Garden Of The Forking Paths?

“Global imbalances matter” seems to be the favoured warcry over at Brad Setser’s blog these days (I’m not sure anyone really disagrees with the idea that they matter, all the arguing seems to be about how much and why). Recently however Brad seems to be drawing support from a rather unexpected quarter: “one part of the Economist” (well, one part is definitely better than none), the part which believes that despite what happened in 2005, 2006 will be the year of the “great dollar decline”: And why would this be? Because, of course, global imbalances do (here read the US CA deficit), in fact, matter.

Now there is another view available on this.

However this issue is more interesting, since the part of the Economist which believes that the US CA deficit will prove decisive in 2006, also seems to believe that global ageing isn’t in fact a terribly important phenomenon (and here).

The Economist seems to take the view – as Claus Vistesen puts it – that “Rich countries’ populations are shrinking … not to worry though“?

In fact Claus seems much nearer the mark than the part of the Economist which seems to be arguing that ageing doesn’t matter too much when he says:

I agree with the zest of their arguments, namely that the new realities mean that there will be fewer people in the workforce to support more old people in the future. In a global perpspective I also believe that the world would benefit from having fewer people on the whole. However, the point that escapes The Economist in the midst of their optimism is that some countries will have a hell of a lot more difficulties adapting than others, and as such these demographic trends might have a real negative effect, at least some places in the world.

Yes, I would say that this is just the point that escapes the ‘ageing doesn’t matter so much’ part of the Economist, who seem to believe that population meltdown in Japan wouldn’t be a problem since “the last Japanese will (only) die as soon as 2800.” (Actually the article on Japan is near to scandalous, since it only focuses on the legal minimum pensionable age, and misses entirely the important point that most Japanese already continue working after 65, and even by the age of 75 25% of the population are still working).

I have already posted extensively on the population turning point in Japan (and here). So now I would simply make two points. Firstly it is the age structure of the population which matters, not its size, and secondly, it is curious how all those people who seem to want to argue that the US current account deficit is the most important determinant of today’s global economy also feel themselves impelled to downplay (if not actually try to ridicule) the idea that changing global demography (from Bolivia, to Vietnam, to Turkey, to China, to France, to Germany, to Japan) has any important role to play in helping us understand current economic phenomena. I think there is a choice here: two world-views are colliding, and the paths are forking.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

6 thoughts on “Garden Of The Forking Paths?

  1. Nice exposition of your point of view; not sure my part of the economist is the same part of the economist as your part of the economist though.

    And do explain to me once again why demographics explains why Saudi Arabia (quite young) is financing the US, or why China went from not financing the US in 2000 to the United States most important source of financing in 2005? The relative demographics did not change that much. And why China’s demographics trump other factors thought to determine capital flows?

    I think the demographics v. current account dictonomy is a bit too sharp. the US is the “youngest” of the advanced, no longer so industrialized economies. But the advanced economies aren’t financing the US — the much younger (setting Russia aside) emerging economies are.

    If demographics explain the capital flow from western europe to the east (rather than say a low capital to labor ratio and profitable investment opportunities), why are countries as demographically different as Bulgaria and Turkey both running big current account deficits?

    Demographics are one factor, but they still don’t seem to me to be the driving factor for current capital flow patterns. Am sure the debate will continue.

  2. Hello there Brad,

    “I think the demographics v. current account dictonomy is a bit too sharp.”

    Well maybe. What I’m drawing attention to is that there do seem to be two camps, and those who tend to say the US current account deficit is fundamental don’t seem to give too much importance to the demographics (I hope I am being fair), while those who think the demographic changes are strong and significant tend to expect to see some of these CA phenomena (I’ve been citing lots of papers over at your blog and elsewhere to this effect).

    “And do explain to me once again why demographics explains why Saudi Arabia (quite young) is financing the US”

    Actually I don’t think I’ve even told you once so far (although I do agree you keep asking 🙂 ). I don’t think this is so hard to understand within what you call my theoretical construct. SA is as you say, a pretty young country. Indeeed, if you look at this chart here, you will see that with a TFR of 4.5, it falls somewhere in this group of countries:

    Sao Tome and Principe, Djibouti, Gabon, Ghana, Guatemala, Saudi Arabia, Cambodia, Bhutan, Haiti, Pakistan, Laos, Kenya, Central African Republic, Cameroon, Iraq, Senegal, Sudan, Madagascar, Comoros etc.

    And if you look at the median age (21.28) it is somewhere in the middle of this list:

    Ecuador,Libya, Jordan, Uzbekistan, Philippines, Bangladesh, El Salvador,Turkmenistan, Bolivia, Saudi Arabia, Grenada, Paraguay, Papua New Guinea, Nicaragua, Ghana, East, Timor, Syria, Bhutan, Lesotho, Nepal, Congo, Cambodia, Namibia, Tajikistan, Pakistan, Iraq

    Now what sets Saudi Arabia apart from most of the countries in these lists (with Iraq potentially as the other main exception) is the level of oil wealth that they can accumulate. But in other terms they are very similar. Emmancipation of women is low (otherwise there wouldn’t be so many children), education of women is also low (ditto), they are not politically stable, and there is no sign of a normal economic development process taking off anytime soon.

    In another context, over at Indian Economy Blog, I upturned Sebastian Mallaby as follows:

    “Education may or may not spark development, depending on whether economic conditions favor it, but development certainly can spark an educational takeoff.”

    I think Sebastian has the causal arrow the wrong way here. I think this should read:

    “Education may or may not spark development, depending on whether DEMOGRAPHIC conditions favor it, but education certainly can spark a DEMOGRAPHIC takeoff.”

    I’d like one, just one example of where mere economic policy provoked development absent the demographic transition. Just one will do.

    This I think is the point. There is no possibility of SA (or Iraq) going off on a normal path of economic development until the demographic transition really takes off, and in the meantime – in the absence of ‘investment opportunities’ – resource rich countries will accumulate reserves they can’t spend, even though part of the population remain horribly poor.

    I have written up Bo Malmberg’s schematisation of all this here. I am being accused of being a demographic determinist, but I think this misses the point: I think here you need a concept of circular causality, non-linear self-reinforcing processes (of the sort economic theory normally bucks at trying to model) and something like Luhmann’s system-theoretic concept of “embedding” (more to come on all of this one day soon I’m afraid).

    “or why China went from not financing the US in 2000 to the United States most important source of financing in 2005?”

    This is much easier, if you follow the thread of the demographic dividend argument, China took off, that’s what happened: all non-linear processes have tipping points of some kind or another. Of course later there will be another one, and China may become a deficit country by 2020, just like the US: who knows?

    “If demographics explain the capital flow from western europe to the east (rather than say a low capital to labor ratio and profitable investment opportunities), why are countries as demographically different as Bulgaria and Turkey both running big current account deficits?”

    First of all, I wouldn’t run all this mechanistically. Obviously currency values matter. If the US currency value could fall, obviously the deficit would correct. It can’t fall, since it is the reserve currency, and the weak euro and yen won’t let it, and to understand the weak euro and the weak yen you need to understand something about demographics, that is my argument.

    Turkey is a pretty central, demographic-dividend case. Bulgaria is a huge outlier, and I would rather you got onto Jeffrey Sachs about this, since he seems to be responsible for the Bulgarian peg with the euro, and as you know from our debates about Argentina, I am strongly anti pegs (including in the case of China, although I feel the Chinese one needs to be relaxed gently due to possible serious global impacts).

    Turkey, as I say, is a much clearer, and more interesting example, as a country in the early stages of the take-off runs a deficit, only subsequently to run a surplus, look at Japan or the tigers here.

    Well, I guess I’ve said enough for now. As you say: the debate will continue.

  3. Incidentally Brad, as I’ve just indicated in comments on your blog, maybe here I am missing the point about Saudi Arabia etc. Maybe you are not asking why there isn’t enough investment taking place inside SA, which is what I’ve been trying to answer, but the much easier question as to why they have a surplus.

    As you yourself indicate, this is to do with global demand for and supply of oil. Since China, India etc are taking off, and the OECD countries haven’t yet adjusted their consumption patterns (and diversified sufficiently their sources) the price goes up. With a high price, underdeveloped, resource-rich countries run surpluses. I don’t think we need PhDs in economics to see that.

    If Germany, Japan etc were investing more to meet more resilient internal demand, more of these surpluses would be soaked up there.

    The other alternative would be for the global economy to grow more slowly, and India and China not develop so fast, but I personally regard this way of doing it as a greater evil.

    In any event, I find it hard to tie-in the Saudi oil surplus with the US fiscal deficit. I am struggling with this one.

  4. Hello Edward and Brad,

    I find that your discussion of the nexus between demographics and CA phenomena mirrors, at the macro level, my own current fascination with the microeconomic dynamics of wealth vis-à-vis income. The link to age demographics of course is that an older person, having accumulated wealth, wishes to turn that wealth into income (interest) whereas a younger person provides income in exhange for capital.

    I find that at the macro level, the distinction between wealth and income is quite fuzzy. This confusion may well have something to do with “dark mattter” (which I know you are currently looking into, Brad).

    Anyway, although I personally obviously cannot add to your insights on demographics (Edward) and CA dynamics (Brad), I have found Antal Fekete’s views on interest to be quite stimulating. Although I know that Fekete is regarded as a monetary crank (even by other “monetary cranks”), and is considered a pariah even by Austrian economists (not exactly mainstream), I believe his micro ideas can shed light on these macro puzzles.

    I also know that deducing macro phenomena from micro principles is akin to extrapolating natural selection from quantum physics, but I would like to give the pointer to Fekete to you guys anyway.

    P.S. Brad, I’ve posted comments on your blog before as José (about Spain’s trade deficit).

    Edward, nice to make your acquaintance, and BTW Osasuna failed to win for the first time this season at its home pitch, at its first match after the stadium’s name change to “Reyno de Navarra” . How’s that for an omen for the autonomy debate in Spain?

  5. SA GDP is very dependent on the oil price and that price is much higher than expected. It takes about a minimum of two years to decide/plan to invest money so the fact that they now have a surplus is not surprising. They would have run a deficit without the uhnexpected oilprice explosion.

  6. Edward,

    Here is a snippet from Fekete’s exposition of his theory of interest, where the connection between aging and capital markets can be glimpsed.

    “What happens when a man with income to spare but who is in need of wealth meets another with wealth to spare but who is in need of an income? Fair exchange is indeed possible in this case. Just why the problem of converting income into wealth and wealth into income is important follows from the fact that man is mortal and he knows it. As he grows old, his former surplus of mental and physical energy will inevitably turn into a deficit.”

    The apparent disparity in the capital market actions of nations with similar age structure can be explained through differences in their capital structure and mode of capital formation. Again, Fekete has something to say about this:

    “The formation of the rate of interest is usually explained in terms of a diagonal model of the capital markets featuring two participants: the supplier and the user of ‘loanable funds’. This model is woefully inadequate as it blots out the time element between the raising and repayment of the loan and, more fundamentally, the crucial process of capital formation. It ignores the Principle of Capitalizing Incomes. Our theory presented in this course will involve a step-by-step refinement of the diagonal model into a square, a pentagonal and finally a hexagonal model of the capital markets. The square model has four participants: the annuitand (the man who is accumulating capital to support his future annuity), the annuitant (the man who is already drawing an annuity), the entrepreneur and, finally, the inventor. They are distinguished by their respective needs that they bring to the capital market to satisfy as follows. The annuitand needs to convert income into future wealth; the annuitant needs to convert wealth into income; the entrepreneur needs wealth in order to convert it into future income; and the inventor needs income in order to convert it into future wealth. The square model has the merit of clearly identifying the ultimate sources of supply and demand for wealth and income.”



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