Who Said Economists Didn’t See The Crisis Coming?

Question: who said this in 1990?

“For about 15 years, the United States runs current account deficits, so that more than 6 percent of U.S. assets are owned by foreigners in 2010. High saving for the subsequent 15 years results incurrent account surpluses and reduces foreign capital ownership to 3.5 percent. Past 2020, however, with the rapid increase in the number of elderly, the United States again runs current account deficits, so that in the steady state almost 9 percent of U.S. assets are owned by foreigners.”

Answer, among others the current director of the US president’s National Economic Council, Larry Summers. In this monster article (An Aging Society: Opportunityor Challenge? – be warned large PDF download) written with David M. Cutler (Massachusetts Institute of Technology), James M. Poterba (Massachusetts Institute of Technology), and Loise M. Sheiner (Harvard University) and published in Brookings Papers On Economic Activity.

The whole thing is incredibly wonkish, so perhaps you won’t want to read it, but it is there, even if some of the details are wrong, and, remember, he is only talking about a model, and what it predicts. On the other hand the whole piece is extraordinarily prescient, even foreseeing the decline in US savings and their recovery (which of course is associated with the movements in the current account).

Basically, Summers et al are only saying (but 20 years earlier) what Claus is saying in that pesky chart I keep insisting on putting up (see below).

But now that you are getting used to looking at it perhaps the time has come to explain a bit more about it. Summers et al spoke about a new steady state (where the US again reverts to current account deficits). This is the situation Finland, for example, may be near too. But if you look at the chart, this is not a steady state, since their is no homeostatic correction mechanism this time, and the need for exports (the export dependency purple line) simple heads off exponentially towards infinity, while the level of deficit does the same in the opposite direction.

The reason that the need to export moves exponentially upwards is that median age doesn’t just move up from one level to another, and sit there, but keeps climbing steadily upwards, and the more it rises, the less bang for the buck GDP growth you get from any given level of exports. This is the situation we are seeing now in Germany and Japan, and it is evidently not sustainable. So, if we don’t do something, and do something now, to stop median ages rising too rapidly, then more crises are guaranteed, and the next round will make this crisis will seem like, now how do they put it, oh yes, a picnic.

That this way of thinking about things is one piece in the new, post-crisis, macro mindset that will emerge, I have no doubt, since the crisis is all about imbalances, and this is one model for understanding them. Basically one group of people – the current account surplus people (China, Japan, Germany, Sweden) – were afloat with money, and spent their time recklessly lending it to another group of people – the current account deficit crowd (you know, the United States, Iceland, Ireland, the UK, Spain, Portugal, Greece, Romania, Bulgaria, the Baltics, Hungary and New Zealand etc, etc) – who needed to fund their deficit habit, and did it by equally recklessly borrowing money. So if you want to understand the banking crisis, you need, as Brad Setser would say, to follow the money and find the surpluses and deficits.

And all of this helps us understand not only the crisis, but also the problems we are going to have getting out of it, since as Larry Summers noted over lunch with the FT’s Chrystia Freeland “‘The global imbalances have to add up to zero and so, if the US is going to be less the consumer importer of last resort, then other countries are going to need to be in different positions as well.’

As Freeland highlights, on this possibility, Summers is bullish. “The very great enthusiasm for accumulating reserves that one saw globally is likely to be a smaller factor over the next decade than it has been in recent years” he predicts. And so too is economic growth (going to be a smaller factor over the next decade), Edward Hugh rapidly adds, since with everyone looking to export their way out of trouble, we have to ask, as Krugman pointed out, the tricky question about just who the customers with the current account deficits are going to be to enable all the exports. There is a long hard road ahead.

And the first evidence of this can be found in yesterdays US trade report, May exportswere up 1.6 percent, while imports were down 0.6 percent resulting in the smallest trade deficit since November 1999. Well, this is what the world wanted, and this is what it is now going to get. So everyone should be happy, I guess.

This entry was posted in A Fistful Of Euros, Economics and demography, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

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".

8 thoughts on “Who Said Economists Didn’t See The Crisis Coming?

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  3. “So, if we don’t do something, and do something now, to stop median ages rising too rapidly”
    Isn’t it fortunate that this is not the way causality is running in the long term (i.e., from ageing to economic results)?
    If things worked differently and ageing was indeed the scourge it’s made out to be, we would, of course, have to think about the utterly impossible. Like the ideas Edward has proposed in the past, e.g. having central banks “target median ages”. How would they go about that? Is ZIRP pro- or anti-ageing? In context, Edward appeared to see it as the latter. Yet it’s exactly what the BOJ has been following for longer than any experimenter should require a trial-and-error arrangement to last. OTOH: Is there anyone out there who would want to claim that higher-interest-rate policies could serve to make family formation more affordable? Or consider that other suggestion from Edward regarding migration: the idea to put a price label on every person that immigrates into a country. This misses a) that one could equally well decide to put the label on émigrés rather than immigrants, and b) that it’s either just a statistical gimmick or nothing other than the revival of the slave trade.
    Basically Edward’s reasoning is an attempt at being an economic humanist without letting this humanism affect the intellectual model of the economy. The outcome is paradoxical (Think about Carlyle vs. Mill).

    Why is it that Atul Gawande’s recent healthcare story in the New Yorker couldn’t have been written in Japan or Germany? To recap: there is a place in Texas where healthcare costs per person run higher than personal incomes do. If ageing was as detrimental to the economic well-being of a country as the demographic school insists it is, equivalents of Gawande’s story would be something you’d expect German magazines to be filled with on a weekly basis. Yet they aren’t, because “systemically” healthcare is an economic, not a demographic issue that is handled sufficiently differently in Germany for that Texan scenario to have been avoided. Of course, if demographics is not the single most relevant factor with regard to healthcare, then this applies to all other sectors as well.
    So what will happen? The answer: the relative difference between the (high) number of young people losing their jobs in the U.S. vs. the (lower) number of older workers becoming unemployed there is going to be higher than that same relative difference in Japan and Germany. The effect? Less of a consumption retrenchment in the ageing societies and more “affordable family formation” there (due to real estate prices that have been falling for far longer, e.g.).
    “So everyone should be happy, I guess.” (At least, if demographics was everyone’s primary concern. Now let’s go back to being unhappy about real problems – like high unemployment per se.)

  4. Edward,
    Almost all of your fascinating writing touches on the need to maintain and boost fertility rates. But these would ultimately fall everywhere – and presumably that’s a good thing – the planet can’t take 10 billion people all living like the first world. So it seems to me that you are saying that the growth model, on which our economies are based, is good for times of population growth, but will fail us once (if) we stabalise global population. Or is there a way round this one?

  5. Hello Mink,

    “So it seems to me that you are saying that the growth model, on which our economies are based, is good for times of population growth, but will fail us once (if) we stabalise global population. Or is there a way round this one?”

    I’m afraid so. This would seem to be the conclusion. But the point I am trying to get across is that there are a number of different dynamics at work here. The problem you mention is a problem in the very long term, ie after 2050, or whenever. As you also point out, in the shorter run global population is rising sharply, so there is plenty of scope in the system to move the deckchairs around to everyone’s benefit.

    What most concerns me at the moment, is that we try and understand the short term dynamics of these imbalances. If we don’t, and don’t take measures to correct them – and incidentally Jörg I am clear I don’t have all the answers here – then we are just headed into another – and even bigger – version of what we just experienced.

    What we can see clearly is that surplus countries do risky lending, while deficit countries do risky borrowing, and in the end it all blows up. Now we can be sure that a lot more countries, including the US and the UK are now about to become surplus generating countries (ie net lenders). So who will be the deficit countries?

    Well let’s try India and Brazil. Could you imagine what things might look like in 2020 if what just happened to Latvia and Iceland were to happen to India and Brazil? This danger exists I’m afraid. The first step to trying to avoid this kind of outcome would be to try and better understand the dynamics of the imbalances, and move away from simplistic ideas that countries like Japan, Sweden, Germany and China are simply “bad” becuase they run surpluses.

    Or should that be the US, Spain, the UK, the Baltics, New Zealand etc are “bad” because they run deficits (according to your political preferences)?

    Such thinking is entirely superficial, and misses the big picture completely. As Summers showed, it is quite possible to model what has been happening, and get results which are reasonably credible.

    Basically, even if we need a new kind of growth (or non growth) model in the long run, we need to manage the transition from high growth to zero (or negative) growth reponsibly, and try top avoid the more dramatic boom bust components of the process.

    In the long run, as Keynes so aptly said, we are all dead.

    And yes, Jörg, I do favour central bankers targeting median ages, I think slowing down the *rate* of population ageing should be an objective, since allowing it to happening too fast will only crash welfare and pension systems, as we are about to see (unfortunately) in Germany and Japan. We are in the age of new monetary tools, than god for that, maybe as well as looking at what the longer term inflation expectations were, they could start giving equal importance to surveys on “ideal familiy size”, that would be a start.

  6. What do you mean with decreasing the median ages. Fewer old people or more pre middle aged adults or more kids.

    Asking 20 year old their “ideal family size” is useless because they don’t get kids and have no influence and when they are 30 they will have changed their minds multiple times.

    A bigger problem is that the optimal “ideal family size” from an economic point of view is 2 kids when your 30 if you’re in a couple and zero kids if you’re alone. Which leads when you consider the single, barren and kids who die young to a TFR of about 1.7

  7. “So, if we don’t do something, and do something now, to stop median ages rising too rapidly, ”

    This is ludicrous nonsense, of course.

    The only economic “problem” with the rising median age is the dropping percentage of people working. Continue to increase the retirement age to match the increase in the median age, and that problem is solved. If you can get as many people as possible working jobs they *enjoy*, you don’t even have to do that: they’ll keep working voluntarily.

    Amazing to see such ignorant ideas propounded. We do not need to keep producing babies faster — that’s just lunacy.

  8. Hello Anonymous Cluebat, and welcome.

    “The only economic “problem” with the rising median age is the dropping percentage of people working.”

    Do you have ANY empirical evidence to support this statement? The empirical evidence on the other side is piling up daily.

    I would say that the evidence I present from Larry Summers, working with a simple toy model in 1990 and predicting movements in the US CA balance just playing around with life ccycle moving median age possibilities is pretty impressive. But not to you evidently.

    So could you give me just one fact to support your case?

    “Continue to increase the retirement age to match the increase in the median age, and that problem is solved.”

    Well, excuse me, but could you take a quick look at Germany and Japan, since they are doing exactly that. Japan now how 25% of the male population still working at 75 (something you can’t do in Latvia, since on average men die at 65). And yet the export dependency simply grows and grows. Or try Sweden.

    We are in the midst of a huge crisis caused in part at least by these very same imbalances.

    “Amazing to see such ignorant ideas propounded.”

    Quite. So please, just one fact?