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

by Charles Goodhart

But as the baby boomers retired, and the ratio of the old (individuals who were dissaving) to workers (who were saving) rose, the household saving ratio started declining.

In steady state, with the dependency ratio constant, the personal sector savings ratio would be a positive function of the rate of growth, since working savers would put more aside for their old age than dissaving retirees.

But dependency ratios are likely to worsen for decades to come and the growth rate of output to decline. Many of those who argue that personal sector savings will remain high enough to keep real interest rates and aggregate demand low (the secular stagnation camp) do so on the assumption that (i) the age of retirement will rise relative to the expected age of death, and/or (ii) that state benefits to the old will fall relative to the average income of workers. If either were to happen, the rate of increase of expenditure on the elderly would be less than the output generated by workers. Both are possible, but neither are likely, for social and political reasons.

Moving home is stressful; some measures place it almost on par with the stress of divorce. The old have generally paid off their mortgages and have no need to move, until and unless they become incapacitated and cannot look after themselves.

The frequency of housing moves therefore declines with age (see Diagrams 5.3 and 5.4). With the aged still living in houses that are becoming too big for them, the ratio of housing space to population is likely to rise. The result? Housing investment will not fall by as much as the decline in the working population.

Under-occupancy is identified as one of the key issues. Average household size has fallen from 2.48 in 1980 to 2.36 in 2018, largely because of the ageing population. If household size today were the same as in 1980, there would be 1.3m more dwellings available.

The rising age of marriage/family creation and particularly the increasing age of having children (Diagrams 5.5 and 5.6) are bound to affect the investment/savings balance for households. Note the increasing number of women having children in their forties. Back in the 1970s and 1980s, most people would marry in their early twenties, have had most of their children by age 35 and have expected their children to have left home by their late forties.

Nowadays, all those datings have shifted onwards by several years. We assume that young singles, below 30, tend to discount the probability of decades of aged retirement so much that they will not save adequately for it.

Our aging population has placed unsustainable pressure on government and employer-sponsored pension systems, leading to a growing trend for individuals to take responsibility for financing their own retirement. But savings have failed to keep pace with the decline in traditional pension plans, leading to the current retirement savings deficit.

Ever since the financial panic accompanying the GFC abated in 2009, conditions for the corporate sectors in most advanced economies have become extremely favourable. The share of corporate profits in national income over the years 2010–2017 has increased quite strongly in most countries, Italy being an exception, and has become much higher than during the years 1990–2005

During these same recent years, interest rates, both real and nominal, have declined sharply, and equity valuations have increased in a continuing bull market, except in Japan.

Under these circumstances, one might have expected that fixed investment would have increased strongly. Instead, however, investment ratios in western economies have remained stagnant, although the investment ratio in China has remained elevated (Diagram 5.8).

The result is that the non-financial corporate sectors in several advanced western economies have been in surplus in recent decades. The main exception is China, where investment has continued apace, largely financed by higher debt (Diagram 5.9).

So, a key question is what has caused such investment ratios to be so low, despite the otherwise favourable circumstances that have seemed to have held during recent years? There are several competing explanations, none of which are mutually exclusive, and all of which may have played some role in this. There are, perhaps, four main candidates as explanations. These are: 1. Growing corporate concentration and monopolisation; 2. Technology; 3. Managerial incentives; 4. Cheap labour.

1. Growing corporate monopolisation There is some evidence, mostly relating to the USA, that there has been an increasing degree of concentration and monopolisation in the corporate sector, see, for example, Autor et al. (2017, 2019), Covarrubias et al. (2019), Crouzet and Eberly (2019) and Philippon (2019). If so, then that would lead to higher profit margins, a greater share of profits in national income than otherwise, and lower investment.

2. Technology The leading sector currently comprises technological companies, who rely much more on human capital than on fixed capital in the form of steel, buildings, heavy machinery, etc. The development of software, for example, requires a lot of human skills and effort, but relatively little fixed investment. Insofar as technology is shifting the balance towards human capital and away from fixed investment, the ratio of expenditures on fixed capital to total revenues and output is likely to decline, possibly quite sharply.

3. Managerial incentives As will be discussed in much greater length in Chapters 11 and 12, the alignment of managerial incentives with those of shareholders enjoying limited liability is likely to lead to a focus by managers on maximising short-term equity values. This can be done most easily by buy-backs, i.e. using profits to increase leverage by substituting debt for equity; but short-term profitability can also be enhanced by cutting back on longer-term fixed investment and R&D. This line of argument has been stressed by Smithers in several books (see Smithers, 2009, 2013, 2019).

4. Labour has become cheap The combination of globalisation and the demographic sweet spot has led to an unprecedented jump in the available global supply of workers within the world trading system. Why invest in expensive equipment at home, in order to raise productivity, when one can increase output at lower cost b...

What the balance might be between these four explanations is not easy to discern, and we make no attempt to do so here. But we think that all these potential explanations have merit, perhaps particularly the final two, that managerial incentives have been, from the point of view of society as a whole, misaligned, and that investment in most western economies has been held down by the shift of production to China and Eastern Europe.

The trends of globalisation and of demography are now beginning to reverse. Populism and protectionism have become powerful political influences in the context of economies where real wages have stagnated over the last 30 years. Meanwhile, the demographic sweet spot, leading to a massive increase in the workforce and fall in dependency ratios, is on the verge of reversing sharply, as has already happened in Japan. This will have the effect of raising real wages in most western economies, and that is likely to lead businessmen to invest more per unit of labour in order to raise productivity and to hold down unit labour costs.

But insofar as the low investment ratio has been due to the short-termism of managers, owing to the incentive structure under which they operate, this particular...

On the other hand, rising unit labour costs, and the increasing relative bargaining power of labour, will curtail profitability, compared with the glory decades of 1980–2020, when globalisation, demography and easy money delivered a capitalist heaven. Those days are swiftly passing by, and the future for capitalist profitability will be becoming much harder earned.

Traditionally, and normally, the (non-financial) corporate sector has run deficits, with investment exceeding retained profits. Quite unusually, as demonstrated earlier in this section, this sector has in many countries moved into surplus. For the reasons set out above, we expect this to be a relatively short-lived feature, with such surpluses eroding, and, quite likely, returning to deficit in the coming decades.

The role of part-time, i.e. non-regular, employees grew as cost pressures increased. Their share in total employment rose from about 13% in 1990 to just under 30% by 2018. From the firm’s perspective, a fall in the ratio of insiders to outsiders was important very simply because ‘outsiders’ were not given long-term contracts which made their wages easier to suppress.

So strong was the incentive to change this ratio that even in periods when full-time employees were actually being laid off, employment growth for part-time employees remained positive and even rose.

In a nutshell, dimming prospects for growth required that firms reduce costs to protect themselves. The customs in the labour market, however, would not allow for a rapid, Western-type adjustment in whi...

Instead, firms employed a far more complex strategy that changed the structure of employment and forced wages and ho...

In a nutshell, almost nothing from Japan’s story is going to be applicable to most of the West as it ages.

First, the global backdrop over the next thirty years is going to be nothing like the last thirty. The world was swimming in labour thanks to the demographic tailwinds over the last thirty, but will struggle with the demographic headwinds over the next thirty.

Put simply, while Japan had a global escape valve while its local workforce was shrinking, these options simply will not be available as the entire g...

Second, Japan-style labour market customs are not applicable to the West. There are serious economic costs to layoffs in the euro area, for example, but no western economy face...

Third, participation rates have already been rising for the last twenty years in the advanced economies. Yet participation rates are well below Japan’s levels and will take some time before they come close. Participation in most advanced economies varies inversely with the generosity of the pension system.

Net migration has already turned. Inward immigration into the AEs and outward migration from the EMEs have receded.

With demographic headwinds intensifying, more migration is necessary, but this remains a politically charged issue. If the current political tension surrounding immigration persists, as we fully expect it to, importing labour to offset ageing of the local labour force is not a viable strategy.

Numerically, yes. Economically, highly unlikely. The demographic headwind in economies that are ageing very quickly could be offset to quite an extent numerically by demographic tailwinds in economies where the labour force is likely to grow for the next decade or more.

The world can access the abundant labour in these economies in two ways.

First, immigration from these economies into labour-deficient ones can directly offset the shrinking labour force there.

Second, if this more direct route of transferring labour between economies is unavailable, then capital can flow ...

These flows of capital can be combined with the local supply of labour in the labour-abundant economies to produce goods and services which, in turn, can be ...

First, it has an abundant supply of labour that will keep growing beyond 2050, a capital-labour ratio that desperately needs to be raised, and a level of human capital that can absorb new technologies much faster than its peers.

Second, capital is therefore likely to continue to flow to India as this contrast becomes even more clear. Given the extremely poor capital-labour ratio, any such accumulation of capital will be transformative.

Third, the inflow of new capital will bring with it the latest technology that is embedded in this capital. The incremental stock of capital will thus not only improve the capital-labour ratio, it will transform the quality of that interaction manifold. Anyone who has used India’...

Fourth, elections are increasingly being dictated by the ability or failure of incumbents to convince aspirational voters of a decent economic future. Prime Minister Modi has been voted in with an even stronger mandate, and many state el...

Finally, regulators are using technology to upgrade an overwhelme...

If all of that is true, then why has India’s growth suffered so much over 2018 and 2019?

Both India and China have gone through a significant slowdown over 2018–2019, and investors have attributed too much of that slowdown to political hubris and the trade war (respectively) and too little to the shock to the shadow banking sector.

India’s banking sector is going through a massive consolidation in its public sector banks and a clean-up of bad debts in the aftermath of aggressive lending by its non-ba...

While the constraints on lending are creating significant dislocations at the moment, cleaner banks are vital if India is to embark...

India’s new bankruptcy code (the IBC) is a vital ingredient for the present and the future. The IBC has already been applied to a large number of firms in the manufacturing sector and it is also being applied to delin...

We think India will beat China in global growth over the next decade, and perhaps even the one after that. However, it will not be able to lift world growth the way China did for three reasons: