The Great Demographic Reversal

I have just read the introductory chapters to a book by Charles Goodhart and Manoj Pradhan called The Great Demographic Reversal and listened to a couple of interviews with them that are available online.

They warn that the future will not be like the past. Instead, they claim that the period between 1990 and 2018 was unique and the favourable economic conditions during that time will not occur again.

Sweet Spot
The following factors made the last three decades a sweet spot for the advanced economies of the world.

• Globalisation of the world economy due to improved communications and container shipping allowed industrial production to be moved from high wage countries to low wage countries.

• The rise of China caused a massive increase in the workforce available for economic production. Working Age Population available increased by 600 million.

• The reintegration of Eastern Europe also increased the workforce available. Additional Working Age Population of 200 million.

• The effective labour supply effectively doubled over the 27 years between 1991 and 2018, putting downward pressure on wages.

• Declining membership of trade unions also put downward pressure on wages.

• Prices of consumer goods declined due to cheap imports from China, etc. This enabled people to cope with the decline in their real wages.

• Low birth rates in the West and women returning to the workforce reduced dependency rates.

These changes had several important consequences.

• Deflationary pressure allowed Central Banks to keep interest rates very low, which produced booms in assets like housing and shares.

• Low interest rates made it easy for governments to borrow.

• Declining real wages and increased asset prices have increased inequality.

Turning Sour
The conditions that created the economic sweet spot are disappearing.

• Wages in China are increasing as the shift in population from rural to urban areas slows down. China is becoming a middle-class economy, so is no longer a low-wage producers.

• Declining birth rates in many parts of the western world are reducing the Working Age Population in many countries. This will put upward pressure on wages.

• Extended life expectancy means there are more retired people to support.

• Dementia is increasing the costs of caring for the elderly. This will create fiscal problems for governments who cover most health care costs.

• Globalisation is retreating due to economic sanctions and increased political nationalism. This will increase the costs of production.

• Declining Working Age Population will result in declining output, unless productivity surges.

• A shift to an inflationary bias as the bargaining power of workers increases.

• Interest rates will rise because the elderly are dissaving and the corporate sector is investing in capital equipment to compensate for labour shortages.

Central banks will be unable to keep interest rates as low as they have in the past.

• If Central Banks push up interest rates to control inflation, economic recessions will occur.

• High debt ratios in the public and private sectors will constrain monetary policy, as rising interest rates will create unexpected financial pressure for debtors.

• Quantitative Easing has shortened the duration/term of public debt, so rising interest rates will create fiscal problems for governments trying to pay the interest on their debt.

If these authors are correct, the world economy now faces head winds that it has not encountered during the last few decades. They show an interesting graph of the ratio of Federal Debt to GDP produced by the US Congressional Budget Office. The impacts of COVID and Aging Population are more permanent that the effects of war. This is just one of the challenges the authors highlight.