Posts about Business, Economics, and Finance
Hey all,
I read a very interesting book recently that provided what I thought an undervalued perspective on both the past 40 years in the global economy and some important points to consider for the next 30 years in the global economy. It seems quite relevant to Australia as many of the troubles (and boons) facing countries due to these dynamics have been visible in Australia so its interesting to consider them as part of a global system when typically the view is local.
The Great Demographic Reversal: Ageing Societies, Waning inequality, and an Inflation Revival by Charles Goodhart & Manoj Pradhan
The Past 40 years (1980-2021)
Why did Central banks have such an easy time achieving their inflation targets (within the band of 2-3%) between 1990-2021 while interest rates were steadily declining and reached record lows post-GFC? And why did central banks have such difficulty reviving inflation between 2008-2021?
Why did the labour share of economic output shrink in developed economies between 1980-2020?
What do the next 20-30 years hold for inequality, inflation, and interest rates?
The answer given by Goodhart & Pradhan to these question is that over the last 40 years (1980-2020) the global economy has been operating under conditions of an unprecedented boost to the labour supply that has acted as a huge disinflationary force globally. The labour supply boost has come from 4 main factors:
The integration of China into the global economic system.
Post-1991 the integration of Eastern Europe into the global economic system.
An improving dependency ratio due to a large baby boomer generation with a declining TFR (so fewer child dependents and not many old people meant a large working population)
The addition of women into the workforce
To give an idea of the numbers of people involved the author's provide figures that the growth in the working age population (WAP) of USA/Western Europe between 1990-2020 was 60 million total, while China added 240 million WAP in this timeframe and the addition of Eastern Europe added a further 200 million WAP to the global economy. (As an aside, this book was released 2 days after the Cardi B hit of the same acronym so they got scooped on this acronym in a pretty funny way).
This enormous boost in the labour supply (in combination with a liberal economic outlook led by globalisation) has had the effect of being a massive disinflationary force on the global economy so that inflation could be comfortably kept within the 2-3% bound even as interest rates steadily dropped. It also significantly weakened the bargaining position of labour which lead to a declining amount of national output going to labour in developed economies which led to a surge of inequality within countries while inequality between countries dropped due to offshoring, the decline of private sector unions due to weakened bargaining power etc.
The ability to maintain inflation in the sweet spot of 2-3% while interest rates dropped was mistakenly attributed to effective central bank actions when the lion's share of the credit was the favourable demographic structure. This has allowed central banks to enjoy a significant amount of independence without political controversy as the decline in interest rates meant that greater debt ratios could be easily sustained without debt interest payments increasing (making it easy for politicians to promise lots of stuff to lots of people without worrying about raising taxes to pay for it).
The authors posit that the conditions of the last 30-40 years are now over due to global aging alongside a relative collapse in globalisation and so we are going to be moving from a disinflationary environment to an inflationary environment. They think this will have a number of different impacts which I will cover in 3 headers of inflation, interest rates, & inequality.
The Next 30 years
Inflation
The authors predict that inflation will be a much more persistent problem in the coming decades because the older populace that was previously working/saving/spending will now stop working/stop saving but will still be spending. This is happening globally and combined with much longer lifespans means that the ratio of producers relative to consumers will be less and less favourable over time. This will be a major inflationary force in the global economy compared to the major disinflationary force demographics have been for the past 30-40 years.
Interest Rates
The author's believe that interest rates will be higher than the average of the last 30 years and remain high as businesses/government will invest large amounts of capital investment in an attempt to improve productivity as well as meet other goals (such as "greening" the economy). However because of the large amounts of debt built up during the low interest rate period the author's believe there will be considerable pressure to keep interest rates low in the short/medium term and that the independence of central banks will be threatened over this. However, as the market determines the interest rate in the long term they expect that over the long term interest rates will be considerably higher than the average of the last 30-40 years.
Inequality
The author's predict that changing demographics will give increased bargaining power to labour who will pursue both increased (after-tax) wages as well as a revival of private sector unions as the balance shifts into their favour. The author's believe that the widening inequality within the countries of the developed world will shrink a decent amount over the next few decades.
Potential counterfactuals
There are two major factors that the author's believe could lead to a different outcome from what they predict above. These are:
The integration of India/Africa into the global workforce to create a repeat of the conditions that held when China/Eastern Europe were integrated into the global workforce.
A massive productivity boost from automation/AI/something else.
They consider both of these to occur partially but to not be significant enough to change their overall predictions of a world returned to an inflationary environment with higher interest rates and relatively tight labour markets and a subsequent increase in the bargaining power of labour.
While India and Africa both possess large and growing WAP's these are not as productive/educated as those in China/Eastern Europe were for a number of reasons. They are countries that have less infrastructure, are less well-governed, and are more corrupt than China/Eastern Europe were at the time of these production shifts. The production shifts would also be occurring in an overall global environment that is far less optimistic about globalisation in general with significant efforts being made to reshore much manufacturing. There is also the potential for mass migration from these countries to advanced economies (so instead of shifting production to cheap workers, shift cheap workers to production) but the numbers required would be so destabilising in populations already wary of more immigration this would be politically and socially non-viable. So while India and Africa will be areas of growing importance over the next 30 years and some shifting of production to these countries will occur, they will not be enough to offset the global aging and demographic shifts in the opinions of the authors.
For automation, the authors are more circumspect and think while there is room for automation the amount required would be both enormous and difficult as previous automation has already picked many low-hanging fruits in this area. But there is always the chance of black swan AI events or other breakthroughs changing things but this is inherently impossible to predict.
Reviewer Comments:
http://eprints.lse.ac.uk/107545/1/The_Great_Demographic_Reversal_Introduction_to_New_Book.pdf
The above link is to the opening chapter of the book (18 pages) which lays out the core arguments with lots of charts/graphs if you want a further read directly from the horses mouth.
Personally I found the author's perspective to be fairly persuasive and it does answer a lot of questions in particular about why central banks have had such a hard time restarting inflation post-GFC. It also helps explain why inflation took off globally all at once. Covid jumpstarted a process that was going to occur naturally due to changing demographics.
I am perhaps a little more optimistic about the trajectory of India/Africa/Globalisation than the author's but can also see how they reached the conclusions they did.
I also really liked the long-term perspective taken by the authors of looking at important conditions over decades that impact the economy as so often economic discussion is focused on the next 2-5 years at the very most. Whereas this perspective of a decades long explosion in the supply of labour being a core foundation to many of the smaller changes we observe is quite appealing to me as someone with a background in historical study.
Anyway I hope you enjoyed this and I would be interested in any counterpoints to the author's ideas or just general thoughts on the topic in general. Or if you read the linked PDF and think I misunderstood or misrepresented the author's arguments, please post corrections.