More on the Fertility Trap
Sunday, May 20, 2007 at 10:13PM Not too long ago I did a post on the fertility trap hypothesis which states that once a country sees its fertility rate (TFR) drop below 1.5 it will for various reasons (see post) face tremendous difficulties in raising the bar back up. This was of course also something very relevant to publishing over at Demography.Matters and Edward Hugh also takes time to elaborate on the idea. Now, what he comes up with is a pretty solid idea I think of what might happen to country once fertility has dropped to such low levels and the population accordingly ages rapid pace. In fact, my economic analyses are to some extent at least guided by the framework put forth by Edward and which we are trying to advance and tune as time goes by. Here is an excerpt of the relevant section ...
Essentially the argument, as it is presented here, is that as median ages rise beyond a certain point - 42/43 let's say - the structural characteristics of the economy change. While younger economies - let's say with median ages in the 35 - 39 range - are driven by large scale borrowing (on aggregate), domestic consumption surges, and, of course imports and current account deficits to match the domestic savings weaknesses, the more elderly ones can exhibit higher relative savings levels (Japan, German, Italy, Finland, possibly Switzerland), can no longer rely on domestic consumption to anything like the same extent, and increasingly come to depend on export growth for GDP growth.
Now, of course, this produces a mechanism whereby four things happen:
1) In order to compete for exports these economies have a permanent pressure on their tradeable sectors, whereby outsourcing is continuous and ongoing, wages are continuously compressed, and structural reform is permanent. Since the very export dependence is only further reinforced by the continuing process of change in the population pyramid (ie domestic demand never "recovers" as such) this is all self-reinforcing. That is the more time passes the more there is downward pressure on the wages of young people.
2) Due to the comparatively lacklustre economic growth performance there is a constant shortfall in the tax income necessary to guarantee existing welfare and pension commitments. This shortfall is produced by the low levels of trend growth (think Italy, Germany and Japan) which you can generate exclusively on the basis of export growth. Since the changing pyramid structure (here is another part of the feedback loop) means that an increasing part of the voting population comes to be over 50, the tendency, as we are in fact seeing, is to attempt to maintain welfare commitments by increasing the tax burden, which affects the consumption and earning possibilities of the young directly.
3) Migration factors. The general lack of growth in the economy, and the tendency towards increase retirement ages and higher participation rates at the older ages, all mean that there is a relative lack of well paying jobs at the entry level, a phenomenon which makes outward migration an increasingly attractive proposition for educated young people (again, as we are seeing in Germany and in Italy). This out-migration once more feeds back into the structural evolution of the population pyramid. If the out migration is in part compensated for by in-migration of lower skilled workers, then this tends to retard the process of moving towards higher value work, a feedback which one more time would seem to find reflection in lower wage levels on average in the younger age groups.
4) Impediments on pro-natal policies. The pressure on fiscal resources which result from the previous three factors mean that effectively it becomes increasingly difficult to generate the resources to finance really meaningful pro-natal policies which might attempt to "tease" fertility back up towards a higher level. As time goes by this problem only gets worse.
OK, these are really simply a set of working notes. Comments, as always, welcome.
As Edward says in the end we are really talking working notes here and I would not by a long shot say that we have it all right at this point but this is what we are working and thinking on at the moment at least. As always, as data comes in and the empirical situation changes so does the theory. One of the most fundamental question is then not so much whether demographics matter or not but moreso how and how much it matters in countries such as Italy, Germany and Japan which are all set to age very rapidly. This should then be investigated on the basis of the individual countries and also in a global context as more and more countries inevitably will join the league of ageing societies in the next 10-20 years.
CV
Ape Man who also features in the comments has a very relevant post over at his own blog responding to the comments section of this post. What he tries to pinpoint is that demographic change is real and does indeed come with a real economic and cultural effect.
One is simply to point out that demographic change is very real and it is happening before our eyes. One would think that I would not have to make this point but a surprising number of otherwise sensible people seem to be in denial about this.
For example, yesterday I was involved in a discussion about the fertility trap over at the Alpha.Source. During that discussion one commentator said (speaking about demographic effects)…
"I think this is hocus pocus, given the uncertainty. It’s like studying macroeconomics during the next ice age: meaningless."
This is common reaction when anyone starts talking about the economic effects of changing demographics. Most people deny that demographic data has any relevance. After all, it is all about the future and nobody knows what the future will bring.
But as the New York Times article on Québec shows, that is just not true. Demographics are changing the way we live right now. More to the point, even those demographic concerns about what will happen in the future are based on demographic changes that have already happened.
Well worth a look; note also Ape Man's response to a recent post over at the Economist's Free Exchange.
Demographics
Reader Comments (8)
In my opinion, what ever the effect that ageing has on saving is dwarfed by culturally differences. Just compare a American baby boomer with some one from Japan of the same age. I don't think demographics can completely explain the difference.
So to my mind it would be a bit of a trick to prove that demographic changes are affecting the savings rate apart from cultural changes. For example, even if Japan's demographics were at replacement level, I could imagine a situation where the younger generation in Japan is saving less money then their parents just for cultural reasons. That change might hold true even as younger generation ages.
In this hypothetical case, could that drop in savings really be attributed to demographics or just difference between people who experience the aftermath of World War II and people who only knew prosperity?
Having said that, if memory serves me aright, it is well known that people in their 40's and 50's do most of the saving as they are at peak earning potential and they are past the start of phase (i.e, they don't have collage debt to pay and they typically don't need to buy a house). You will note that this is the age group that Edward is talking about.
As for retirees, they don't do as much dissaving as you might think. They are trying to live on return on capital, not using that capital up. More over, the elderly often times save a portion of their income even though they are retired. They don't really seem to disave until they feel that they are at death's door and want to beat the tax man by spending it on their grand kids. Again, I don't have country wide data right on hand, but that is what I observe in the elderly whose finances I am familiar with.
In my opinion, most of the dissaving effect of having a lot of retirees tends to fall on the government through higher health care costs and other government benefits for the elderly. This will force them to either raise taxes or tap the debt markets as Edward notes.
In other words, if by savings rate you mean the private savings rate as opposed to the national savings rate (as I understand Edward to be doing), retirees probably won't affect the savings rate much.
In fact I can image a situation were there is a bulge of population in the in the 40's an 50's whose savings more then make up for increased government expenditures. As that bulge moves on into retirement, I expect to see the governments consume more of the private savings due to increased expenditures on the elderly.
Under this model, I would expect Japan's private savings rate to stay high by world standards, but their national savings rate to shrink as the population ages.
France & Scandinavia are doing much better with fertility than countries that do less to support (working) mothers and children. An accident? Maybe economists think so. But before your dire scenarios come to pass, methinks some folks would be willing to support the hard work of (working) motherhood with some effective policies.
thanks for your comments ...
You raise important questions and no doubt we need to answer in order to test our theory/hypothesis. Let me begin with this ...
'I think this is hocus pocus, given the uncertainty.'
I am not sure what kind of uncertainty you are talking about here. One thing which we know will happen during the next 10-20 years is rapid ageing in key societies on earth. Basically, Germany, Italy and Japan are at the forefront of this but even France will age rapidly since she too has been through a transition from about replacement levels in the 1970s to about 1.4 in the mid 1990s.
The key is then, what will happen? Now, I think Ape Man has a point in terms of culture and clearly the life cycle hypothesis cannot be applied with same force to all countries but then again, it cannot I imagine be completely ignored either. This then brings us to Reason's point will the elderly dissave and how and what about working households?
There has been a lot of effort for example applying the life cycle hypothesis to Japan and the data suggests that individuals save the most between the age 30-39 which then levels off in the 40-49 and 50-59 range. So when does dissavings occur? Well it depends on age of retirement and as Japan is one of the countries which have pushed this very far we can expect the threshold for dissaving to move as well. Moreover, I think Apeman raises a crucial point in terms of the NATURE of dissavings since all this talk about RAPID dissavings strikes me as very odd. I mean, it is not as if people dissave towards a 'known' end point. This means then that as life expectancy increases, savings will have to be strechted furhter. Finally, we need to think about the empirical foundation here. The rapid dissaving hypothesis persists that Japan for example at some point will run dry of savings and assets and start to import capital (i.e. running a current account deficit). However, this is highly unlikely in my opinion. What we are in fact seeing is like Apeman notes that Japanese retail investors are hard at work sending their savings abroad in the search for yield, a strategy which seems perfectly reasonable given the low yield on capital in Japan and the general issue of deflation.
Moreover, Japan will of course fight off the situation described above in terms of rapid dissavings since this would essentially mean 'game over' with the liabilities already existing on the public books (i.e. public debt is about 170% of GDP). So Japan will export and they will be good at it since if they can't export, they won't be able to get growth. In many ways the continuos current account surplus should then be understood as much needed Japanese savings.
In terms of household savings on an aggregate basis this will most likely go down of course since the ratio of retired(non-working) households to working households will increase. Moreover, wages are falling and have fallen for a decade now which is also of course is depressing the saving rate. The interesting thing in my opinion will be whether in fact not the saving propensity will be skewed towards ever younger ages as young households are met with forced savings through fiscal measures as well as the precautionary motive in an economic environment where trend growth keeps nudging down.
Ok, this is some thoughts ... I will have much more to say later in a more comprehensive note. But thanks for contributing.
Claus
Interesting exchange of views. There seem to be two issues involved here:
i) the LFT hypothesis itself
ii) savings, investment and the life cycle
On the LHT hypothesis, I would accept completely dissent's point that this is all very speculative (although it is about what may be happening now, rather than what did or did not happen during the ice age). I would however point out that it is often hard to separate science from "hocuspocus" when faced with new and unanticipated phenomena which may imply the need for a paradigm shift.
Surely this is what hypothesis formulation is all about, to enable novel ideas to be tested, and, if necessary, rejected. There is a clear falsifyability component here: if those societies which may be caught in the LFT steadily climb back towards replacement fertility then the hypothesis will fall. But even if the hypothesis is ultimately a bad one, there may still be much to be learnt from it - as a heuristic - science simply works like this.
What I am saying is that even by testing it and finding it to be ill-founded we may uncover mechanisms we previously failed to notice.
The problem, of course, here is the time scale.
Dissent mentions France and Scandinavia, we could also mention the US. These societies have, for a variety of reasons, been able to avoid falling below the 1.5 fertility mark. So what is it that makes Japan, Italy, Germany, Singapore, Taiwan, S Korea etc so different?
And how can newly developing societies - China, India, Brazil, Turkey, Morroco etc - avoid dropping to the lowest low levels? I think this is an issue of no little importance.
20 years from now China seems set to look more like Germany or Japan (ie structurally condemned to live by export growth) than like France or the US. Can anything be done to avoid this? I think it is a question worth asking, since the impact on global economic balances would be substantial if this were to happen. I mean at present China has a relatively small trade surplus and this is already causing all kinds of issues.
Now,as for the LFT itself, you could say there is a strong and a weak version. On the strong version account these societies would NEVER escape from below 1.5 fertility. Now "never" is a very long time, so really dissent would be right, if this is what we were talking about, maybe it would be virtually hocuspocus, although remember that once we get into the 2020s large scale migrations may be virtually over, since China itself (and then India) would be needing migrants (if they were to follow the US, UK, Spain model of economic growth) and this is clearly going to be impossible. So societies who have not found their way back up to near replacement fertility are going to face very serious structural problems once we hit the 2020s. I personally have little doubt about that.
The principal mechanism which could lead lowest low fertility to become permanent would undoubtedly be the ideational one, not the economic one. Ideal family sizes have been steadily dropping, and societies have been becoming more heterogenous (in terms of family models etc) and not more homogenous. So if very low desired family sizes really took hold it is again hard to see how this could change.
To believe such a change is possible you really need to postulate the existence of some sort of homeostatic mechanism - like the one which operated in the pre-industrial "Malthusian" era.I see very little reason for believing this.
The significant thing about the modern era seems to be the fact that the relationship between rising living standards and having more children broke: ie the sign on the correlation changed.Now to justify the return to near replacement fertility, it seems to me that you need to postulate a second sign reversal, and I would like to hear some arguments to justify this anticipation, since it seems to go very strongly against most of the contemporary evidence.
As I have suggested, even were the strong version of the LFT hypothesis to be ultimately rejected (and it may well be), there is another weaker version which, from our present vantage point, may be considered to be much more interesting, and this would be something like postulating that a mechanism may be at work which would maintain fertility below the 1.5tfr level, for those societies caught in the trap, for a generation or so. This possibility would have - and is already having - consequences which are far from negligible, since in the context of below replacement fertility (whether "just" below, or far below) long term structural damage is caused to the population pyramid.
This is the so called "momentum" argument. The importance is quite simply that if, with each passing generation, cohort size is reduced to - say -two thirds of that of the previous generation, then the shape of the pyramid is affected, and for many years into the future.
Now this situation has already happened in some societies, and indeed the position could easily continue for another generation, but really, short of encouraging significant migration - which needs economic growth to drive it, and it is precisely weak economic growth that we are seeing in these societies - there seems to be little in the short term that can be done to correct the problem.
But, as I am indicating, we are still in time to try and stop others following suit, and this is why I think consideration of this hypothesis is important -even if in the end we "happily" were able to reject it - since to have been in the position to have acted, and to have done nothing would really be rather irresponsible, at least IMHO.
That is the big difference between the debate on these issues today and that which took place 20 years ago. Perhaps it was difficult back then to see what might happen, and so it was hard to avoid the current state of affairs. But now we can see a lot better what is going on, so history, if it repeats itself, will do so not as farce, but as tragedy.
Ape Man raises a lot of interesting points. In the first place I would say he is right to draw attention to the ambivalence in the way I use the term "savings".
Before going further, and this is rather in harmony with what I have said in the previous comment about the LFT, I would ask people to bear in mind that Claus and I are very much feeling our way in the dark here. In our own way we are trying to formulate a hypothesis, and while I am happy with the direction in which we are moving, and the relationship I think we are seeing between this "hypothesis" and the data which is coming in, there are all sorts of issues and areas where we are either too rough and ready, or even wide of the mark, and all this surely needs a great deal of refining.
But then, and again going back to my earlier comment, if you don't try and formulate a hypothesis, and go on to try and test it, then you just never get to ask certain kinds of questions, since your line of enquiry tends to condition the kinds of question you ask.
So the question - among others - which Claus and I are asking is basically this:
"there is a consensus view that both the German and the Japanese economies are driven by exports for GDP growth. Is this simply a transient phenomenon, or are there underlying structural drivers which condition the process?"
Now we are asking this question really in order to test the hypothesis that population ageing - as reflected in rising median ages - may be an important factor (not necessarily the only factor) conditioning this process.
Now if we are right in this hypothesis all sorts of things would seem to follow, and in particular the whole neo-classical tradition of convergence and steady state growth (at least as it currently stands) would need to be substantially revised. That is the implications of us being right would be non-negligible and far reaching (this, in part, I suppose is why Claus and I are so interested in all this, beyond simple human concern that is). And this non-negligible point would seem to be one of the reasons why this whole line of argumentation meets with such strong resistance. And righly so, since what would science be worth if people were willing to throw so many things overboard without a fight.
Now this hypothesis is testable, and falsifiable, and over a relatively short time scale. Should the German and Japanese economies be able to move from export-driven to internal-demand-driven growth, then Claus and I would have, to say the least, to do a serious rethink. We are obviously suggesting that there are good reasons for assuming that this will not happen, and far from it not happening, we would postulate that as median ages steadily rise in other societies, the same pattern should repeat itself.
This latter argument is hard to formulate at this point in a falsifiable manner, since it is still hard to "calibrate" precise median ages for certain phenomena, and we are still a long way from quantifying the life cycle component in relation to other components - such as the behavioural one - which may be at work.
One idea which I have recently had is that we could look at property driven asset booms, and see if there are any cases of a society with median age >40 which have had serious and sustained booms of this kind. Italy, eg has seen some increase in property prices in recent years, but this has been far short of what has been going on in the US, the UK, Spain, Ireland, Australia etc.
Greece turns out to be an interesting case, since it is just on the borderline (median age just below the threshold) and Greece has experienced a significant property boom. The Netherlands is another interesting case, since it is now just pushing the 40 mark, and did have a sizeable boom in the late 90s, but this is now behind us, and so the interesting question is whether the Netherlands could experience this process again, or whether it is now undergoing a longer term structural transition along the lines of Germany and Japan. As I say, there are a lot of outstanding questions here, and calibration issues abound
Now for the savings bit. As Ape Man notes, I am really talking about private (household) savings. We also, as the discussion has indicated, need to think about public savings AND corporate savings.
Now what is clear in the case of Japan is that while absolute dis-saving is not taking place (at least not yet), the level of aggregate private saving has been dropping steadily in recent years. So - at the private individual - level Japan is still saving. As Claus points out, were present trends to continue this savings rate might well eventually fall into negative territory. But it is hard to be clear about this at this point, since the aggregate situation depends on the relative sizes of the different cohorts (which we now more or less know) and the rate of increase in per capita incomes across cohorts (which we obviously don't know in advance, since this in part depends on the rate of economic growth going into the future. We do know that real wages seem to be falling, but since what we seem to have are, one more time, aggregate data, it is hard to see how the different cohorts are affected by this process).
Claus, however, does raise an interesting point about saving rates increasing in the younger age groups (something which is very different from what we are seeing in the UK or the US, where it is often the growing indebtedness of the 30s age group which is driving consumption). Now this change in Japan is not so surprising really, since if long term pension and health benefits are not secure, then it is only to be expected that people attempt to accumulate more in the way of savings across the life cycle to try to make individual provision.
I don't have data on Japan corporate saving, but it does seem that this has become important (indeed think about the whole global "capex" debate, and Bernanke's savings glut thesis, and it's modification into the "investment dearth" one). What we have is an economy where domestic consumer demand remains structurally weak (and we need to investigate the reasons for this in a bit more depth), and where investment decisions (on the margin) are driven by perceptions of economic growth elsewhere. This is why, I suspect, we see so much volatility in investment decision making in Japan.
Now coming to public finances, it is clear that significant dis-saving has been going on for some time now (think of the public deficit), and despite promises of early remedial action, it is hard to see this actually coming to pass. Recently it has become fashionable to think that taxes (I am thinking here of the German VAT rise, but there is also a tax raise issue in Italy) can be raised in a weak internal demand situation with little in the way of long term impact, but I seriously doubt the viability of this view, and I think Japanese consumption would really feel the pinch from any sustained move in this direction.
The other remedy - reducing spending - is much more viable, but much more difficult to get agreed in an environment where a growing percentage of the voters are over 50 (another of the feedback mechanisms).
So at some point push will come to shove here. When will this be, and what will it look like? This is really hard to say at this point, since it depends on so many factors we still barely understand. This is why I prefer to stick to what is actually happening now, and get round to what happens in the longer-term future as we get there. But the problem is lying out there, no doubt about that.
One final point:
"whatever the effect that ageing has on saving is dwarfed by culturally differences"
Obviously we are all agreed that there are various factors at work here, and that one of these is a cultural behavioural one. The difficulty is that it is difficult to sustain a statement like this when noone has really tried to evaluate the relative weighting of each of the components. I would also add that under globalisation, behavioural components can change much more rapidly than previously. I will give you just one example: the home-bias of Japanese retail investors. This has undergone a sudden and dramatic change in recent years, just look at the current low values of the yen which seem to be driven by the search for yield on the part of retiring salarymen, something we have never seen before. So nothing here is etched in tablets of stone, and we should always remember this.
But what I suspect will happen is that the domestic economy will inevitably restructure and become more labour intensive as older people need more personal services. I agree there is a potential problem with entry level positions in export industries that may need some sort of government support (training subsidies?). But in the case of Germany and Italy, being part of a diverse EU, young people moving around to gain experience may not be a bad thing. Some of them will undoubtably return eventually, perhaps pulled by the needs of elderly parents.
In Germany now, despite some foreigners calling it a gerontocracy, we are starting to see a movement towards doing something about pro-natal policies, although certain institutional problems (especially short school hours) are very intractable. A total lack of foresight is not inevitable and the societies you mentioned are still rich and not militaristic (now - and with low birth rates they can't afford to be). The total economy is growing more slowly that countries with growing populations, but income per head is still OK. With a bit of belt tightening here and there and budgets can still be found (Germany has been gradually reducing pension commitments).
There is also the evolutionary argument. If there is a genetic influence on pro-natalism, then evolution must be working in its favour.
Longer term, of course, housing costs may fall and encourage in migration, and national dissaving may end up causing the exchange rate to fall, etc, etc. There are many possible scenarios, the economic influence is probably not determinate.
Thansk for keeping the discussion going ...
'the economic influence is probably not determinate'
I absolutely agree on this one since we really don't know what is going to happen but we can I guess, a bit like Edward and I, make qualified guesses.
'The export orientation of Japan and Germany is long standing and predates their demographic transition. I have a suspicion that large balance of payments deficits has a relationship to large levels of immigration (immigrants bringing capital and propensity to import with them).'
Well, I don't think that demographics are the ONLY thing which matters in terms of capital and trade flows but I do think that there is reason to believe that export orientation (i.e. a positive trade balance) somewhat by default will be endemic to societies as they venture up the median age latter. Of course, 'correlation' does not necessarily mean 'connection' but I still think this is one of the strongest legs in the hypothesis. The main reason is that these countries just don't have the internal demand to go into deficit.
Having said that you are definitely spot on in terms of immigration. Spain is an excellent example here!
'But what I suspect will happen is that the domestic economy will inevitably restructure and become more labour intensive as older people need more personal services'
Here, I have to diasgree, at least when it comes to the potential benevolent effects of such a restructuring. There is no doubt that the elderly indeed will need more services but we need to ask ourselves what this means for economic growht (i.e. the dependency ratio issue). We must remember then that labour is set to become a relatively scarce ressource and that if this scare ressource is devoted to taking care of elderly people it will translate into less value added which will mean less or even perhaps negative growth rates.
This is, in part, why Edward and I are so keen about pointing to the competitive export sectors since this is, in part, where a lot of the value added needed to sustain growth comes from.
Regarding pro-natal policies this is obviously beginning to dawn on many Eurpoean policy makers (e.g. also in Poland). There are however two points here. Can the society afford to carry out pro-natal policies to an extent that they would work?
And will they have a meaningful effect?
For example, in Germany, Italy, Japan
and even France rapid ageing is a realitiy save an enormous and ongoing external shock due to immigration which at this point is unlikely.
This does not meant that pro-natal policies should be neglected but simply that at this point it is very unclear as to their effect in the short term.