Thank you for the explanations. It makes your posts a lot clearer for me.

Incidentally Nanne, this is a fair point. Since this debate is now moving along at a fairly rapid clip, and beoming something a bit more serious than a simple amicable dispute between bloggers, I think Claus and I do need to define our terms a bit better.

What we have is a hypothesis, and obviously there are rival hypotheses. You mention one, which is normally termed the global labour arbitrage theory.

Clearly nothing yet is irrefuteably demonstrated.

What Claus and I are drawing attention to are a number of interesting empirical correlates. We are not simply talking about Germany here. The situation in Japan is also now pretty clear, and it is becoming reasonably clear in Italy. Finland may be going the same way, and Switzerland could be another case. Now what all these countries have in common is their comparatively high median ages.

Switzerland is an interesting example since it is also becoming a source of the carry trade due to the low interest rate environment which is a by-product - as in the Japanese case - of the weak internal demand issue. What is the carry trade you may ask? Well see Claus or Brad Setser’s blogs for this, and I will try and post something here later in the week.

Now, what Claus and I do have is a theoretical model which offers a causal explanation, and then we have empirical backing in the data. This isn’t a bad start for a hypothesis I feel.

The global labour arbitrage hypothesis could handle most of the phenomena I have mentioned, but what I feel it cannot handle is why other countries (which just happen to have rather lower median ages) don’t experience the same effect. The reason why they don’t have the effect is essentially due to the fact that people are much more prepared to borrow in these societies - the US, the Uk, France, Ireland, Spain etc - yet they are exposed to exactly the same forces on global wages.

So until this theory can crack this particular nut I would say that Claus and I have it, but then I think at the end of the day this is for others to decide.

There is one last interesting detail for those of us pursuing the demographic hypothesis, which is the question as to just why we are getting the global labour arbitrage effect at this particular point in time. Basically this is to do with the rise of places like China and India. But why are these countries taking off economically at precisely this moment in time? A complete explanation of the process requires that this topic be addressed.

Well, of course, we do have some sort of explanation, since we would argue that these countries are precisely in this moment at the stage of the demographic transition where they start to feel the full impact of the demographic dividend.

This point isn’t accepted at all by, for example, the guys and gals over at the Economist (see last week’s issue), and that is why the debate which Claus and I are forwarding here in Europe is being mirrored by a similar debate which Nanubhai Desai and I are fielding out in India (go see the posts on the India Economy Blog, which are really causing something of a stir in India).

So if you want to apply something like Occam’s parsimony principle, then we could also argue we have some support in the simplicity and level of generality of the model.

Of course none of this means we are right. Here only time will tell.

Well this is an interesting point, obviously.

Firstly there is the interesting detail that Milton Friedman (now I know you don’t like him Alex, but just bear with this pragmatic point) modified Modigliani (who the perspicacious will realise was a Keynesian) by incorporating a bequest motive element, so this to some extent explains saving mania.

But there is another point here, relative generation size and relative wealth.

Now on the generation size, the think generations are the boomer ones, and they are just coming up to retirement, so they outsave everyone else really.

Secondly, each generation is richer than the one before it (or has been up to now, I need to be careful here I think), so obviously the 55 - 65 age group is saving of a rather bigger income base than the 75 - 85 generation may be dis-saving off.

So this is what we have at the present, but given that the younger generations are both going to be asked to do some forced saving (in the form of Vat and other taxes to pay for the old paygo systems) and be asked to save for themselves in the new pension schemes, one way or another a lot of saving is likely to be going on, and of course this is what we are seeing in the data.

So it isn’t exactly as if Claus and I are shooting arrows into the void here, we are providing an explanation for (or account of) the existing data. Plausible? That is for you to decide, but I’d like to here some alternative accounts to make a comparison of plausibility.

Incidentally Alex, your view is what everyone was imagining was going to happen. All the models through to 2050 incorporate this idea, and it may happen, but first we need to think about what happens between now and 2050, this was the point about Keynes’s in the long run we’re all dead bit, you need to thing abbout the short and middle runs to be able to get through to the long run.

Ok, this is important and obviously it is difficult to quantify totally. However, there is a fairly strong theoretial foundation to be found of this in Modigliani’s life cycle hypothesis on savings and consumption. In fact, life cycle theory which deals with income and saving decisions of individuals during their life time is the key theoretical instrument here. Basically it stipulates as Cyrus emphasises that elderly people tend to save more than in their younger years.

So what I am in fact arguing is indeed a bit like Cyrus is describing it. However, I don’t think Edward and I are fundamentalists and there might be a lot of other reasons as to why people tend to (all things equal) save more or perhaps even to save ‘excessively’ from a macroeconomic perspective. What you say about Germany and wage moderation might indeed be an explanation as well. But we also need to think about how consumption is financed these days and debt is an important issue here and since modern capital markets (with great differences though) allow people to consume on debt in the ‘young’ years we might expect some volatility in the life cycle behavior with a more heavy relative bias towards saving as a country ages.

Another thing about ageing and its impact countrywide and indeed globally from a life-cycle perspective is that this in fact is a global phenomenon and crucially that no-one knows how far this can go. This of course brings us right smack into Alex’ point and I think this indeed will become an issue at some point but as always it is the path up until this point which is important and it is here that we argue (Edward and I that is) that the life-cycle component of saving and consumption is important.

What I’m missing in your and Edward Hugh’s analysis is the causal link. Why exactly would an ageing population have a higher marginal propensity to save and a lower marginal propensity to consume? As far as I can see, the low consumption rate of the German economy might more plausibly be caused by the long period of rather extreme wage moderation (people didn’t get more money, so they didn’t spend more), with an added contribution of economic uncertainty caused by the (until very recently) high unemployment rate and increased volatility on the labour market. I haven’t investigated the problem at great length, so perhaps you could explain if and why these don’t suffice as an explanation.

I don’t think I ever said that tax hikes were necessarily good for the economy neither in general nor in the specific case of Germany. However, as you say yourself tax hikes can be a necessary evil and in Germany’s case this is where we are at I am afraid. As I point to there are two imminent reasons; the first is that Germany needs to abide to the fiscal demands of monetary union and secondly the sustained process of ageing is putting the German government budget under strain. In this sense you can do a number of things and one of the things is to impose tax hikes in order to finance the increased cost burden as a result of the increasing old age dependancy ratios.

‘Do you really think deflation is a remote possibility… certainly not with these tax rates.. stalling of the economy is much more likely’

I am not sure I agree here, at least not in principle. The point is that the domestic economy migth very well as you say stall as a result of the continuing downtrend of consumer spending and as such the domestic economy could come under deflationary pressures. So why is this a problem? Well, currently the CPI rate in Germany is running along at around 1.7% but the ECB is still vigilant mind you and if I am right in terms of the effects of fiscal tightening where is the floor at this point. Oil prices are of course volatile and will probably go up again but they are also falling at the moment so I am just pointing to the underlying dynamics here which all imho point to a downtrend in inflation rather than an increase.

I don’t think I ever said that tax hikes were necessarily good for the economy neither in general nor in the specific case of Germany. However, as you say yourself tax hikes can be a necessary evil and in Germany’s case this is where we are at I am afraid. As I point to there are two imminent reasons; the first is that Germany needs to abide to the fiscal demands of monetary union and secondly the sustained process of ageing is putting the German government budget under strain. In this sense you can do a number of things and one of the things is to impose tax hikes in order to finance the increased cost burden as a result of the increasing old age dependancy ratios.

‘Do you really think deflation is a remote possibility… certainly not with these tax rates.. stalling of the economy is much more likely’

I am not sure I agree here, at least not in principle. The point is that the domestic economy migth very well as you say stall as a result of the continuing downtrend of consumer spending and as such the domestic economy could come under deflationary pressures. So why is this a problem? Well, currently the CPI rate in Germany is running along at around 1.7% but the ECB is still vigilant mind you and if I am right in terms of the effects of fiscal tightening where is the floor at this point. Oil prices are of course volatile and will probably go up again but they are also falling at the moment so I am just pointing to the underlying dynamics here which all imho point to a downtrend in inflation rather than an increase.

That the German economy was able to absorb the, by any standard, does indeed show the resiliance of that economy…. but the argument cannot be used to say that high tax rates are good for the economy, quite the reverse.

Do you really think deflation is a remote possibility… certainly not with these tax rates.. stalling of the economy is much more likely.

I cannot trust any notion that proposes high tax rates are a good thing - perhaps a necessary evil for a short time, but do not ever suggest that this is or ever should be the normal state of affairs - high taxes, in all quarters are ruinous, and only belong in decrepit socialist states that cannot manage their economy.