuing future cash flows from an asset. Our task is moving capital to where there are the highest returns. Our objective is to seek returns. But we are specialized; what about viewing the question more broadly?

The foundation of the European Social Market economy is growth: When we are old, our contributions to the taxation system plus the contributions of current workers are enough to cover our health and wealth in retirement. Given that no generation has yet saved enough, one is always reliant on the next. Second, the safety net that the state provides during periods of economic turbulence, such as the COVID-19 pandemic, relies on future income—the earnings of the future repay the debts racked up in bad times. Economies rely on growth because a stagnant economy leaves such debt unpaid, and it becomes an economic burden via rising interest rates.

Many books have sought to answer the question, ‘Do we need growth?’ They include EF Schumacher’s Small Is Beautiful (1973) and, more recently, Edward Skidelsky and Robert Skidelsky’s How Much Is Enough?  (2012). Both books consider whether we should stop striving for growth and enjoy where we are, effectively pulling up the economic drawbridge on better living standards. They essentially argue  we need to give up (deny) the opportunity for better lives. The same thinking underpins John Maynard Keynes’s 1930 paper, ‘Economic Possibilities for our Grandchildren’, written in the teeth of the Great Depression, where he expressed the hope that we would benefit from innovation and growth via working five or ten hours a week. Our living standards would not improve, but at least we would have more time to watch football (for US readers, soccer).

Why is this question back? It is not just because of the 15 years of economic stagnation but because of the simultaneous, extraordinary collapse in the birth rate. Whether its cause is political, as in the one-child policy in China (abandoned in 2016), or changing economic priorities of new generations, the peak is in sight. The world’s population will likely peak in the 2080s.¹ But this hides huge regional variation. According to INED, Europe’s population is already in decline; the population in the Americas should peak in 2050 and then plateau; in Asia the peak should happen in 2050, and by the end of the century the population may be lower than it is today; thus, the sole area of population growth is Africa.²

Conventional economics would suggest that importing labour is the way to offset the demographic declines. The current the political reaction to immigration in the G7 is a resounding ‘no more’. Weak growth on a per-capita basis has undermined this Blair/Merkel era of population economics.

So, if the only way of delivering the Social Market economy is through investment and growth, is it still viable?

It is much cited that Japan was the first economy to discover this problem in the 1990s. Data from the Financial Times³ points out that the productivity of the Japanese worker improved sharply over this period of population aging and decline, but it was not enough to grow the economy as a whole. The social contract continued, the saving ratio stayed high, investors held risk-free and low-risk assets such as bonds, and inflation became political anathema. Common beliefs held that inflation would destroy the wealth of the aging population that had voted in successive governments. Action could only be taken when the crisis of growth became apparent and prompted Prime Minister Shinzo Abe’s reforms 20 years later. Abe was the 11th Prime Minister in 12 years and remarkably remained in power for almost eight years as consensus emerged for action.

There is another path, and this again comes from Asia. The fertility rate in South Korea fell below 2% in 1983 and in Taiwan in 1986; in those nations it is currently 1.08% and 1.27% respectively.⁴ But their focus on high growth, innovation and export industries has not led to the same collapse in growth and living standards. The state has not had to raise huge levels of debt in either country as in Japan; the debt-to-GDP ratios remain below 50% in South Korea and, in the case of Taiwan, just 22.4%.

The key has been a tacit agreement between the voters, the corporate sector and the government. The pact between employer, employee and government illustrated by the negotiations for Samsung’s artificial intelligence (AI) workers’ bonus,⁵ although others elsewhere in the conglomerate who are not benefitting are less happy.

The question then becomes how does any economy, large or small, attempt to organise itself to grow enough to offset the demographic decline? Voters will not tolerate the message, ‘you cannot have what your parents have.’ The economic models from Asia, which include China’s, provide a starting point for the debate. The United States, driving at AI with investment and innovation, provides another. What will not work is increasing state deficits, incentivising an aging population to hold interest-earning bonds to pay for their retirement, while the shrinking working population try and earn enough to pay the interest bill.

As investors, we hold a key role: to be the conduit for the wealth owners, who range from individuals to the great pension plans, to greater returns, returns that justify the risks taken to invest in productive assets rather than the state. To invest in both public and private markets. We need the state to allow investors to benefit from those returns, in fact to incentivise and applaud the companies from AI to infrastructure and from housebuilders to retail.

 But, as we saw in Japan, it takes a crisis to create change. There is an old saying in politics that all elections offer the electorate a simple choice: The incumbent will say you can’t afford to change; the challenger says you must change. The voter, both young and old as we saw in Japan, will at some stage react when they reach the tipping point: when they can’t afford not to change.

Parting shot

Football’s (or soccer’s) greatest tournament is making final preparations before commencing in June in Canada, Mexico and the United States. There will be endless analysis of the effect and efficiency of dynamic pricing, the cost of transportation, the impact on local economies, who travelled and who did not, and what were the effects of heat on supporters as well as players. Amid the triumphs and failures on the pitch, there will probably be more data and resulting Ph.Ds than ever before.