Saying Goodbye To One Crisis and Hello To The Next

Saying Goodbye To One Crisis, Only To Say Hello To

The Next One?

Edward Hugh

Macroeconomist, Barcelona

International Employee Benefits Association

11th Annual IEBA Conference | Brussels | 8 - 10 March 2011


In this presentation I will argue that

• The most recent crisis was not an arbitrary phenomenon

• There is an underlying process we need to understand

• The worst is undoubtedly over in the last crisis

• Yet despite this we may have simply clutched victory from the jaws of defeat in one battle, only to then go on and lose the next one.


What Was The Last Crisis All About?

It was all about debt, and about how heavily indebted societies were going to be able to claw their way back to growth.

The Key Point To Grasp – This Process Is Structural, Not Cyclical


So Just Why Was There So Much Debt?

• Badly Structured Financial Products?

• Poor Regulation?

• Or Was There Something Else Going On?


Case Study: The Eurozone

Here is a key part of the puzzle. During the first 10 years of the Euro some European countries borrowed heavily, while others lent. As a result Spain’s households contracted a lot of debt. Yet German households didn’t.

Why this difference?


One Conventional Account

The “one size fits all” monetary policy didn’t work. Spain had negative interest rates during the key years of the housing boom.

But that still leaves us with a question: why didn’t it work?


Credit Driven Private Consumption Booms

Both Spain and Germany have had these.

The only real difference is in theTiming.Germany 1992 – 1999Spain 2000 - 2008


Current Account Blues

Germany didn’t always run a current account surplus. All through the 1990s the current account was in deficit.

And Spain won’t always run a current account deficit, even if that seems hard to believe right now.


The Key 25 to 49 Age Group

This group peaked in Germany – as a % of total population around the turn of the century.

And in Spain it peaked towards the end of the first decade of this century.


In The BackgroundThose Famous “Global Imbalances” But Just Why Did The Imbalances Build Up?

Japan, Germany and China – the usual suspects – had substantial current account surpluses.

While that other group – the debtors, countries like the UK, the US and Spain – ran substantial deficits.


Could Something As Simple As Median Population Age Help Us Understand?

Ours is an age of rapidly ageing societies. What is so modern about our current situation is not the ageing itself, but its velocity, and its global extension.


The economic and social implications of the ageing process are going to be profound. According to a recent report from credit rating agency Standard & Poor’s:

• the process is seemingly irreversible. • No other single force is likely to shape the future of national economic health, public finances, and policymaking over the coming decade

Population Ageing – A Unique Historical Challenge

Strangely, the issue receives only a fraction of the attention that has been devoted to global climate change, even though, arguably, ageing is a problem our social and political systems are, in principle, much better equipped to deal with.


As far as we are able to understand the issue at this point, population ageing will have major economic impacts and these can be categorised under four main headings: i) ageing will affect the size of the working age population, and with this the level of trend economic growth in one country after another

ii) ageing will affect patterns of national saving and borrowing, and with these the directions and magnitudes of global capital flows

iii) through the saving and borrowing path the process can influence values of key assets like housing and equities

iv) through changes in the dependency ratio, ageing will influence pressure on global sovereign debt, producing significant changes in ranking as between developed and emerging economies.


While population ageing is universal the short term impact will be much more localised.

The pace of aging varies greatly across countries and regions.

The effects of the process are expected to be most pronounced in those countries that remained complacent in the face of ultra-low fertility rates (total fertility rates of 1.5 and under), which in effect means Japan, the German speaking countries and much of Southern and Eastern Europe.


Another way of looking at these demographic changes is in terms of the dependency ratio, which can be defined in a number of different ways depending on the problem being addressed.


In In Germany total population is expected to fall from its current level of 82 million reaching anything between 69 and 74 million by 2050, depending on the future course of life expectancy, immigration and fertility. And the proportion of people aged 65 and older is projected to rise from just under 20% today to just over 33% by 2050. At the same time, the number of very elderly (those aged 80 and over) will nearly triple to as much as 15% of the total population.


Among emerging economies, the East of Europe stands out as by far the worst case in the short term. In 2025, more than one in five Bulgarians will be over 65 - up from just 13 percent in 1990. Ukraine’s population will shrink by a fifth between 2000 and 2025. And the average Slovene will be 47.4 years old in 2025 – one of the oldest populations in the world.

Eastern Europe Will Be Very Hard Hit


The ageing problem goes well beyond the confines of the EU or the G7. In particular China stands out among developing economies, since the degree of ageing we should anticipate, when viewed in terms of absolute numbers and velocity, is simply staggering.

It is during the 2020’s that China’s age wave will arrive in full force. The elder share of China’s population seems set to rise steadily from 11 percent in 2004 to 15 percent in 2015, and then leap to 24 percent in 2030 and 28 percent in 2040. Over the same period, China’s median age will climb from 32 to 44.

China Will Be One Of The Most Rapidly Ageing Countries in the 2020s


The key groups are prime savers, prime borrowers, and prime productive workers. Where these actual age brackets lie, and the extent to which they may overlap, is still a subject of some controversy,

One of the key points to grasp, is that the proportion the population which is to be found in one of the ‘prime’ age groups at a given moment in time, is absolutely critical, and much more important for understanding the processes at work than the mere size of the working age population.

Estimates of the exact age extension of the different groups vary, but 25-40 would be a good rule of thumb measure of the borrowing range, 40 to 55 for the peak savers, and 35 to 50 for the prime age workers.

Beyond this, the question is an empirical one of measuring and testing to determine more precise boundaries and frontiers.

Importance Of The Prime Age Groups


There is a generally accepted wisdom in academic work known as the “life cycle hypothesis” (Modigliani). This suggests that the population’s financial behaviour changes depending on age. In terms of adult life, those in their twenties and early thirties tend to be net borrowers as they are relatively low earners at the same time as they look to buy housing, expensive durables and fund their burgeoning families. At some point around middle-age this group then tends to move from being net borrowers to net investors as they move into their economic prime and accumulate financial assets to hopefully fund their retirement. As theyapproach retirement this group then start to shed the financial assets they’ve been accumulating to fund their nonworking days.

Life Cycle Effects


With this kind of understanding of the demographic component of saving and borrowing patterns it is not hard to see how demographic forces may have played an important role in the run up to the most recent crisis, making possible what Federal Reserve Chairman Ben Bernanke once called the ‘savings glut’.

The Savings Glut


As I have been arguing, if economies transit from being consumption driven to export driven, and it would appear that the process is not merely random, then we are not talking about choosing between options or “growth models”. There is not a choice here, since there are deep underlying structural dynamics at work, and these dynamics seems to be intimately associated with the dynamics of the demographic transition

The Demographics Of Export Dependency


The young Danish economist Claus Vistesen and I have proposed a model based on the close association of the export dependent phenomenon with population ageing and the demographic transition. Using Modigliani's life cycle saving and borrowing idea, and the Swedish demographer Bo Malmberg's idea of population "ages" (child, young adult, middle aged and elderly), Claus Vistesen has prepared the adjacent chart which attempt to illustrate the process which might be at work.


Dangers of Sovereign Debt Default?

According to the recent Standard & Poor's report, the cost of caring for the growing numbers of dependent elderly will both affect growth prospects and dominate public finance policy debates across the globe, and for many years to come.

Even if most governments have long been aware of the need to prepare for the looming problem, the rapid build-up of government debt over the past three years has effectively heightened the need to do more to advance reforms aimed at containing the risks to sovereign budgets, especially in countries with high expected future increases in age-related spending.


Assuming no policy change, Standard and Poor’s estimate that developed country deficits could rise from 5.7% of GDP currently to over 7.4% of GDP by the mid-2020s. The interest cost of the growing debt burden may exacerbate the budgetary impact of demographic spending pressure. And if nothing is done deficits will rise inexorably to 10.1% of GDP in 2030 and 24.5% by the middle of the century. This would lead the general government net debt burden to increase to 78% of GDP through to 2020, only to then accelerate thereafter. By 2030, the net debt burden is projected to be at almost 115%, at the same time as being on an explosive path to which would see average developed country sovereigns hitting 329% of GDP by 2050.

And The Numbers Are Daunting


Of course, such numbers are not either fundable or sustainable, they are only a simple illustration of what would happen if changes are not made.

Evidently, emerging market sovereigns are in general in a relatively better position due to their current level of economic development and their relatively lower pension system coverage.

But it is not unreasonable to assume that as these economies develop, government welfare spending may grow faster than GDP as has been the trend in advanced economies during the last half of the 20th century.

Time To Act Now In Emerging Economies


A Delicate Balancing Act

Reasonable empirical confirmation exists that the recent surge in global imbalances was, in part, an offshoot of slow-moving underlying demographic determinants of global capital flows.

The near-term adjustments will mean more emerging market current account deficits and less developed market ones.

At a global level, demographic pressures will continue to imply that the increase in desired saving will exceed the increase in desired investment. This has one clear implication: globally interest rates can be expected to remain low.


In terms of policies to address the pressures of ‘ageing’, the debate in terms of social security and healthcare often focuses on raising retirement ages to reduce dependency rates and alleviate fiscal pressures.

Extending working lives relative to the time spent in retirement will not only help address the pension issue, it should also serve to accelerate the tendency towards larger current account surpluses across most developed economies, in particular in those parts of Europe which are in the process of private sector deleveraging as part of their fiscal sustainability programme.

Longer, Healthier Working Lives


Surely it is more than a simple coincidence that the Nikkei peak was hit at exactly the same time as the key 35 to 54 age group arrived at its highest value relative to the dependant groups. That the Nikkei then spent the best part of two decades failing to show any meaningful recovery could also have much to do with the ongoing ageing of the population and the decline in the number of those in their economic prime. Deutsche Bank’s Jim Reid in From The Golden To The Greying

Is Japan The Canary In The Coalmine?


No recovery in long term fertility, ever longer life expectancy, declining trend GDP growth, and ever higher government debt. These are all clearly long term unsustainable. One day or another “something” will happen in Japan.

The Japan Problem Is Simply Not Sustainable


Time To Act – What Can Be Done?

Short Term:- Continuing and Continuous Structural Reform

• Labour Market Reform• Pension Reform• Heath System Reform• Immigration

Longer Term

• Raise Fertility Rates• Global Rebalancing Initiatives• Acceptance that the Modern Growth Era – like modernity itself – doesn’t last forever.


Edward Hugh: One of the standard pieces of economic observation about countries recovering from financial crises is that their recoveries are export driven. But as you starkly ask, at a time when the financial crisis is generalized across all developed economies “to which new planet are we all going to export”? Many developing economies badly need cheap and responsible credit lines, and access to state-of-the-art technologies. Do you think there is room for some sort of New Marshall Plan initiative, to generate a win-win dynamic for all of us?

Is Global Rebalancing Politically Realistic?

My Question To Paul Krugman


Paul Krugman: Um, no. Not realistically as a political matter. We’ll be lucky if we can get the surplus developing countries to spend on themselves. My guess is that our best hope for recovery lies in environmental investment: taking on climate change could, in terms of the macroeconomic impact, be the functional equivalent of a major new technology.

And Krugman’s Response

So There We Have It – The Priority Is Climate Change

Thank You For Your Attention

Saying Goodbye To One Crisis and Hello To The Next

Economy & Finance