Demographics to reverse Multi-decade Global Trends

An article by Goodhart and Pradhan from the BIS can be found here and here.

The three trends are:

• a global saving glut causing interest rates to decrease
• the cost of labor considered as a production factor decreased
• inequality increase within advanced economies (AE) and decrease between AE and emerging economy (EE) countries

China and Eastern Countries workers Glut

At the basis of the analysis is the fact that consumption needs vary with age as follow:

A demographic sweet spot was caused by having a temporarily reduced dependent ratio due to people having less than 1 child while the aged population was still limited. This is bound to end as life expectation increases in all EE.

As China and Eastern Europe opened up their production systems the number of worker available to for AE production increased by 120%. This created unemployment and a downward pressure on wages in AE.

A point that we found to be controversial in this paper is that China lack of financial opening and capital control enabled high growth at lower rate in China than if the country had been opened. Indeed, interest rates in China were higher than in the US until recent years and it is not clear that opening financial markets would have caused chinese rates to be higher.

Labor costs are expected to increase due to much of that labor glut retiring between now an 2025.

Inflation will be the result of a tug of war between consumers needing less as consumption reduces with age and producers having higher labor costs.

Population Age and Effect on Economic Growth

This paper shines also by the comments it attracted. One of them by Masaaki Shirakawa, a former BOJ governor who later worked at the BIS.

Key Takeaways

Few takeaways from this study:

• the supercharged growth due workers having less children to support is not going to continue as these workers are going to retire and will become dependent
• the negative effect (mixed with other conjunctural problems linked to the end of a debt super-cycle) is being observed in Japan in the 90s and in Europe starting in 2010
• worker gains in productivity have been huge in all AE, but translated in growth only in the US given the phasing out of some workers. This bodes ill when workers retire in greater numbers throughout AE and EE.
• as labor supply will diminish, wages will increase
• as rates are lowest, cost of capital is already at its lowest, and it could be that wage inflation will cause price inflation.
• it is not clear that central banks can increase rates to fight inflation since the massive debt to be refinanced would cause fiscal shocks
• inflation currency instability and and fiscal shocks are threats to the viability of international investments.