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March 17, 2023

Demographics threaten Germany’s triple-A status

An ageing population, reduced labour supply and increased public spending threaten Germany's triple-A rating. This is a warning for many.

By Adrian Murdoch

Demography, Germany, triple-A, credit, Moody's
“I’m listening!” German Chancellor Olaf Scholz has a ticking social timebomb on his hand, warns Moody’s. (Photo by Sean Gallup/Getty Images)
  • Moody’s argues the reduction of labour supply and increased public spending on social care, health and pensions threaten Germany’s triple-A rating.
  • The OECD anticipates Germany’s old-age dependency ratio will increase from 34.8 in 2015 to 63.1 in 2075.
  • By 2050, those over 65 will account for 18% of Asia’s total population, up 10 percentage points from 8% in 2019.

While the attention of ESG investors is generally focused on climate risks, social problems –specifically ageing – should not be brushed under the carpet.

That it usually is, was highlighted by Larry Fink, chairman of BlackRock in his letter to investors last week. He referred to it as a “silent crisis” that is rarely discussed in the news or media.

“The longer we delay the conversation about it, the larger the crisis grows,” he wrote.

Highlighting the declining birth rates across Europe, North America, China, and Japan, he worried that the demographic shift would leave countries with smaller working populations and cause income to grow more slowly or even decline.

This is more of a threat than it seems. A February report from ratings agency Moody’s argues not only that ageing is Germany’s greatest ESG-related credit risk, but the reduction of labour supply and increased public spending on social care, health and pensions all threaten to topple the European country’s triple-A rating. 

Not just a problem for Germany

This is not a problem that is unique to Germany. Kathleen Brooks, the founder of London-based market analysis company Minerva Analysis, notes that this “multi-decade shift” will impact emerging markets and developed markets alike.

To put this into context, the global labour supply has grown continuously for the past 30 years, which Brooks points out, is thanks to three trends. First, the reintegration of the Eastern European workforce after the collapse of the Soviet Union. Second, the rise of China and its inclusion in the World Trade Organisation in 1997. And third, benign demographic trends in most advanced economies. As a result, “the effective global labour supply rate doubled between 1991 and 2018,” she says.

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The most recent report from the European Commission, however, looked at demographics to 2030 and showed birth rates across the region are expected to fall sharply. Now, the problem is how the issue should be handled.

Demographic pressures

Germany’s positive approach to ESG aligns with its triple-A rated peers and, as Moody’s points out, the country stands ahead of other EU-27 member countries.

It has a low exposure to environmental and social risks and boasts strong governance. More to the point, its ability to respond to environmental hazards or social demands is high, thanks to what the ratings agency calls “high-income levels, large fiscal capacity and very high quality of governance”.

Nonetheless, the demographic pressures on Germany remain significant. The Organisation for Economic Co-operation and Development (OECD) anticipates the German old-age dependency ratio – the number of individuals aged 65 years and over per 100 people of working age – will increase from 34.8 in 2015 to 63.1 in 2075.

Thanks to longer life expectancy and falling birth rates, the Moody’s report characterises Germany’s population as “ageing at one of the fastest rates globally”. In fact, the share of people of working age (15-64 years) already fell from 69% to 64.2% in the decade up to 2021 [see chart]. It is only expected to fall further.

There will then be a series of connected knock-on effects, as a declining labour pool will damage growth. At the same time, the country will be faced with a significant bump in pension spending. The European Union predicts a 1.9 percentage point rise in pension spending by 2050. The long-term effect will make Germany less competitive.

An IMF report from 2020 that looked at fiscal spending and ageing populations found “In ageing economies, the positive output effects of government spending shocks during recessions are weaker, while during booms, the positive government spending shocks reduce output and the negative effect is long-lasting.”

The pressure will also raise the deficit dramatically. Moody’s estimates Germany’s government debt could be as high as 80% of GDP by 2050, almost certainly putting its triple-A rating at risk.

Lower levels of investment

The same issue is at the heart of the pension strikes currently affecting France. Although the majority of voters are opposed to government plans to raise the pension age by two years to 64, President Emmanuel Macron has recognised the move is essential and has bypassed French Parliament to implement the policy. There are simply not enough younger workers to prop up the system.

Beyond Europe, it is a particular issue in Asia. The issue is well known in Japan, but last year the population in China dropped for the first time in 60 years. A recent article by the Asian Development Bank’s economists Aiko Kikkawa and Raymond Gaspar points out that by 2050, individuals aged over 65 will account for 18% of Asia’s total population, up 10 percentage points from 8% in 2019.

At the same time, they say, the workforce will shrink. The number of people aged between 16 and 64 will peak in 2045 before beginning to decline.

This threat to countries’ finances should not be underestimated. Even if the current inflationary climate calms down, Minerva Analysis’ Brooks stresses higher debt levels will be needed to fund medical costs and social care. “Higher debt levels in countries as varied as the UK and China could lead to sovereign rating downgrades, and lower levels of investment, both domestically and abroad, in the future,” she concludes.

[Read more: Retirement housing is driving New Zealand green finance]

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