At present, the European Union’s ratio of working-age persons (aged 15 to 64) to persons aged 65 and older stands above 4-to-1. By the year 2025, the ratio will fall below 3-to-1 before dropping to near 2-to-1 in 2050. The total EU working population will peak near the end of this decade before falling by 43 million people over the next half-century.

As the business world (and even the real estate industry) becomes increasingly global, the significance of these trends should not be underestimated. There is a critical link between demographics and behavior of the financial markets.

For those under age 40, consumption is high relative to income. The period from 40 to 65 marks a person’s prime saving years, when income rises and the ratio of consumption to income falls. After 65, income falls and assets are divested to finance consumption during retirement. The move of U.S. baby boomers into their savings years is considered a large contributor to positive performance of U.S. financial markets during the 1980s and 1990s.

We are in the formative years of “Euro-nification” but individual member countries—with vastly different interests—are making many critical policy decisions that will alter the future of the EU. In late June, Germany announced plans to push $21 billion in tax cuts into 2004, one year earlier than planned. France is taking a similar path. These moves will inflate debt and undermine a basic tenet of the EU—the Stability and Growth Pact.

Additional tough policy decisions lie ahead—most notably, how to contend with pension liabilities associated with the European pay-as-you-go system (and in a forthcoming era of disinvestment, which will lead to flattening asset prices). Pension reform is very high on political leaders’ and the public’s agenda, but astonishingly little has been done.

The medicine of reform may taste bad today, but the bitterness will grow exponentially for each year that decisions are delayed. As it stands now, the European Commission has modeled that Europe’s portion of global output could fall from 18 percent today to near 10 percent by 2050. Without major reforms, the European Commission suggests that the potential annual growth rate in GDP will be only 1.3 percent between now and 2050. For the same period, potential GDP growth in the U.S. is forecasted at 2.5 percent.

While it is easy to dismiss forecasts for 50 years into the future, these long-term macro trends will have a very meaningful impact on near-term financial market flows, fiscal/monetary policy and standards of living. Diverging demographics and varying local government policy responses accentuate stresses on the EU. Lastly, many investors will argue that while macro dynamics may provide a head or tail wind, short-term, local market dynamics will continue to be the main driver of returns for specific investments.

As mentioned earlier in this issue, several U.S. REITs (including ProLogis, Shurgard and Mills) have forged ahead with successful strategies of investing in Europe—generally through co-investment vehicles (which mitigate certain risks). Certainly opportunities for other trendsetters will also emerge. However, absent a highly targeted business model, I’d prefer to be running the race with the powerful wind of demographics at my back.