China's rise since the 1980s has brought an
era of low inflation and real interest rates; it also stimulated emerging
economies. This combination has resulted in high prices for equities, real
estate and commodities. The impact on personal income distribution has been
positive globally, but negative within most countries. In a highly acclaimed
book, Charles Goodhart and Manoj Pradhan announce the end of the golden age[1]. Changes in demography will reverse decades of trends: declining
growth in wages and inflation, falling interest rates, and greater inequality
between countries, while inequality is falling in many countries.
The main reason for this turning point is,
Goodhart and Pradhan claim, the end of the supply shock on global labour
markets, a product of mainly China´s demography cum globalisation. China's working age population is shrinking, its
old-age dependency ratio is rising. Globalisation is on the retreat (not least
as a result of the US policy of China's containment). As Martin Wolf aptly
points out, the prophecy of imminent inflation is less significant than the
book's analytical framework[2]
- at least beyond the financial markets.
Fig.
1: China's demography by age cohorts, 1950-2100
Their forecast is not that new. The far-reaching
and well written book by Goodhart and Pradhan is definitely to be recommended.
But neither are its theses "original" nor "surprising", as
the blurb suggests. In large parts, the thesis could have been written at the OECD Development Centre. Indeed, they
were. Several publications and lectures since 2005 bear testimony to this; they
have been dubbed ShiftingWealth [3] by the OECD in
English; the German equivalent was christened Weltneuvermessung [4].
Our core argument since 2005 was that the
integration of China and India into the world economy effectively doubled the potential
labour force to be integrated into the world market economy. China brought in
750 million people of working age, India 450, and if we add the former
"Eastern Bloc", the additional labour force amounted to 1.5 billion[5]. Real GDP growth clearly depends on the number of workers, either
through the skills they deploy or their ideas. A simple production function, in
which capital contributes one third of income (the rest is provided by low skilled
labour and know-how) translates the demographic shock into wage effects. Since
doubling the global labour supply halves the ratio of capital to labour, the
productivity of unskilled labour is reduced - by just over 16 per cent.
Equilibrium wages, which are clearing the labour market, fall by the same
percentage. Foreign trade theory and its central globalisation theorem (Stolper-Samuelson) predicted that lowering
the prices of wage-intensive goods would result in trimmed wages (for low
skilled work) and richer profits.
Meanwhile, China's labour reserve army
migrated from the hinterland, where employment is low-productive and mostly
seasonal, to the productive urban area. This migratory flow was supplemented by
those who had been laid off from unprofitable state enterprises. A dual labour
market model from the 1950s, which we owe to Nobel Prize winner Arthur Lewis, illustrated the
consequences: as long as the surplus of unproductive labour in rural areas had
not melted away, pressure on real wages remained[6]. This kept profits high in China's modern sector - an incentive to
reinvest there.
Fig. 2: Real wage index China 1979-2020
-
Median of weekly wages for
full-time employees -
Meanwhile, rural labour supply has largely
been redirected to the modern sector; in China, scarcity prices for labour are
again being paid, and wages are rising. This is not only imminent, as Goodhart
& Pradhan postulate, but has been happening for several years now (Fig. 2).
Fig.
3: Population trend in sub-Saharan Africa by age cohorts, 1950-2100
As for the future, it is not only China's
demography that will determine the global level of labour-intensive goods and
services, inflation and interest rates via subsistence wages of underemployed
people. Africa and South Asia are at the forefront here, but are largely ignored
by Goodhart and Pradhan. The United Nations predicts that Africa's working age
population (15-24; 25-64) will rapidly increase [7]to over one billion people by 2050; by 2100 it will probably be two
billion (Fig.3).
In South Asia (including Bangladesh, India,
Pakistan, etc.), the cohorts of the working age population will rise to about
1.6 trillion people by 2050 - only after that is a moderate decline predicted
(Fig.4). If we add up the UN forecasts for sub-Saharan Africa and South Asia,
the working-age population is expected to increase to more than 2.5 billion
people in 2050. While in China the working-age population (15-64) will shrink
by almost 200 million people between now and 2050, the working-age population
in Africa (500 million) and South Asia (400 million) will increase by a total
of almost one billion people.
So, the demographic reversal may not have
started after all.
Certainly, it is unlikely that the two
'young' regions will integrate into the global economic division of
labour as successfully as China has done since 1980. But the massive increase
in the job-seeking population in Africa and South Asia will overshadow the
comparatively small decline in China's working age cohort by 2050. Despite the
book's title, demography is a weak aspect of Goodhart and Pradhan's book.
Fig.
4: Population trend South Asia by age cohorts, 1950-2100
Goodhart and Pradhan expect real interest
rates to rise as a result of the demographic changes underway in the
industrialised countries and in China. Their macro and financial orientation
leads them astray when they explain the long fall in global real interest rates
with China's hitherto high propensity to save, the reinvestment of China's
supplier credits in US government bonds and the ageing of the population in
developed countries. Some of the arguments are reminiscent of the empirically
rejected Bernanke thesis that
international current account imbalances can be explained[8] by the Asian glut of savings.
In explaining high savings in the Asian
region, on the other hand,[9]
an observation developed by Amartya Sen (1990) has received
strong empirical support: the son
preference (measured as the son-girl ratio, the result of abortion of
female fetuses). For a sample of 22 countries, the OECD found[10] a strong finding: savings rates rose from 21% with a low level to
51% with a strong son preference. For China, where the sexes were and remain
particularly unequally distributed due to the one-child policy (son/girl 1.2), Shang-Jin Wei[11]demonstrated a close empirical connection between savings rate and
son preference in spatial and temporal dimensions. How will this gender effect,
ignored by Goodhart and Pradhan, affect the propensity to save and interest
rates in the future? So far, there is little evidence of the abandonment of
gender-selective abortion in China or India.
Another structural explanation for
persistently high savings rates[12]
is the high level of corporate savings in manufacturing due to
undervalued exchange rates. In the context of underdeveloped financial markets,
the internal financing of Asian companies is dominated by the retention of
profits or the creation of provisions. However, massive sustained appreciation
of the weighted external value of the currency can translate into lower
corporate savings, especially in emerging markets[13].
Conclusion: Will Goodhart and Prahan's
thesis be confirmed that changes in global demography will reverse decades-long
trends in interest rates, wages and inflation? Much will depend on how
successfully the young but poor subcontinents of South Asia and Africa can
integrate into the global economy. It cannot be ruled out that the effectively
effective global labour supply will continue to cap wages and prices for
labour-intensive goods and services. High savings rates, and thus low interest
rates, will continue to accompany us even if mass abortions of female fetuses
are carried out in Asia and companies there remain self-financed.
[1] Charles Goodhart & Monoj Pradhan (2020), The Great Demographic Reversal: Ageing
Societies, Waning Inequality, and an Inflation Revival, London: Pelgrave
Macmillan, August. The book has several predecessors that can be traced back to
2015 (with Pratyancha Pardeshi). Cf. with http://eprints.lse.ac.uk/66775/.
[2] Martin
Wolf (2020), Why
inflation could be on the way back, Financial Times, 17. November.
[3] Martin Grandes, Nicolas Pinaud & Helmut Reisen (2005), "Macroeconomic
Policies: New Issues of Interdependence", OECD Development Centre Working Papers No. 241, Januar. Helmut Reisen (2005), China's and India's Implications for the
World Economy, Basel University Lectures Series, erwähnt in Martin Wolf
(2006), Answer
to Asia's rise is not to retreat, Financial
Times, 14. März. Der term ShiftingWealth was established by OECD
(2010), Perspectives on Global Development 2010: Shifting Wealth,
Paris: OECD.
[4] Helmut Reisen (2008), "Die Neuvermessung
des Welt", Internationale Politik, July/August 2008.
[5] See
for example Helmut Reisen (2006), "Globalisation,
Proletariat and Precariat", Internationale
Politik, 1/2006.
[6] In order to eradicate rural poverty, China is now again pushing
migration from rural areas.
[7] In highly developed countries, the 25-64 age cohort represents the
working age population. In poor countries, this restriction would be
inadmissible because of the shorter period of education and the importance of
the informal sector. The 15-24 age cohort is therefore also relevant for labour
supply.
[8]
Menzie D. Chinn & Hiro Ito (2007), "Current
account balances, financial development and institutions: Assaying the world
"saving glut"", Journal
of International Money and Finance, Volume 26, Issue 4, June 2007, S. 546-569.
[9] Amartya Sen (1990), "More than 100 million women are missing",
The New York Review of Books, Vol. 37(20),
S. 61-66.
[10] OECD (2010), Perspectives on Global Development
2010: Shifting Wealth, Paris: OECD.
[11] Shang-Jin
Wei (2010), "The
mystery of Chinese savings", Voxeu.org,
6. Februar.
[12] Niall Ferguson & Moritz Schularick (2007), "'Chimerica'
and the Global Asset Market Boom", International
Finance, Vol. 10.3, S. 215-239.
[13] Marcus Kappler, Helmut Reisen, Moritz Schularick & Edouard
Turkisch (2012), "The Macroeconomic
Effects of Large Exchange Rate Appreciations", Open Economies Review, vol. 24, S. 471-494.
