It’s demographics, stupid
Category: Thought for the day
From China to Japan, Russia to Britain, there is one underlying force economists can do nothing about. It is in the news again. In China it is set to create the single biggest economic challenge for the country since it tried to pick-up the pieces from the Cultural Revolution. In Japan we are now entering phase 2. In the UK, it is just beginning to bite.
I used to talk about China entering the Lewis Turning Point a lot in this column. I used to say this will be the single most important economic development of the next decade. But I am not sure I mentioned it once last year. That isn’t because it’s gone away, rather it’s bubbling below the surface.
The Lewis Turning point is named after the former winner of the Nobel Memorial Prize in Economics, Sir William Arthur Lewis. It is supposed to describe that moment in a country’s development when it runs out of workers to migrate from the countryside to the city. Consider this statement, taken from an IMF report published last month: “The growth rate of the core 20-39 subpopulation [of China)… shrank to zero in 2010. By 2035 it is projected that the proportion of China’s population aged between 0 and 14 or over 65 will be 50 per cent.”
The IMF paper concluded that China will pass the Lewis Turning point between 2020 and 2025. Okay 2025 still seems like a long way off, but as that date approaches, the effects of China’s demographic switch will become more obvious.
Let me say, before I move on from China, that this does not have to be a disaster. If as a result of China’s population changes, we see average wages rise that is a good thing. Maybe we put too much emphasis on GDP, and not enough on GDP per capita.
For more on China’s ageing population, See this IMF working paper: Chronicle of a Decline Foretold: Has China Reached the Lewis Turning Point?
Then again, to guess what the future has in store for China look at Japan today. I think economists under-rate the economic effects of Japan’s ageing population. As Japan’s population shrinks, and as the proportion of those of working age falls too, the massive level of government debt will start to look very worrisome.
There is another problem, however. In Japan the household savings ratio has fallen dramatically in recent years. A few years ago a credible case could be made for saying that Japan’s government debt was affordable because it was largely funded internally by Japanese saving. Today, while corporate savings remain high, Japan’s savings ratio is under 3 per cent. In Q2 last year the UK savings ratio was 6.6 per cent.
To me, the explanation of Japan’s falling savings ratio seems simple. The high proportion of the country that are retired are now drawing down savings.
Two decades ago, the story was different. At that point the threat was the ageing of the workforce. Japan’s population worried about how they were going to fund their retirement and saved more. This was a main factor behind Japan’s growth slowing to a crawl and may have been the key reason why Japanese asset prices crashed and interest rates fell to near zero. Ironically, as Japan’s ageing population saved more, the effect was to make their savings worth less. On the other hand, another effect was for inflation to fall, and mutate into deflation. While that may have been bad news for the Japanese economy, for its ageing population it was a positive development.
But I do worry about the implications of Japan’s falling savings. Projections suggest that Japan’s savings ratio will go negative in a few years’ time. So consider this scenario: it is 2023. Never before in history has a country seen such a high proportion of its population retired. Its pensioners are drawing down savings, such that aggregate demand exceeds Japan’s output. At this point, I think inflation will become a danger for Japan.
I have said here many times that I am cynical about QE leading to inflation, because demographic factors are working in the other direction. In any case, the more central banks push down interest rates, the more baby boomers think they need to save. For that reason, despite government borrowing and one round of QE after another, over the last 20 years Japan has suffered from deflation not inflation.
For a similar reason I think QE is not likely to lead to lead to dangerous levels of inflation in the West. The picture is complicated by global pressures pushing up food and energy prices, but despite all that talk about QE being little more than a Faustian pact that will lead to hyperinflation, I think inflation will remain modest for some time.
The inflation picture further out is less rosy, however. When all those workers making up the baby boomer generation who are currently saving for retirement, finally retire they will draw down savings. At this time inflation may rise sharply, interest rates shoot up, and house prices come under massive pressure. That is the point when we may pay the price of today’s monetary policy.
These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees