Saying Goodbye To One Crisis and Hello To The Next

Saying Goodbye To One
Crisis, Only To Say Hello To
The Next One?
Edward Hugh
Macroeconomist, Barcelona
International Employee Benefits Association
11th
Annual IEBA Conference | Brussels | 8 - 10 March 2011

In this presentation I will argue that
• The most recent crisis was not an arbitrary phenomenon
• There is an underlying process we need to understand
• The worst is undoubtedly over in the last crisis
• Yet despite this we may have simply clutched victory from
the jaws of defeat in one battle, only to then go on and lose
the next one.

What Was The Last Crisis All About?
It was all about
debt, and about how
heavily indebted
societies were going
to be able to claw
their way back to
growth.
The Key Point To Grasp – This Process
Is Structural, Not Cyclical

So Just Why Was There So Much Debt?
• Badly Structured Financial Products?
• Poor Regulation?
• Or Was There Something Else Going On?

Case Study: The Eurozone
Here is a key part of the puzzle.
During the first 10 years of the
Euro some European countries
borrowed heavily, while others
lent. As a result Spain’s
households contracted a lot of
debt. Yet German households
didn’t.
Why this difference?

One Conventional Account
The “one size fits all”
monetary policy didn’t
work. Spain had
negative interest rates
during the key years of
the housing boom.
But that still leaves us with a question:
why didn’t it work?

Credit Driven Private Consumption Booms
Both Spain and
Germany have had
these.
The only real difference is in the
Timing.
Germany 1992 – 1999
Spain 2000 - 2008

Current Account Blues
Germany didn’t always
run a current account
surplus. All through the
1990s the current
account was in deficit.
And Spain won’t always
run a current account
deficit, even if that seems
hard to believe right now.

The Key 25 to 49 Age Group
This group peaked
in Germany – as a
% of total population
around the turn of
the century.
And in Spain it peaked
towards the end of
the first decade of this
century.

In The BackgroundThose Famous “Global Imbalances”
But Just Why Did The Imbalances Build Up?
Japan, Germany and China –
the usual suspects – had
substantial current account
surpluses.
While that other group –
the debtors, countries
like the UK, the US and
Spain – ran substantial
deficits.

Could Something As Simple As Median Population Age
Help Us Understand?
Ours is an age of rapidly
ageing societies. What is so
modern about our current
situation is not the ageing
itself, but its velocity, and
its global extension.

The economic and social implications of the ageing
process are going to be profound. According to a recent
report from credit rating agency Standard & Poor’s:
• the process is seemingly irreversible.
• No other single force is likely to shape the future of
national economic health, public finances, and
policymaking over the coming decade
Population Ageing – A Unique Historical Challenge
Strangely, the issue receives only a
fraction of the attention that has
been devoted to global climate
change, even though, arguably,
ageing is a problem our social and
political systems are, in principle,
much better equipped to deal with.

As far as we are able to understand the issue at this point,
population ageing will have major economic impacts and
these can be categorised under four main headings:
i) ageing will affect the size of the working age population, and with this
the level of trend economic growth in one country after another
ii) ageing will affect patterns of national saving and borrowing, and with
these the directions and magnitudes of global capital flows
iii) through the saving and borrowing path the process can influence
values of key assets like housing and equities
iv) through changes in the dependency ratio, ageing will influence
pressure on global sovereign debt, producing significant changes in
ranking as between developed and emerging economies.

While population ageing is universal the short term
impact will be much more localised.
The pace of aging varies greatly across countries
and regions.
The effects of the process are expected to be most
pronounced in those countries that remained
complacent in the face of ultra-low fertility rates
(total fertility rates of 1.5 and under), which in effect
means Japan, the German speaking countries and
much of Southern and Eastern Europe.

Another way of looking at
these demographic changes is
in terms of the dependency
ratio, which can be defined in a
number of different ways
depending on the problem
being addressed.

In In Germany total population is expected to fall
from its current level of 82 million reaching anything
between 69 and 74 million by 2050, depending on the
future course of life expectancy, immigration and
fertility. And the proportion of people aged 65 and older
is projected to rise from just under 20% today to just
over 33% by 2050. At the same time, the number of
very elderly (those aged 80 and over) will nearly triple to
as much as 15% of the total population.

Among emerging economies, the East of Europe stands
out as by far the worst case in the short term. In 2025,
more than one in five Bulgarians will be over 65 - up
from just 13 percent in 1990. Ukraine’s population will
shrink by a fifth between 2000 and 2025. And the
average Slovene will be 47.4 years old in 2025 – one of
the oldest populations in the world.
Eastern Europe Will Be Very Hard Hit

The ageing problem goes well beyond the confines of the EU
or the G7. In particular China stands out among developing
economies, since the degree of ageing we should
anticipate, when viewed in terms of absolute numbers
and velocity, is simply staggering.
It is during the 2020’s that China’s age
wave will arrive in full force. The elder share
of China’s population seems set to rise
steadily from 11 percent in 2004 to 15
percent in 2015, and then leap to 24
percent in 2030 and 28 percent in 2040.
Over the same period, China’s median
age will climb from 32 to 44.
China Will Be One Of The Most Rapidly Ageing
Countries in the 2020s

The key groups are prime savers,
prime borrowers, and prime
productive workers. Where these
actual age brackets lie, and the
extent to which they may overlap,
is still a subject of some
controversy,
One of the key points to grasp,
is that the proportion the
population which is to be found
in one of the ‘prime’ age groups
at a given moment in time, is
absolutely critical, and much
more important for
understanding the processes at
work than the mere size of the
working age population.
Estimates of the exact age
extension of the different
groups vary, but 25-40 would
be a good rule of thumb
measure of the borrowing
range, 40 to 55 for the peak
savers, and 35 to 50 for the
prime age workers.
Beyond this, the question is
an empirical one of measuring
and testing to determine more
precise boundaries and
frontiers.
Importance Of The Prime Age Groups

There is a generally accepted wisdom in academic work known
as the “life cycle hypothesis” (Modigliani). This suggests that the
population’s financial behaviour changes depending on age. In
terms of adult life, those in their twenties and early thirties tend to
be net borrowers as they are relatively low earners at the same
time as they look to buy housing, expensive durables and fund
their burgeoning families. At some point around middle-age this
group then tends to move from being net borrowers to net
investors as they move into their economic prime and
accumulate financial assets to hopefully fund their retirement. As
they
approach retirement this group then start to shed the financial
assets they’ve been accumulating to fund their nonworking days.
Life Cycle Effects

With this kind of understanding of the demographic
component of saving and borrowing patterns it is
not hard to see how demographic forces may have
played an important role in the run up to the most
recent crisis, making possible what Federal
Reserve Chairman Ben Bernanke once called the
‘savings glut’.
The Savings Glut

As I have been arguing, if economies transit from
being consumption driven to export driven, and it
would appear that the process is not merely random,
then we are not talking about choosing between
options or “growth models”. There is not a choice
here, since there are deep underlying structural
dynamics at work, and these dynamics seems to be
intimately associated with the dynamics of the
demographic transition
The Demographics Of Export Dependency

The young Danish economist Claus Vistesen and I have
proposed a model based on the close association of the
export dependent phenomenon with population ageing
and the demographic transition. Using Modigliani's life cycle
saving and borrowing idea, and the Swedish demographer Bo
Malmberg's idea of population "ages" (child, young adult,
middle aged and elderly), Claus Vistesen has prepared the
adjacent chart which attempt to illustrate the process which
might be at work.

Dangers of Sovereign Debt Default?
According to the recent Standard & Poor's report, the cost of
caring for the growing numbers of dependent elderly will both
affect growth prospects and dominate public finance policy
debates across the globe, and for many years to come.
Even if most governments have long
been aware of the need to prepare for
the looming problem, the rapid build-up
of government debt over the past three
years has effectively heightened the
need to do more to advance reforms
aimed at containing the risks to
sovereign budgets, especially in
countries with high expected future
increases in age-related spending.

Assuming no policy change, Standard and Poor’s estimate that
developed country deficits could rise from 5.7% of GDP currently
to over 7.4% of GDP by the mid-2020s. The interest cost of the
growing debt burden may exacerbate the budgetary impact of
demographic spending pressure. And if nothing is done deficits will
rise inexorably to 10.1% of GDP in 2030 and 24.5% by the middle
of the century. This would lead the general government net debt
burden to increase to 78% of GDP through to 2020, only to then
accelerate thereafter. By 2030, the net debt burden is projected to
be at almost 115%, at the same time as being on an explosive
path to which would see average developed country sovereigns
hitting 329% of GDP by 2050.
And The Numbers Are Daunting

Of course, such numbers are not either fundable or sustainable, they are
only a simple illustration of what would happen if changes are not made.
Evidently, emerging market sovereigns are in
general in a relatively better position due to their
current level of economic development and
their relatively lower pension system coverage.
But it is not unreasonable to assume that as these
economies develop, government welfare spending
may grow faster than GDP as has been the trend
in advanced economies during the last half of the
20th century.
Time To Act Now In Emerging Economies

A Delicate Balancing Act
Reasonable empirical confirmation exists that the
recent surge in global imbalances was, in part, an
offshoot of slow-moving underlying demographic
determinants of global capital flows.
The near-term adjustments will mean more emerging market
current account deficits and less developed market ones.
At a global level, demographic pressures will continue to imply that
the increase in desired saving will exceed the increase in desired
investment. This has one clear implication: globally interest rates
can be expected to remain low.

In terms of policies to address the pressures of
‘ageing’, the debate in terms of social security and
healthcare often focuses on raising retirement ages
to reduce dependency rates and alleviate fiscal
pressures.
Extending working lives relative to the
time spent in retirement will not only help
address the pension issue, it should also
serve to accelerate the tendency
towards larger current account
surpluses across most developed
economies, in particular in those parts
of Europe which are in the process of
private sector deleveraging as part of
their fiscal sustainability programme.
Longer, Healthier Working Lives

Surely it is more than a simple coincidence that the Nikkei peak was
hit at exactly the same time as the key 35 to 54 age group arrived
at its highest value relative to the dependant groups. That the
Nikkei then spent the best part of two decades failing to show any
meaningful recovery could also have much to do with the ongoing
ageing of the population and the decline in the number of those in
their economic prime.
Deutsche Bank’s Jim Reid in From The Golden To The Greying
Is Japan The Canary In The Coalmine?

No recovery in long term
fertility, ever longer life
expectancy, declining trend
GDP growth, and ever higher
government debt. These are
all clearly long term
unsustainable. One day or
another “something” will
happen in Japan.
The Japan Problem Is Simply Not Sustainable

Time To Act – What Can Be Done?
Short Term:
- Continuing and Continuous Structural Reform
• Labour Market Reform
• Pension Reform
• Heath System Reform
• Immigration
Longer Term
• Raise Fertility Rates
• Global Rebalancing Initiatives
• Acceptance that the Modern Growth
Era – like modernity itself – doesn’t
last forever.

Edward Hugh: One of the standard pieces of
economic observation about countries
recovering from financial crises is that their
recoveries are export driven. But as you
starkly ask, at a time when the financial crisis
is generalized across all developed economies
“to which new planet are we all going to
export”? Many developing economies badly
need cheap and responsible credit lines, and
access to state-of-the-art technologies. Do
you think there is room for some sort of New
Marshall Plan initiative, to generate a win-win
dynamic for all of us?
Is Global Rebalancing Politically Realistic?
My Question To Paul Krugman

Paul Krugman: Um, no. Not realistically as a
political matter. We’ll be lucky if we can get
the surplus developing countries to spend on
themselves. My guess is that our best hope
for recovery lies in environmental investment:
taking on climate change could, in terms of the
macroeconomic impact, be the functional
equivalent of a major new technology.
And Krugman’s Response
So There We Have It – The Priority Is Climate Change
Thank You For Your Attention

Saying Goodbye To One Crisis and Hello To The Next

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