Get ready for the great de­mo­graphic re­ver­sal

Ul­tra-low in­fla­tion and in­ter­est rates could end as a gen­er­a­tion of re­tirees be­gins to spend its sav­ings

The Daily Telegraph - Business - - Front Page - Roger Boo­tle

Last week I ar­gued that as and when ag­gre­gate de­mand re­cov­ers af­ter the coro­n­avirus cri­sis, cen­tral banks might adopt a laxer at­ti­tude towards in­fla­tion. But will de­mand ever re­cover to the point where in­fla­tion­ary pres­sures re­vive?

It is now widely be­lieved that de­pressed ag­gre­gate de­mand, ac­com­pa­nied by ul­tra-low in­fla­tion and near-zero in­ter­est rates, is the new nor­mal. This state of af­fairs pre­dates Covid. Af­ter all, in the years af­ter the fi­nan­cial cri­sis of 2007/09, and orig­i­nat­ing even be­fore then, the world was char­ac­terised by ul­tra-low eco­nomic growth and low in­fla­tion – de­spite ex­tremely stim­u­la­tory mon­e­tary pol­icy.

Some dis­tin­guished econ­o­mists sug­gested that we were in an era of sec­u­lar stag­na­tion. What’s more, they said, there was no ob­vi­ous end in sight.

There came to be pretty gen­eral agree­ment that the world was suf­fer­ing from an ex­cess of de­sired sav­ings in re­la­tion to de­sired in­vest­ment – the so-called sav­ings glut.

But there was dis­agree­ment about the main ex­pla­na­tion. Some econ­o­mists em­pha­sised in­creased in­equal­ity. Some stressed global im­bal­ances. Oth­ers pointed to de­pressed cor­po­rate in­vest­ment and blamed the struc­ture of ex­ec­u­tive in­cen­tives.

It is tempt­ing to con­clude that each of these has some­thing to con­trib­ute to an ex­pla­na­tion of what has hap­pened, with the ex­act mix­ture dif­fer­ing be­tween dif­fer­ent parts of the world. But it is in­tel­lec­tu­ally un­sat­is­fac­tory to rely on a rag­bag of ex­pla­na­tions for a ma­jor global phe­nom­e­non.

A new book has just ap­peared which pro­poses a sin­gle ma­jor de­vel­op­ment as an ex­pla­na­tion of what has hap­pened – The Great De­mo­graphic Re­ver­sal, by Charles Good­hart and Manoj Prad­han.

The au­thors do not negate the can­di­date ex­pla­na­tions re­ferred to above, but in­cor­po­rate most of them within an over­ar­ch­ing ex­pla­na­tion, in­clud­ing a fac­tor that has been un­duly ne­glected by most econ­o­mists, namely de­mo­graph­ics.

Their ex­pla­na­tion be­gins with the in­te­gra­tion into the global trad­ing sys­tem of China and other emerg­ing mar­kets. This ef­fec­tively amounted to the ad­di­tion of over one bil­lion work­ers and not much cap­i­tal to the world econ­omy.

The re­sult, as you would ex­pect, was a de­pres­sion of real wages in the de­vel­oped world and higher prof­its, lead­ing to in­creased in­equal­ity, down­ward pres­sure on in­fla­tion and, given the sav­ings propen­si­ties of these coun­tries, de­fi­cient ag­gre­gate de­mand at the global level. This had to be coun­ter­acted by ul­tra-loose mon­e­tary pol­icy.

So much, so con­ven­tional. Where the au­thors bring some­thing new to the ta­ble is their stress on de­mo­graphic fac­tors within the de­vel­oped world.

Over the years 1980 to 2010, in most de­vel­oped coun­tries, the work­ing age pop­u­la­tion was ris­ing quite sig­nif­i­cantly, re­flect­ing the ear­lier baby boom. Mean­while, the de­pen­dency ra­tio, that is the ra­tio of both young and old non-work­ers to work­ers, de­clined as the birth rate fell and the num­ber of re­tirees hadn’t yet risen. The par­tic­i­pa­tion rate in the work­force was also in­creas­ing, driven partly by the in­creased em­ploy­ment of women.

This in­ter­nal de­mo­graphic fac­tor had ef­fects in ex­actly the same di­rec­tion as the China fac­tor. So the world econ­omy ex­pe­ri­enced the largest ever pos­i­tive labour shock.

Good­hart and Prad­han say that over the years from 1991 to 2018, the ef­fec­tive labour force for the world’s trad­ing sys­tem more than dou­bled.

Be­cause of the at­ti­tude of China and other emerg­ing mar­ket coun­tries to run­ning cur­rent ac­count sur­pluses, their rise boosted world sav­ings and de­pressed world de­mand.

The in­ter­nal de­mo­graphic fac­tor in the West did the same be­cause of the typ­i­cal pat­tern of sav­ing and spend­ing across a per­son’s life­time.

The peak sav­ing years are the mid­dle ones. In re­tire­ment, by con­trast, peo­ple typ­i­cally spend in ex­cess of their cur­rent in­come and fi­nance this by run­ning down their ac­cu­mu­lated as­sets.

For the last 40 years, with re­gard to the growth of the labour force, the de­vel­oped coun­tries of the world have been in a so-called de­mo­graphic sweetspot. But as far as the gen­er­a­tion of ag­gre­gate de­mand is con­cerned, this was in fact a de­mo­graphic sourspot. The age dis­tri­bu­tion of the pop­u­la­tion favoured sav­ing over spend­ing.

What of the fu­ture? Nowa­days, very few peo­ple think that we will ever re­turn to the con­di­tions that we once thought of as nor­mal, in­clud­ing de­cent in­creases in real in­comes and de­cent lev­els of real in­ter­est rates.

But those of you with an in­ter­est in his­tory will know that, since the In­dus­trial Rev­o­lu­tion at least, we have been through sev­eral dif­fer­ent eco­nomic eras, each one sharply dif­fer­ent from the oth­ers. And in each one peo­ple have typ­i­cally be­lieved that the cur­rent con­di­tions, no mat­ter how dif­fer­ent from what went be­fore, were bound to con­tinue ad in­fini­tum.

Good­hart and Prad­han’s anal­y­sis is strik­ing not only for the ex­pla­na­tion of past and cur­rent trends but also for what it says about the fu­ture. They ar­gue we are now at a de­mo­graphic turn­ing point. In both East and West, pop­u­la­tions are age­ing rapidly. Many coun­tries, in­clud­ing Ja­pan, Ger­many and China, are go­ing to ex­pe­ri­ence dra­matic drops in the work­ing age pop­u­la­tion, ac­com­pa­nied by ma­jor dis­sav­ing by the old and re­tired. Only con­tin­ued rapid pop­u­la­tion growth in Africa and In­dia may stand in the way of a sig­nif­i­cant shift in global eco­nomic con­di­tions.

Global age­ing is go­ing to lead to a re­ver­sal of many of the things that have come to be re­garded as the new nor­mal. Once the Covid cri­sis is over, dur­ing the next few decades there will be an in­ten­si­fy­ing short­age of labour that will drive up real wages and re­duce in­equal­ity.

Mean­while, as this is ac­com­pa­nied by a re­vival of ag­gre­gate de­mand, there will be up­ward pres­sure on in­fla­tion and in­ter­est rates.

I re­alise that this vi­sion seems a long way from cur­rent re­al­ity. And, in my view, you cer­tainly should not an­tic­i­pate any­thing like it in the im­me­di­ate fu­ture. In­deed, quite the op­po­site.

But if you are go­ing to peer into the fur­ther fu­ture then you must be pre­pared to see some­thing markedly dif­fer­ent from cur­rent re­al­ity. Good­hart and Prad­han meet this chal­lenge. I sus­pect that they are on to some­thing.

The world’s age­ing pop­u­la­tion points to a short­age of labour in the com­ing decades

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