The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival

by Charles Goodhart

Except that China’s savings were even larger—the financial repression encouraged high household savings, high enough to finance domestic investment and push national savings higher tha...

The capital that entered China was met by the PBoC in the foreign exchange markets through a massive sterilisation effort to prevent the Renminbi from appreciating. The PBoC purchased US dollars in the fo...

As a result of these purchases, China’s FX reserves grew dramatically, as mentioned earlier, to just below USD 4 trillion. These hard currency reserv...

Under the stewardship of the State Administration of Foreign Exchange, China’s official agency for managing reserves, hard currency reserves were invested almost entirely in the deep and liquid asset markets in the advanced economi...

Global capital thus flowed ‘uphill’, from China (and most of North Asia) to the advanced economies, helping create what the Federal Reserve’s ex-Chair Ben Bernanke termed the ‘global savings glut’. The excess of desired savings over desired investment in the AEs was driving the equilibrium real interest rate lower by itself, since the dependency ratio improved in the 1980s. ...

The US consumer, fabled for needing no encouragement to spend, got some help nevertheless. Falling interest rates raised the value of asset prices, including housing. The sharp decline in manufacturing employment in the 2000s, mentioned earlier, went largely unn...

The surge in consumption during the 2000s added fuel to the fire as imports grew strongly, and the bilateral current account balance between the USA and Chi...

Central banks misinterpreted these global, demographic trends for the success of their inflation targeting regimes which were introduced from 1990. The over-confidence of central banks in their ability to control inflation, volatility and financial stability contributed to the...

China’s greatest contribution to global growth and globalisation is past us. The current account surplus peaked in 2007 and it will now move into a deficit over time. Nominal GDP growth topped out in 2012 at around 18% and fell very sharply to just over 5% in 2015 before recovering somewhat. Investment growth and the property sector mirrored this fall but have remained in a much more subdued, post-crisis-type state since then. Its stock of hard currency reserves still stands at USD 3 trillion but could fall further as the current account moves into deficit territory.

China’s working age population has been shrinking (Diagram 2.5), a reflection of its rapidly ageing population. The internal migration that had provided a seemingly endless supply of labour to the industrial zones has reached the ‘Lewis turning point’, a point at which the surplus rural labour supply no longer provides a net economic benefit through migration (discussed further below).

On the capital side, China’s phase of rapid capital accumulation in the sectors that are connected to the global manufacturing supply chain has already drawn to a close.

The collapse in the manufacturing complex and the property sector back in 2014–2015 has been followed by consolidation and capacity cutting rather than in more capital accumulation.

Globally, China’s demographic reversal comes at a time when the social tide has turned against globalisation. That means global incentives are not aligned towards con...

With labour and capital flows both constrained, China has now turned to upgrading technology as a means of sustaining growth and compensating for the contracting supply of labour.

Without the influx of foreign firms and with the current intense scrutiny around the acquisition of technology by Chinese firms in foreign markets, the transfer of technology that was present in the past will no longer be in place.

Second, the starting point of China’s firms has improved to a point where reaching up towards the global standard no longer means a huge rise as it did in the past. Innovation thus has to be created at home, and of a magnitude that is quite large. That is the part that looks like a tall task.

The emphasis on innovation and technology will suit the already-educated urban population, but it will act against the ‘flying geese’ model, (a strategy to move investment to rural areas) that the administration hopes, or hoped, would materialise.

Innovation naturally requires highly educated and trained workers. That is the kind of labour that already resides in the developed, coastal regions of China, not the type of labour supply that is avai...

In theory, a global pool of educated workers could at least partially offset some of the risks we have mentioned here. However, since every major manufacturing economy among the AEs and EMEs is going through a similar demographic transition, the global demand for such skilled labour is likely to intensify.

Within China itself, the educated labour force already resides on the coast, close to the production hubs, and in the urban areas.

More specifically, it would export to other economies the prospective excess capacity created by the lack of economically viable demand for infrastructure within China.

That initiative has been heavily backed not just by China but also by many of the countries through which the project passes.

More recently, serious questions have been raised about the profitability and financing of this ambitious plan. In a world where growth has been meagre, we doubt there will be enough activity t...

China’s ability to create growth for itself from this venture is,...

Could the capital account lead to a change in the direction of the current account? Should the capital account move into a persistent deficit, then the curren...

However, it is not clear what direction the capital account will take. On the one hand, China’s households hold too much of their wealth at home and have been trying to hold more foreign assets. At the same time, the flows associated with the investments in...

On the other hand, opening up the financial sector and access to China’s financial markets will provide incentives to global investors to allocate funds to China’s assets. How ...

Agarwal et al. (2019) argue that just 10% of China’s bank deposits moving to buy foreign assets would mean USD 2 trillion of funds flowing to markets offshore. The history of capital account liberalisation, however, shows that freeing up household flows is the least predictable and hardest to control part of capital flows. As a result, such a...

There are questions around the viability and financing of the Belt and Road Initiative and the speed with which it can be implemented. As we have stated earlier, the return on China’s assets has been modest and uncertain, which means that the willingness to invest heavily in China will be dampened. The direction o...

The role of the private sector has increased dramatically. Over the last ten years, the private sector contributed for over 60% of GDP, over 70% of tax revenue, over 80% of innovations, and over 90% of employment.

Contrary to popular perception, consumption growth and the services that cater to consumption are already leading the next leg of China’s structural slowdown, taking over after a huge adjustment in the role of investment in the economy.

On the investment side, the beleaguered manufacturing and property sectors will focus on raising productivity and show the kind of discipline that most post-crisis survivors do.

China’s corporate debt carries a much lower risk of default than many believe, but its resolution does not bode well for t...

In both Japan and China, the labour market is incapable of acting as a shock absorber—because of long-standing cultural norms in Japan and because of social-stability reasons in China.

demography and globalisation,

the macro-economic balance between savings and investment,

purely monetary p...

A more complex argument depends on how different sectors of the economy (households, corporates and the government) change their savings and investment behaviour in response to ageing.

If we are right in our political economy assumption that the social safety net will remain in place, then the age profile of consumption will continue to be flat or even upward sloping. The elderly will depend on (and vote for) government support and continue to save too little for the longer life they have inherited. The ineluctable conclusion is that tax rates on workers will have to rise markedly in order to generate transfers from workers to the elderly.

Boomers vs Milennials!!

Workers, however, would not be helpless bystanders. Labour scarcity in AEs (and some EMEs) will put them in a stronger bargaining position, reversing decades of stagnation in AEs. They will use that position to bargain for higher wages. This is a recipe for recrudescence of inflationary pressures.

The re-birth of inflation is our highest conviction view among the effects of demographics, and it is one that both financial markets and policy-makers are dismissing at their own peril. But what is the logic behind this deeply counter-conventional inference?

In order to make hiring workers profitable, employers must plan to pay them less than the expected value of their production. Unless workers dissave from their past accumulated wealth, workers’ compensation is necessarily less than their production. This is a deflationary impulse. Dependents who do not work, on the other hand, consume and do not produce. Dependents are inflationary.

Normally inflation is treated as a monetary phenomenon. Given the expansionary monetary policies in recent decades, trying to explain current disinflationary pressures in this way would be a struggle.1

Of course, there is also the return to capital, profits. But again, relatively more workers will tend to raise profits. As consumption out of profits is less than consumption out of wages, see, e.g. Kalecki (1954), an improvement in participation rates is deflationary.

The intuition behind this result is simple. An increase in consumption by itself creates an inflationary impulse for a given basket of goods and services. The act of production has the ability to expand the stock of goods and services for a given level of consumption and is therefore disinflationary. Dependents (the young and the old) are purely consumers and hence generate an inflationary impulse, whereas workers can offset this inflationary impulse through production.

Wage growth has shown a surprising tendency to remain low despite a sharp reduction in unemployment, which we discuss at much greater length in Chapter 8. Suffice it to state here that we believe that this has largely derived from a falling Natural Rate of Unemployment (NRU).

combined effect of a cutback in globalisation, opposition to immigration, and the decline of new young entrants into the workforce, will lead to a shrinking of the labour force in demographically challenged countries. As this happens, the bargaining power of labour in such countries will rise again. The continuing downwards shifts both in the NRU and in the size and power of private sector trade unions will first stabilise and then start to reverse.

The NRU will once again start to rise invisibly behind the scenes. As usual, this will catch the authorities unawares. From the 1950s to 1970s, politicians and officialdom failed to appreciate that the NRU (or U*) was steadily rising, ushering in decades of rising inflationary pressures. From the late 1980s until very recently, they similarly failed to appreciate the reverse trends, leading to decades of deflationary pressure.

We think it more than likely that, once again, the authorities will fail to see the underlying (demographic) trends and will attempt to keep growth up above, and unemploymen...

Ben Bernanke (2005) famously attributed the declining real rate of interest from the 1990s onwards to a ‘savings glut’. This was down to two drivers: first, baby boomers saving for their future retirement and, second, by the ageing, but increasingly prosperous workers in Asia (especially in China) saving for their old age due to an inadequate social safety net. The result was that household savings ratios were high.