Tough choices: Investing in a changing world

The political conference season is over, with all parties promising a better future after current austerity. But politicians, just like investors, are inveterate optimists, and few are willing to contemplate the realities of the “new normal”.

The underlying future

The Atlantic world is ageing rapidly, is over-borrowed, and tied into a level of spending which is neither affordable nor sustainable. RDR has been designed for this reality, even if unconsciously. IFAs need to interpret the investment reality of the ‘new normal’ to investors still not saving enough for a comfortable retirement and expecting double digit stock market growth to resolve their problems.

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A report to the European Central Bank (ECB) a few years ago spelled out this reality very bluntly: “Europe is growing old and we have to afford it. On the basis of current projections the old-age dependency ratio is expected to more than double from around 25 per cent today to more than 50 per cent by the middle of the century. And the overall dependency ratio is expected to increase from around 50 per cent today to 80 per cent in fifty years’ time.”

The old-age dependency ratio measures the number of older people aged 65 years or above for every 100 persons of working age – those defined as aged between 15 to 64. As Chart 1 shows, this ratio is rising throughout Europe. It is important because it shows the relationship between the economically active compared to economically inactive.

The economically active pay more income tax, corporation tax and, to a lesser extent, more sales and VAT taxes; the economically inactive – those under 15 and over 65 – tend to be the beneficiaries of those taxes through government spending on education, pensions and healthcare. If today our children are complaining that they find it hard to make ends meet, why should we expect them to support us at a level higher than they themselves enjoy?

Demographic message

But the old-age dependency ratio is one of only two parts of the total dependency ratio, which is the sum of the old-age dependency ratio and the youth dependency ratio, or number of children under 14 for every 100 workers. The rising costs of youth dependency, especially in developed countries, are easily underestimated. The youth dependency ratio assumes that children over 14 can work but in practice in developed countries, only a relatively small proportion of people under 18 years of age are financially independent.

Economic growth comes from an increasing work force, as well as improved productivity so, without the political will to encourage immigration, Europe’s demographics spell slow growth and rising debt. An alternative was spelled out in a last minute addition to the Conservative conference message: no benefits for the under-25s but ‘work or learn’ instead. This is only the beginning of the necessary rethink of Europe’s social welfare system.

Back to the future

Modern economic growth is also based on mass demand – some 70 per cent of America’s GDP is made up of consumer spending, and this reflects the efforts of socially imaginative politicians, such as US President Theodore Roosevelt and the UK’s Prime Minister David Lloyd George. It was they who forced through a redistribution of income from capital and the rich, to the middle classes and the poor. The apogee of this political movement was the 1960s and 70s in Britain but, since then, the process has been in reverse.