• Why is the US economy and stock market leaving us in the dust?
  • Population growth explains the US’ boom
  • We are in uncharted demographic waters, so be careful

The media is busy debating why the US’ economic recovery from Covid continues to leave Europe’s in the dust.

While Europe has seen no economic growth for a year, the US economy is soaring so fast that economists are worried it broke its speed barrier.

The same goes for the stock market, although investors should be wary of the assumption that GDP and stock performance are correlated in the first place. According to financial market historian Russell Napier, there is no such correlation.

Still, the US markets are rising fast while Europe’s are floundering. To be fair, that’s almost entirely down to seven massive global stocks that happen to be listed in the US market. So, it might not reflect GDP conditions on the ground at all.

The leading theory for the transatlantic divergence in GDP is that the US government has pushed the pedal to the metal on spending while Europe is back to its old austerity ways.

The US is spending like a drunken sailor, to the point where its annualised interest bill is now hitting $1 trillion after doubling in just 19 months!

Other theories include differences in trade and energy costs. Apparently, making yourself energy dependent on Russia is a bad idea…

Now, all these theories may or may not explain the divergence. But the obvious answer is so boring that nobody wants to bother discussing it.

There are, after all, only two ways to increase your GDP. Well, three if you consider Ireland’s practice of hosting global digital corporations by providing them with tax benefits to move their nominal residency to your country.

But the textbooks still say that to increase your GDP you can either increase your population or increase how much each person produces – your productivity.

Economists have a bad habit of focusing on productivity and ignoring population. Which is what has occurred in this debate too.

Actually, bizarrely enough, one particular article that discussed the US’ economic outperformance relative to Europe did an excellent job of pointing out that demographics are in fact the key variable when it comes to long-term performance, but then failed to look into the same population data in the short term to explain the short-term divergence!

It was published in the Financial Times:

The divergence between the US and the EU economies is astonishing. That is not a statement about the long run. While the US has grown much more than Europe this century, that is virtually all down to different rates of population growth. If you compare inflation-adjusted gross domestic product per capita, expressed in internationally comparable currency, the EU and US have performed identically since 2000.

In other words, US GDP has only outpaced Europe’s economy since 2000 because it added more people.

My argument is that this factor is playing a role in the short term too.

During and since Covid, the US population has continued to grow. Which really puts the pandemic into perspective, but let’s not go there…

In Europe, meanwhile, the population has been falling.

Now, I’m about the last person to claim that population or migration statistics are accurate enough to be useful. And it’s not like GDP statistics have covered themselves in glory lately either. However, let’s pretend we’re economists and can assume these statistics to be valid without losing our own credibility.

What does it tell us? Perhaps the divergence in growth rates comes down to population growth, not policy or productivity. Perhaps the US just has more people while Europe has fewer.

This also explains the economic performance of Japan in the longer term, where decent GDP growth per person has been undermined by a lack of population growth, giving Japan’s economy an undeservedly bad reputation.

It’s likely that the US’ migration statistics undercount working-age migrants, which add disproportionately to GDP, while Europe is ageing rapidly after a lot of early retirements during Covid.

Why does the population factor matter to you?

I think the misunderstood debate about European and US GDP growth rates is a symptom of a bigger story. One where our institutions, statistics and debates haven’t yet caught up to the demographic realities that will come to define them.

Developed nations are undergoing an unprecedented demographic change. We don’t really know what declining populations mean for investments, GDP and other considerations. We’re in uncharted waters.

For example, does the policy of austerity work if your population is declining? I’m not so sure because austerity rests on the presumption that your economy will eventually outgrow its debt if you just stop adding more. This works under the assumption that your population will outgrow the debt. But what if the economy just keeps flatlining or sinking as your population falls, and so your debt plus interest just keeps growing?

That’s pretty much what’s happening in Japan. Without a growing population, time is no longer on your side.

And if we can agree that GDP must grow in order to keep our government debt under control, it implies that we must make productivity surge. This is our only way out of a fiscal crisis.

Another consideration is how the decline plays out if we fail. Does it lead to a debt crisis or something else?

The Japanese yen’s tumble suggests it may play out in currency markets instead of bond markets. Germany recently overtook Japan to become the world’s third-largest economy, despite being in recession while Japan’s is not…

The way we think about the world and measure economic statistics is going to have to change as some countries’ populations decline while others’ grow. They are no longer comparable under the metrics we use. Ignoring this factor will lead to misdiagnosing what’s wrong in a country and which policies should be applied.

Investors who do understand demographics and their impacts could stand to profit from others’ mistakes.

Until next time,

Nick Hubble
Editor, Fortune & Freedom