Demographics and the Anatomy of International Capital Flows

After a week where the deck of cards that make up the Eurozone got its so far largest jolt and where there is now not only an imminent danger of a total economic collapse in Greece but also, much more worryingly, signs that Germany herself are beginning to tire of a common monetary union I thought it would be nice to take a longer term and structural perspective on the global economy. And what better way to do this than to dig into the world of academia.

As some of you may know I recently earned my degree from the Copenhagen Business School and on that occasion I also produced a thesis which I’d like to share here.

This thesis is built upon two core arguments. The first is the notion that the demographic transition should be narrated through the perspective of ageing rather than population growth and the second is that ageing on a macroeconomic level represents a strong driver of international capital flows. These two arguments are used to discuss the standard prediction in a life cycle framework that ageing leads to dissaving in the aggregate and thus how old economies should tend towards running current account deficits. Using Japan and Germany as the subjects of analysis, this thesis develops the idea that rapidly ageing societies are not, in the main, characterized by dissaving but rather by the fight against it. Finally, a small empirical exercise acts as a perspectivation on the results to suggest why ageing might lead to a reliance on exports and foreign asset income to achieve growth and what this means in a global context.

In many ways, the ideas, thoughts and arguments that have gone into this work are shaped by the discussions and the activity here at this space and my interaction with the people I have come to know through my online presence. In this way, it is only apt that I present it here I think.

I believe that works such as this (and any other academic/economic piece of research) should be judged on two separate accounts. One is its contribution to the methodology, discourse and lingo of its specific academic field which in my case is international macroeconomics and the second is on its contribution to the more market and policy oriented aspect of its topical sphere which in this case is the international economy and in particular global current account imbalances. I believe my thesis has something to offer on both accounts.

On the first, I will immediately disappoint the purists in announcing that my thesis does not develop a new model although I believe there are clear pathways from the arguments for anyone who likes to tinker with neo-classical modelling. In stead, I think there are two important points that I would like to emphasize as future reference and working points for my academic colleagues.

The first is that economists need a much more broad and dynamic theory of demographic changes than is the original idea of a demographic transition. In my thesis I present this through an attempted coup de grace of the notion that demographic changes should be seen through the perspective of population growth. As an alternative I propose a focus on population ageing. In itself this is not controversial and is already an inbuilt narrative in many (if not most) macroeconomic studies that deal with demographic change [1]. However, my aim here is more fundamental. What I consequently want to establish is the simple fact that the demographic transition is not over and not only that, it is non-linear and path dependent. Once we realize this, it opens up a whole new area of research in which macroeconomics is fused with anthropology and life course theory (sociology) in a way which I believe is crucial in order to truly understand what the macroeconomy, as we tend to call it, actually is.

Second, I raise and discuss the issue of dissaving as a function of old age. Specifically, I imply (although I do not show formally) that what may appear obvious on the microeconomic level may not be so obvious on the macroeconomic level. In other words, there is a an aggregation problem [2] here and it is exactly tied to the fact that while dissaving may seem imminently rational and inevitable in a microeconomic perspective it is not all obvious to me why societies as a whole should want to dissave in the context of persistently low fertility rates and rapid population ageing. Realizing that dissaving will at some point be a binding constraint for e.g. an economy such as a Japan in which ageing simply continues relentlessly, I develop the idea that rapidly ageing societies are not, in the main, characterized by dissaving but rather by the fight against it which has come to represent the key proposition of my thesis. I show this in relation to Germany and Japan as the two oldest economies in the world and try to build frame of reference on which to examine and judge other economies who will inevitably move in the same direction as these two economies.

Finally, and on the second overall account it is with no hesitation whatsoever that I claim how my thesis goes a long way to frame the Gordian knot currently facing the global economy as it exits its worst recession since the great depression. In short, if ageing economies find it difficult to create growth based on domestic demand and momentum and if they are reluctant to rapidly dissave into a very uncertain future where they would rely on foreign credit, the logical consequence is that they must be dependent on exports to grow. Now, the onset and path of this export dependency may vary from country to country, but in a world where all economies are ageing and where, worryingly, a large host of economies are converging to very low levels of fertility, it creates an obvious and practical problem. Who is going to run the deficits to match the desired level of savings of all these ageing economies?

Naturally, not everybody can export at the same time but just take a look at the discussions currently characterising the global economy. Everyone who is claiming a recovery is claiming one on the basis of growth in external demand, but this obviously cannot be true. So, you get the trade wars between China and the US, you get internal squabbles in the Eurozone over whether Germany should sacrifice its competitiveness and just how Greece, Spain etc are suppose to pay down their debt while seeing some form of growth at the same time. All this is about a lot of economies feeling the real and future pressure of deleveraging while only a few brave souls dare to proclaim that they seek growth through domestic sources. Something has to give and one obvious result will be lower trend growth quite simply because there will be lower accumulation of debt either because the capacity to pay off debt has shrunk or because the current level of liabilities disallows any further rapid debt accumulation. However, another consequence will also be an externality represented this higher level of desired external savings present in so many economies at the same time and behind it all, as a the underlying current, I believe is demographic change and how it affects the working of modern capitalist systems.

So, am I going for an early catch of the nobel here?

Hardly and thus the thoughts above represent my attempt to take the conclusions of my work as far as possible (and possibly way too far) on an overall conceptual level. Consequently, if you care to leaf through the thing, you will see lots of concrete empirically rooted points and arguments which are more down to earth than the barrage you have just worked your way through above.

In the end and because of my desire to continue my studies on a PhD level, I have (unconsciously I think) written my thesis with an open end and with many strings that can and should be picked up later. This is naturally what I hope to do in the future. For now, I invite you to have a look and by all means do not read it all, but you may just find some it interesting. Comments of all kinds are naturally welcome.

[1] – After all, it goes back to the idea of a life cycle and more formally the notion of overlapping generations which are two classic methodological concepts in macroeconomics.

[2] – Aggregation problems are not new of course and have haunted macroeconomic representative agent modelling for a long, long time. However, I think that the specific issue in the context of the life cycle in many ways represent the original sin in the context of aggregation problems (but I may be wrong here).

What is Saving?

I have been thinking a lot about the meaning of saving money. Which brings me to what I call the fundamental question of finance: How does forgoing consumption today translate to increased consumption in the future?

In thinking about this question I have identified six distinct answers to this question:

The dog: Place a bowl of food in front of a hungry dog and it will devour it without hesitation, lick the bowl clean and then look around for more. The dog’s world represents the very simplest economic system. What you have now is what you consume now. If there is plenty today the dog will eat itself sick. If there is no food tomorrow he will go hungry.

The squirrel: Before the first human walked the earth, animals such as squirrels discovered the first financial innovation. Just as the squirrel gathers nuts to get through the long winter, there are some goods that we can simply store and use in their current form. This is the simple and most obvious answer to the question listed above. For many people this is as far as they get when thinking about savings. However, money is not a can of beans. Simply storing money today does not automatically translate to purchasing power in the future.

The farmer: Around 10000 years ago humans discovered that seeds left in the ground would grow into new plants. Thus the birth of agriculture also represented the first investments. By not consuming some grain today, early farmers could ensure a reliable supply in the future. Many natural and living things allow this sort of simple investment. We now know that by not clear cutting a forest or fishing a species to extinction we can ensure an adequate supply for the future.

The builder: Some projects take a lot of time and effort before they yield any value. 10 people might have to work for half a year to build a house. Bigger projects like highways and dams can occupy hundreds or thousands of people for years. Of course all of those people need food, shelter and all the other necessities of life. Which brings us to the fourth answer to our big question. When I consume less then I produce, my surplus can sustain those who are working on larger projects. In exchange, I expect to receive some of the benefit of the completed project.

The parent: Over the course of ones life ones needs and abilities change. A new born infant is completely helpless to meet its basic needs. By providing for young children during their peak production years, the parent can count on their children to sustain them as they age. This familial relationship has been a cornerstone of nearly every society in human history. In modern societies this function is often aggregated, in that governments invests in education for children and pensions and medical care for the elderly. The logic is basically the same, individuals in their prime working years consume less then they produce, while the surplus goes to supporting children and the elderly.

The creator: The greatest achievements often require years of effort with only a small possibility of creating anything of value. Great works of literature, billion dollar corporations and medical breakthroughs all follow this pattern. An individual researcher may toil for 20 years with no tangible results before a discovery that creates millions of dollars of value. The artists, entrepreneurs, scientists and writers depend on the savings of the general population to support them in their efforts.

The financial sector is responsible for taking the excess production of today and using it to meet the needs of the future. Some goods can be stored for the future, but the vast majority of the production is services or perishable goods that cannot be stored. Forsaking consumption today does not guarantee that there will be plenty tomorrow.

Restart the bubble

An interesting statement buried in the comments to Steve Keen’s latest blog entry (which itself is worth reading as it discusses how neoclassical economics got us into this mess and how [if] it can be changed – as usual with the Keen blog, the comments are just as illuminating):

I have spoken to many whom I thought educated and found a pattern. Those in debt or those that stand to lose from asset deflation wants the bubble restarted.

… and those who didn’t get into debt, saved prudently and/or bought some gold, don’t want it restarted, I’d add. The observation is that the former are in the majority, but this doesn’t mean they will “win”. I think they are all waiting for someone else to start buying so they can offload their assets and get rid of their debt.

All this Government “help” going on at the moment is about restarting the bubble, which is another way of saying restoring consumer confidence, which is another way of saying let suck some other idiots in to boost up asset prices. The question is will it work, are people so desperate for the bubble to restart that they will believe and thus act, or is there just too much debt?

Before you answer that it is comeuppance time, consider this from February 1991 in “The case for gold in the 1990s” (see my blog of 7 Sep 2008):

The old remedy of inflating out of this predicament by issuing cheaper and cheaper money into the banking system simply will not work this time. The reason is simple – the country is already awash with too many debtors.

Well they got away with it then, maybe they will do it again. But maybe this time people are bit less trusting and a bit more exposed to alternative views via the internet.