Russian Demographics - Something Stirring in the East?

One of the reasons that I have always had a problem with Goldman Sachs' infamous notion of the BRIC economies was not the fact that it excluded other important economies such as e.g Chile or Indonesia, but rather that Brazil, India, Russia and China never belonged in the same group. The reason for this is largely because of demographics. Both Russia and China are consequently set to age much more rapidly than India and Brazil due to very rapid fertility transition in the 1990s. The demographic situation is especially dire in Russia which not only saw a dramatic and lingering decline in fertility in the 1990s but also saw a corresponding increase in mortality (aids and alcohol as big culprits).

A recent piece by Carl Haub suggests however tha while doom and gloom used to be the prevailing tone on the state of Russian demographics recent trends suggest that this should change.

Back in 2000, Russia achieved what Russians consider a dubious milestone, deaths (2,225,300) outnumbered births (1,266,800) by an astounding 958,500. The crude birth rate had sunk to 8.7 births per 1,000 population. Along with a crude death rate of 15.3, natural increase hit an all-time low of –6.6 per 1,000, or –0.7 percent rounded off. The total fertility rate (TFR) bottomed out at 1.195 children per woman. The crisis, as it was seen to be, was definitely noticed, but nothing really effective was done until 2007 when Vladimir Putin announced a baby bonus of the equivalent of $9,000 for second and further births. Putin has been an outspoken advocate for raising the birth rate and improving health conditions in order to avoid the consequences of sustained very low fertility. The program must have worked since births in 2007 jumped to 1,610,100 from 1,479,600 the previous year and have rising ever since. This is one of the very few “success stories” in the industrialized countries’ efforts to raise the birth rate.

Together with the rest of Eastern Europe that was re-joined with the West after the fall of the Soviet Union, Russia experienced one of the most brutal fertility transitions ever seen. Indeed, history seems to have been extraordinarily cruel to many countries in Eastern Europe in handing them a second chance at the end of the 1980s just to take it away with the other hand as their demographic fundamentals collapsed. The birth dearth in the East even stretched into Eastern Germany where the total number of live births fell from 215700 to 88300 in the period 1988 to 1992.

I have previously mused that perhaps those multinationals eager to expand eastwards would have to go all the way to Kamchatka to find qualified labour and perhaps even fail entirely and back in 2006, the only silver lining that the Economist's Berlin correspondent could find was how a residing population had led to a revival of wildlife with the lynx returning to Germany's Eastern borders.

Perhaps though, it is time to put this discourse to rest?

Russia in Transition

From 1989 to 1999/2001 the total fertility rate in Russia fell from replacement levels to around 1.1/1.3 and notable effort [1] has been put into explaining why birth rates fell so much, so quickly.

Grogan (2006) uses a household survey tracking data from 1994 to 2001 and finds that a large part of the decline in fertility among married couples can be attributed to the decline in household income in the same period. Grogan (2006) however also sheds light on other aspects of Russia's fertility during the Soviet era. In particular, the paper sets out to explain completed cohort fertility for women born between 1936 and 1961 and finds that women with higher education had considerably lower completed cohort fertility rates than their counterparts. This squares well with the notion of the quantity/quality tradeoff of fertility famously developed by Gary S Becker [2] and how parents substitute quantity for quality as their income levels rise (with education), but it comes with an important twist in the Russian case. Since female labour force participation was almost universal during the Soviet era and since women with less than higher education often earned the same (or more) than their better educated peers, Grogan (2006) seems to imply an inherent demand, by part of well educated women, for quality rather than quantity in their fertility decisions. 

The other driver of fertility decline in the form of the tempo effect is also present in Russia, but Grogan (2006) is skeptical as to its merits in explaining the sharp fall in fertility in the 1990s. It does appear to coincide with a change in attitude towards marriage and, specifically, births outside marriage, but from 1988 to 2000, mariage rates declined for the broad category of women (aged 15-44) as well as the share of total live births taking place outside marriage rose from about 14% to 26%.

In essence, the tempo effect over the period in question is not linear and seems to neutralize itself over time.

From 1989 to 1994, the share of births to mothers under 20 actually rose and then declined to just above 1989 levels in 2000. Not surprisingly, the share of total non marital live births among mothers aged less than 20 years rose sharply from 1989 to 2000. This suggests that the extent to which non-marital live births increased, it resulted in children being borne to young mothers. From a theoretical perspective, this is important in relation to how a change in the life course towards postponing marriage also leads to a postponement of childrearing. A norm of non-marriage child births may then serve to weigh against the tempo effect of fertility.

This non-linearity of the tempo effect throughout what was essentially a sharp linear decline in fertility is interesting. The charts produced in Grogan (2006, p. 65 fig XI) clearly suggests that from 1989 to 1994 total live births for young mothers aged under 20 as well as those from 20-24 rose as share of overall birhts. This reverses somewhat in 1994 where live births for mothers aged 25-29 starts to increase as well as those aged 30-34. Yet Grogan (2006) notes that since there is no meaningful change in the fraction of total live births of "older" mothers in 2000 relative to 1989, the decline in fertility in Russia is not a postponement phenomenon.

Brainerd (2006) builds on the points above by similarly latching on to the idea that the economic hardship bestowed on Russian citizens in the 1990s contributed to the decline in fertility. This suggests again a more permanent negative quantum effect at work rather than merely a postponement phenomenon. But the underlying causes of the fertility decline is cut very finely by Brainerd (2006). Notably, the paper argues for a pure negative income effect on birth rates and thus a reversal of the standard quantity-quality tradeoff as developed by Becker. The interesting thing here is that little evidence is found that general macroeconomic uncertainty (of the future) affect fertility even if women with more negative expectations of the future had a higher propensity of abortion.

Quantitatively, Brainerd (2006) finds strong evidence for how marriage and a higher income per capita positively affects fertility using a fixed effect estimation with age specific fertility rates as dependent variable. Since marriage rates and income declined in the period 1989 to 1999, it leads to the conclusion that this caused the decline in fertility. I find this plausible, but would note that the estimation results suggests that underlying uncertainty of the future might still be affecting these results. For example, Brainerd (2006) shows how the effect of income on fertility is strongest for young mothers which indicates that permanent income may be a more useful proxy for linking fertility to income levels than the traditional method of using fluctuations in current income. It also sugggests that the income effect might be lower over time in the aggregate if we assume a general process of postponement, but this is dubious in Russia's case following Grogan (2006).

And now lets go make some kids ... ?

In general, the tendency of non-marital births is interesting to dwell on and Perelli-Harris (2008) [3] draws a sharp distinction between two reasons to explain it. The first relates to the notion of the second demographic transition [4] which postulates that the extent to which non-marital births occur in stabile cohabitations, as e.g. in the Scandinavian countries, it reflects a change in value towards marriage and thus a change in the life course. Contrary to this stands evidence, largely from the US, that non-marital births are associated with much less stable unions and, generally, poorer levels of society.

Not surprisingly, Perelli-Harris et al (2008) do not ascribe either of these explanations to the rise of non-marital fertility in Russia, but rather; a mixture of both. One important aspect here is the extent to which, after a non-marital contraception, women with higher education tend to enter into marriage with a much higher probability than women with lower education. But everyone will be able to find sources to support their argument with for example this article by Sergei V. Zakharov and Elena I. Ivanova arguing for a more traditional second demographic transition process in Russia.

One overarching conclusion which emerges on the fertility decline in Russia is that it was not driven primarily by birth postponement but seems to have been pushed by a more lingering quantum effect. The more specific driving forces of this quantum effect is much more difficult to get a hold on, but from the perspective of the macroeconomist it appears as if Russia entered a sinister spiral of increasing mortality and declining fertility just as the economy was meant to rebuild and then later take off on the much hailed wave of convergence. In particular, it appears as if the general adverse economic environment in Russia in the 1990s may have caused fertility rates to "undershoot".

Pro-natalism in Russia, Action and Reaction?

While we may certainly look upon Russia's demographic experience as a frightening example of the effect of negative population momentum, it would be unfair to say that the Russian leadership has been sitting idle. In 2006, Vladimir Putin announced a number of pro-natalist initiatives targeted at reversing the the decline of Russia's population. The plan included longer maternity leave, increased child benefits and most notably a full USD 9000 payment to women opting to have a second child Brainerd (2006).

In May 2009, president Medvedev arranged for eigth families to be courted at the Kremlin where they were awarded the Order of Parental Glory; the Levyokin family chosen to represent the Moscow region had, at the time, given birth to no less than 6 children.

Getting his Priorities Straight

The question is whether it has worked?

According to Carl Haub it has (see above), and if this is indeed one of the few success stories of how  ageing economies can reverse their birth rate, it is worth paying more than scant attention to. The data here is subject to some uncertainty, but following Haub's lead the total fertility rate in Russia stood at 1.54 in 2010 which is up from a low point of 1.2 in 2000. In addition, Haub notes an important distinction between rural and urban fertility rates with the former standing at 1.9 in 2010 and the latter at 1.42. This last point is difficult to underestimate since it shines a rather pessimistic initial light on the strides to increase fertility in Russia. In particular, it casts russia in a more classic emerging market context witha a very abrupt quantity/quality trade-off at work whereby especially urban fertililty undershoots significantly below the replacement level. 

Still, the aggregate picture is improving.

(click on charts for better viewing)

In the jargon of the profession we must now be seriously asking whether Russia is about to join the very few nations that has managed to break free of the fertility trap defined here as how total fertility rates often don't recover (or has not recovered yet!) once they fall below 1.5. The only two other countries which have seen their fertility levels rebound from below 1.5 are Denmark and France.

I would happily announce that this is the case, but the plot is just about to thicken.

On the positive side and given evidence from the academic literature that the tempo effect is not a relevant phenomenon in a Russian context, it stands to reason that this rebound can be interpreted as a real change in sentiment towards having children.

Score one for Russia's pro-natalist policies then?

To some extent though Carl Haub pours water on this idea noting that the second derivative of the fertility increase is falling which leads him to ponder whether the rise of Russian births is losing steam. This argument is taken further by Kumo (2010) [5] who suggests that not only did Russia's pro-natal policies not work in the first place, but also that the rise in the number of births can be attributed entirely to fluctuations in the number of women in their reproductive age. More importantly however, Kumo (2010) emphasizes the difficulties of micro managing fertility and specifically the issue of just how difficult it is to get a lasting impact on fertility from cash transfers. In short, empirical evidence shows that pro-natalist policies rarely have a permanent effect. This is even more likely to be significant in a Russian context as the fund set up to dole out money to fertile mothers expires in 2016.

Ageing in Russia, Adjusting for Mortality

To assume that the Russian government's attempt to push up fertility rates will have a lasting permanent effect is probably as dubious as assuming that it will have no effect at all. In addition, if Russia is serious about securing a future balanced population pyramid, what is to say that there won't be more initiatives?

Still, it appears that just as Russia seem to be making strides in the fertility department, the appalling situation for adult male mortality continues to taint the overall picture. Here, the optimists will call foul play and point out how the main story on Russian demographics has recently been a co-movement of improving mortality and fertility rates. This may be true, but overall conditions are still poor.

According to data from the World Bank only a mere 47.4% of a male cohort can expect to celebrate their 65th birthday which contrasts with 78.5% for women. On average (from 1998 to 2009) only 44.5% of a given male cohort could expect to reach 65 years.

 

Despite the visible improvement since the mid 2000s, the evidence from a birds eye view has not changed. Male life expectancy seems to be mean reverting around 61 to 62 (at birth) and mortality for adult males exhibits an increasing trend. An afinity to Vodka and other spirits as well as too many cigarettes appear to be lingering killers. Recent research (2009) from the medicinal sciences using mortality patterns from Tomsk, Barnaul and Biysk suggests alcohol was a cause of more than half of all Russian deaths at ages 15-54 years.

As a result, the natural increase is still negative as the up-tick in births has still not managed to pip the mortality rate here even if it seems a more lasting change may be underway here.

A Rare Sight

Regardless of the permanency of recent years' improvement in fertility Russia cannot escape a rapid process of ageing. More than anything, this is why I so ardently argue against lumping Russia together with India and Brazil or more specifically; in Russia there is no positive demographic dividend in sight; rather what we have is a negative one.

 Of course, we cannot simply assume that the Russian population will fall from here on as one would assume (and hope) that Russia manages to reverse the trend in mortality. What we can see however is that in terms of the prime age group (35-54), Russia is likely to have peaked already in 2004 even if the effect of the double hump is interesting to consider (a result of assuming a perpetually declining population).

In addition, the process of ageing means that there is almost no chance of Russia being able to contribute to global rebalancing by sustainably running an external deficit. This is one of the single most important macroeconomic characteristics which suggests why we should not label Russia as an "emerging" economy. Russia and the CEE will instead be fighting to escape the mantle that they may just have grown old befor they made it to become rich.

Especially the younger part of the labour force will invariably be subject to a swift decline and the composition of the labour force is crucial to consumption smoothing on the aggregate level and thus capital flows.

However, the most important aspect in the context of ageing in Russia is to adjust for the continuing high mortality rate among men. In a recent piece in Sciencemag Warren C. Sanderson and Sergei Scherbov argue that we should rethink ageing given that as the world population ages so does the threshold at which we can consider a person (or population) to be "old".

(...) as life expectancies increase and people remain healthy longer, measures based solely on fixed chronological ages can be misleading. Recently, we published aging forecasts for all countries based on new measures that account for changes in longevity (5–8). Here, we add new forecasts based on disability status. Both types of forecasts exhibit a slower pace of aging compared with the conventional ones.

This makes perfectly good sense and governments around the world are busy pushing up retirement ages to reflect this, but does this apply in a Russian context? What good would it do to push up the retirement age in Russia if less than half of a male cohort makes it to 65? The principle applied by messieurs Scherbov and Sanderson cuts both ways and in Russia's case we must incorporate an additional accelerant in our analysis of ageing to account for the continuing high rate of mortality and indeed an effect which will take some decades to pass through the pyramid.

Something Stirring in the East?

The recent improvement in Russia's demographic indicators begs the question of whether the glass is half full or half empty. On the former I would note two things. Firstly, Russia has indeed seen a noticeable improvement in both fertility and mortality and it seems to have coincided with the government's strategic aim to actually do something about the country's decaying demographics. Secondly, I will salute the effort in itself. We can all probably agree that Russia has veered a little too much towards the way of authoritarianism under Putin, but whatever the underlying ambitions to push forward a positive population agenda I think it is extraordinarily important.

On the latter however, I am still worried that the trend in mortality have not been reversed and that, if anything, the situation is improving all too slowly. I am open to a more positive spin, but the data and an, admittedly scant, look at the evidence gives little comfort. As a result, ageing in Russia will be much more acute and its effect will have a much larger and negative impact than if life expectancy was a steadily increasing function of time. Indeed, given the continuing poor state of especially male health in Russia it is questionable whether the measures above of "peak growth" apply at all.

The most important feature of Russia's demographic rebound is its potential permanency and especially we should watch whether Russia manages to stay above a fertility rate of 1.5. If this turns out to be case, we could harbour a hope that not only lynxes but also a rejuvenated Russian population may be stirring in the East.

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* All photos in this essay are taken from Creative Commons License accounts at Flickr. Data for the charts are from the World Bank Database and US Census Bureau (long term population forecasts).

[1] - In the following I will make extensive use of Louise Grogan (2006) - An Economic Examination of the Post-Transition Fertility Decline in Russia and Elizabeth Brainerd (2006) - Fertility in Transition: Understanding the Fertility Decline in Russia of the 1990s.

[2] - Becker, G. (1960) - An economic analysis of fertility, In Demographic and Economic Change in Developed Countries. NBER: New York

[3] - Perelli-Harris, Brienna and Gerber, Theodore P. (2008) Non-marital fertility in Russia: second demographic transition or low human capital? In, Population Association of America 2008 Annual Meeting, New Orleans, US 17 - 19 Apr 2008. , 33pp.

[4] - The second demographic transition has many sources but these ones by Dirk J. van de Kaa are a good starting place.

[5] - Kazuhiro Kumo (2010) - Explaining fertility trends in Russia, VOX EU

Ageing and Export Dependency on the Agenda

I know that I tend to harp quite a bit about this theme, but I also trust that my readers by now will be well be used to it. One of the main interesting things about the notion that ageing might be related to export dependency is that while it enjoys little, if any, support in the academic literature it seems to have gotten an increasingly amount of momentum in the context of the market discourse. But then again, perhaps this is not so odd after all in the sense that markets, analysts, and commentators would tend to pick up narratives and ideas quite a bit before they get assimilated into the sometimes arcane world of academia, especially in relation to economics and finance.

In any event, it is with an increasing regularity that we can now observe analysts and commentators alike invoke the idea that for example Germany and Japan are indeed dependent on exports to grow.

Personally and in the context of a more wonkish perspective of why we should expect ageing and export dependency to be related, I have tried to speed the process on the academic side of the fence through two attempts here at Alpha.Sources to explain how this might be seen. The first was a very wonkish piece taken, to some extent, from my upcoming master's thesis and the second was a bit less difficult, I hope, and dealt with the specific case of Germany. To cap it off, I have even written a paper on the topic and I am presenting it this Wednesday in Barcelona; here is the abstract.

The primary manifestation of the demographic transition in a modern economic context is through ageing and the primary transmission from ageing to the macro economy is through its effect on saving and investment behavior. These two effects taken together suggest a strong impact from the continuing process of ageing on international capital flows and global macroeconomic imbalances. This paper explores the potential relationship between ageing on a macroeconomic level and the reliance, or outright dependency, on exports and foreign asset income to achieve economic growth. The paper’s argument is both theoretical and empirical. Using a standard overlapping generation framework (OLG) in an open economy context this paper discusses whether the proposed relationship between a transition into old age and dissaving is feasible and desirable (or even optimal?). Finally, an empirical analysis is presented on Germany and Japan to show how these two economies, as the oldest in the world, may exactly be in a state of export dependency.

It is still rough around the edges, but readable I hope. Comments, critique, and suggestions are welcome.

More generally, I was also happy and honoured to read the recent monthly newsletter from the London based investment company Absolute Returns which included a thorough and fine review of my ideas and thoughts on the topic of how ageing affects capital flows. In fact, the author Niels C. Jensen elaborates in some detail on the obvious and relevant question surrounding the fact that while we may all become de-facto dependent on exports as a function of old age, we cannot all export at the same time. Niels rolls out a fine and thorough argument, but especially; I took note of the following in relation to Japan (my emphasis);

No other country is aging as quickly as Japan. Saddled with a large number of old age pensioners already (the dependency ratio is currently 35), the ratio will grow to an astonishing 76 over the next four decades. The Japanese economy has struggled to drag itself out of a slow growth environment for the past twenty years (give or take). The problems in Japan are well publicised and are often blamed on failed policy measures. I just wonder how big a role demographics have actually played in all of this and whether the Japanese mire is a sign of things to come for the rest of us?

I would never be so stupid to argue that policies, culture, as well as institutions don't matter. They obviously do and are a big part of the picture. However, I also believe that when we come to look at the case of e.g. Japan the demographics, defined by an ongoing and relentless process of ageing, tend to crowd out these other factors. This is especially the case when taken so far as it has been in Japan. But then you only need to realize that Niels is right here. Japan is essentially but one step ahead of the rest of the OECD (with a few exceptions), and it is worthwhile to think long and hard about what this means. I am not being a fatalist here, but simply trying to point in the direction of where the real issue is buried since I also believe, without I hope sounding to alarmist, that the stakes are quite high here, not least in the context of policy advice and guidance to the large batch of emerging economies who are destined to follow the same demographic transition as Japan, Germany et al. if we don't arrive at narrating the issue in a proper way.

Ok, I shall leave it here. Needless to say, that for those of you who are mainly concerned with a P/L (be it yours personally or your clients') I believe the discussion has relevance too since ultimately ageing is first and foremost transmitted through the flow of factors of which capital flows is, by far, the most important [1]. For that reason alone, Niels' piece is worth more than a brief look.

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[1] - Migration holds huge potential here, but labour mobility across borders is a whole different ball game than capital.

Ageing and Global Capital Flows - Is it Optimal to Dissave?

A preliminary apology is in order. What follows is uber wonkish and should be consumed preferably in small quantities. In fact, I am not sure that I have gotten everything right yet. Of course, we never are but in this case it is an important point to make up front. The argument is loosely built on my upcoming master's thesis which seeks to explore the connection between ageing and capital flows and specifically how and whether the former may lead to a state of export dependency; where export dependency is defined as a high and increasing sensitivity of the rate of change of national income to the rate of change of the current account. This is something I have discussed extensively on AS, but in this case I am trying to give it a thorough theoretical spin which means that any non econ-wonks are likely to be lost in translation.

I should stress immediately that this is not a virtue but rather a vice, but I do think that exploring  conventional economic theory (and moving beyond?) is an important part of the process. In the end, the argument should be amendable to plain English and, as it were, plain common sense and intuition as well as, of course, empirical falsification. One thing which I can promise though is that there will be no mathematical models; at least there, I should have provided some comfort. If you want the math, you will have to wait for the thesis.

The best way to frame the following argument is perhaps to insert it in the chronology of the thesis where it appears, in the end, as a perspectivation on aggregate global capital flows. What precedes this is thus an, hopefully convincing, account of the fact that Germany and Japan are effectively dependent on exports to grow as a result of their demographic profiles.

Some Thoughts on Export Dependency

First it would be worthwhile taking a look at the following sketch (click to enlarge) which captures a lot of the issues that will be discussed below. Essentially, it attempts to show, as nastily and brutishly short as possible, what export dependency means in the context of what we could call conventional economic theory.

For non-econ wonks it is likely to be quite difficult to read, but in fact; it is fairly simple. The X-axis  represents the age of an economy here exemplified in the phases of the age transition derived from a study by Malmberg and Sommestad that discusses the demographic transition as a transition in age structure (and not population growth). But really, it could just as well be median age where a median age of 40-50 would the limit to the right and, let us say, about 20-25 to the left. The Y-axis is adopted directly from Higgins (1998,  e.g. table 1, p. 350) who uses empirical estimations to model the effect from age on, in this case, the current account. As I, Higgins also use age on the x-axis (age distributions) and on the y-axis he has age coefficients. This basically means that a negative value signifies that the age structure in the economy influences the current account negatively (i.e. pushing the CA towards a deficit) while the reverse is true for a positive value. Essentially, we need not, initially, bother with the numerical value of such age coefficients here, but merely note whether it is positive or negative and then secondarily we may look at the level effect (i.e. whether the effect is numerically large).

I should immediately point out that there are no direct empirical basis for the curves. The line which is labeled trajectory of export dependency is basically a cubed function designed to show a more less linear association between export dependency and ageing with the added and important feature (hence the cubed functional form) that export dependency tends to increase exponentially when you move into very old age. The blue line naturally do contain some empirical foundation in that it originates from an empirical study Higgins (1998) where it is constructed based on empirical estimations. I shall not go into Higgin's empirical framework here since it would take us into the dark world of time series econometrics but merely point out that Higgins manages to come up with what we could call the textbook representation of the effect of ageing on the current account and it is worth pointing out that he is not the only one. Also Supan et al. (2007), Bryant (2006), Henriksen (2002) and Summers et al. (1990) (among a myriad of other studies) postulate either through theoretical elaborations or empirical estimations a relationship which may be approximated by the chart above.

In theoretical terms, the basis for this "hump-shaped" relationship between ageing and the current account is derived in the context of the simple, yet crucial, intuition derived from Modigliani's life cycle hypothesis which states that consumers spend their working age years saving for retirement where they will dissave those accumulated assets. Then, at some point during working age there is a "peak" which is characterised by the time when the saving rate is highest and thus also, indirectly, where the effect on the current account should be largest. Following convention, this is modeled in economics through the idea of overlapping generations and often in the form of a neo-classical growth theory framework or simply a general equlibrium representative agent framework. I shall not open pandora's box and discuss the merit of these methods here but merely point out that I think it is very difficult to argue against the the basic intution which lies behind these models and thus, as it were, the intuition from the life cycle hypothesis.

In essence of course, the real issue is one of calibration and thus one of empirical analysis to see just how this postulated hump may materialise as well as of course realizing that ageing is not the only variable which influences the current account. It is also here that the fun begins and where things very quickly become very complicated. 

In this respect, it is worthwhile focusing the attention on the so-called dissaving phase which should be a natural result of the move towards an ever higher share of the elderly in the population. The basic mechanism here is simply that in standard economic models "old" economic agents will dissave their entire asset and thus as the old cohorts increasingly will outnumber the young cohorts the dissaving of the former will trumph the saving of the latter and lead to dissaving on an aggregate level. All sorts of ill prophecies have been proposed in the context of this dissaving hypothesis, not least that we are facing an asset meltdown scenario in 2050 because there will be far too many elderly wanting to offload their assets to a much smaller base of younger cohorts who cannot support a satisfactory price (yield) level.

Now, the problem here is that empirical studies have shown that the idea of dissaving, while intuitively strong, is difficult to verify to the extent that theoretical models suggest. This is not difficult to imagine I think. By very nature of the uncertainty of the mortality schedule people do not (cannot) dissave to 0 and beyond this there are may be bequest motives. In an open economy context this further creates the rather dubious situation in which economies well into their old age will have to run persistent external deficits because, presumably, savings will have decline far faster than domestic investment demands. I say dubious here because this is exactly where I have chosen to take my stab at trying to amend the theoretical framework.

Consequently, I am not so sure that this is a plausible end point in the context of continuing population ageing. Specifically, I would like to ask the simple question of whether it is actually optimal for any society to dissave as the theory postulates. I don't think it is and while it is certainly not unlikely that economies may actually dissave (defacto) they will still be dependent on exports to grow and thus the difference between the two curves into the latter age transitions represents an externality. This is also why I think that economies, in stead of responding with dissaving, will fight the point at which they reach this stage since when they do it is effectively game over. Imagine for example how the likes of Germany and Japan would ever be able to finance an external deficit brought about solely on the basis of the fact that savings has declined so fast as to not even be able to meet domestic investment demand which in itself will be declining. In this situation, wouldn't it be much smarter to maintain savings persistently higher than domestic investment demand which can of course only be materialized in an external surplus. I think it will and it is this point which you need to keep in mind as we move forward.

Implications for Global Capital Flows

With these considerations in mind, the key question then becomes; what happens when more and more economies grow to become increasingly like Germany and Japan? (As we know they will, at least in the context of the OECD). Naturally, not everyone can maintain excess exports over imports at the same time so something, as they say, has got to give and it is this something, as it were, which is the topic of this entry.

The focus on the implication of ageing on aggregate global capital flows is not new and is, in fact, an integral part of the analysis in Supan et al. (2007), Higgins (1998) and Bryant (2006) which were also mentioned above. However, in the following we are going to relax the condition of dissaving normally assumed in e.g. OLG models and accept that the propensity to run an external surplus will increase as an economy ages.

If we do this, it should not require too much imagination to see the issues that may rise. For starters, I want to reiterate yet again the trivial fact that not all economies can run an external surplus at one and the same time. This means, quite naturally, that what might be optimal from the point of view of a single economy (i.e. maintaining a surplus as it ages) may not be viable or optimal from the point of view of the global economy.

In order to frame the discussion it is natural to take our point of departure in the discourse on global macroeconomic imbalances.

As so many other things, the financial crisis has completely dislocated this system but it still worthwhile to ponder the nature of the global financial system in a post Asian crisis perspective and up until now. Consequently, the global macroeconomic landscape has long been characterized by what many has termed Bretton Woods II in which a large batch of especially Asian and oil exporting economies have been pegging their currencies to the US dollar who in turn have been running a large current account deficit to match the savings surplus in emerging markets such as China, South Korea, the Petroexporters, Brazil and Russia. In fact, if we cut a lateral line through this argument we could say that the world has hitherto been characterized by the Anglo-Saxon economies running external deficits to match surpluses in big emerging markets as well as Japan and Germany.[1] That however changed abruptly with the advent of the financial crisis and it is interesting to note the initial response by market participants and many scholars in their interpretation. Consequently, as it became clear that the US economy had been mortally wounded on the back of the subprime mortgage debacle the US Fed slashed nominal interest rates significantly. As a result the USD plummeted which led many commentators to hail the US economy’s fall from grace and specifically coined the notion of decoupling in which the Eurozone economy and Japan were pinned as the ones taking up the slack in steering forward global demand. Initial versions of the decoupling thesis thus centered on the shift in emerging market exports from the US to Japan and, especially, the Eurozone and thus in the process also a shift from the US dollar to the Euro as a global reserve currency. As it turned out this was nothing but a mirage masked by the fact that US policy makers essentially acted preemptively to a crisis which turned global during the summer 2007 and now most major central banks in the OECD have slowly bitten the bullet and followed Bernanke into quantitative easing to combat the risk of deflation which would be devastating in the context of the debt overhangs some economies face. Moreover, and as a general point, the global economy already decoupled from the US, and indeed OECD, economy a long time ago. Consequently, it is an irrefutable fact that the global economy is undergoing a fundamental change in which emerging economies such as India, Turkey, Brazil, China; Chile etc will ascend to account for an ever larger share of global GDP and growth. The crucial question is then; how will this process and the process of global ageing be transmitted to the global economy through capital flows?

As a starting point to answer this question I would like to draw the attention to comments made by two of the most prominent members of the global financial punditry in the form of US economist Paul Krugman (PK) and the Financial Times’ chief economics commentator Martin Wolf (MW).

Starting with the former[2] he recently pointed to the fact, in the context of Japan, that external demand was instrumental in ending the slump and providing a relative bounce between 2003 and 2007. As PK further goes to argue, this may present a rather ominous outlook since the extent to which we are all, in the OECD, currently stuck in a “Japan-style” liquidity trap the way out may constitute a rather crowded route. As PK poignantly points out at the end of his small piece;

(...) needless to say, we can’t all export ourselves out of a global slump. So, how does this end?

Krugman 2009

This is indeed a good question and MW makes a similar argument in a recent column[3] where he points towards the fact that the global imbalances themselves may prove to be an impediment to a swift global recovery.

 In short, if the world economy is to get through this crisis in reasonable shape, creditworthy surplus countries must expand domestic demand relative to potential output. How they achieve this outcome is up to them. But only in this way can the deficit countries realistically hope to avoid spending themselves into bankruptcy.

Martin Wolf (2008)

This is of course a very appealing proposition and also goes to heart of idea that, at least, one part of the solution of the current global crisis lies in the resolution of global macroeconomic imbalances. But prey tell, how are these surplus countries going to revert towards a growth path characterized by a more balanced external account and perhaps even an external deficit?

It is in this context that the argument presented in this thesis becomes important. Consequently, there is a big risk that these surplus economies (e.g. Japan and Germany) simply will not be able to heed the call of MW. The main reason for this inability is then, in part, exactly to be found in the economic profile of a rapidly ageing economy with a median age pushing 40 year mark and beyond. Japan and Germany as well as the economies next in line to reach their age bracket cannot achieve growth based on domestic demand in a way which would allow them to suck up excess global capacity through an external deficit.

This is a very important point to stress in the context of the global economy and must be stressed with great emphasis.

Some Charts to Go With This

In order to try to make sense of all this consider the supply/demand chart below which plots the supply and demand for savings in the global economy. Following convention, the X-axis represents quantity and the Y-axis represents price. In this specific case, the X-axis can be seen as the total demand (from deficit nations) for excess investment beyond the level which can be achieved through domestic savings. The Y-axis then becomes the price[4] (interest rate) which equates this demand with the level (supply) of excess savings provided by the surplus nations beyond the level which can be absorbed by domestic investment demand

(click to enlarge)

As a natural consequence of the intuition underlying this small model, equilibrium is a forced (and always binding) condition since, by definition, the sum of external deficits must equal the sum of external surpluses in the global economy. 

If we accept the idea behind the theoretical framework presented in this thesis it is very easy to see the implications of a sustained global process of ageing. As is shown in the diagram the supply of excess savings (external surpluses) will increase with ageing [S(1) to S(2)]. But this is not the only effect. Following the simple intuition of a closed system an increase in supply must be meet by a decrease in demand too since we assume that economies are moving from a position as external deficit nations to a position of external surplus nations. In this sense, the constant level of output (quantity) is largely a simplifying trick in the sense that we let the entire adjustment process occur on the return of the excess savings of surplus nations rather than the quantity of excess widgets they can produce to sell abroad.[5] This produces an effect whereby ageing reduces the price of excess savings in equilibrium.

In order to move forward from here we need to mentally relax, as it were, the idea that deficits need to equal surpluses in equilibrium. In concrete terms, we need to understand the idea of equilibrium does not capture the notion of dependency on exports/foreign asset income to grow.

This is amended in the following graph; (click to enlarge).

The key here is the notion of the critical price level [6]. This should be seen as the level needed to sustain an acceptable level of growth in ageing economies and is thus a direct proxy for export dependency. As the global economy ages and assuming that equilibrium must hold at all times, the supply of excess savings and the demand for these savings decrease both lowering the equilibrium price and quantity. However, the critical price level remains. One key implications of this is a systematic oversupply of savings, or glut if you will, produced by the process of ageing and it is very important to understand that this oversupply is very tangible. It represents the value of external surpluses which would be enough for the likes of Germany, Japan etc to maintain a growth rate consistent with expectations and essentially the maintenance of their market economies. In the jargon of the theory, it represents the point at which ageing economies are optimally smoothing consumption and saving as a function of their intertemporal preference for the latter over the former. Of course, it cannot exist as a real entity but it may still have real implications.

The first obvious effect is to make the variation of ageing economies’ output very sensitive to the variation in out of deficit nations and thus global output. In its strictest form, this is how export dependency emerges. Another notable effect would be that it drives down the return in ageing economies to such an extent that it may fuel so called carry trade flows in which traders borrow in low interest rates currencies and invest in high interest rate currencies. Another example would be how these savings may be used to fund temporary and unsustainable build up of credit expansion in economies running external deficits. This is to say that if the equilibrium depicted above essentially is binding in the long run the implied existence of this excess pool of savings may lead to sudden outward jumps of the demand curve and thus the creation of credit bubbles. The main key to take away from this small economic model is thus the idea of an externality of ageing on a global level. This externality arises as a direct function of the implied existence of an excess of savings over demand as the global economy ages. In the context of the theoretical framework above the externality should be seen as function of the crowding of economies in one end of the spectrum on intertemporal preferences for consumption and saving. Crucially, it also means that what we might find to be optimal in the context of a single economy is not optimal on a global level a point which is certain to make standard economic modeling of aggregation from the representative economy level to the global economy very difficult. In empirical terms it means that what one might find to be the optimal path in a time series perspective of one economy may turn out to have radically different implications in the cross section when more or all global economies are involved.  

Further studies should attempt to develop this idea further since it provides a useful venue of analysis as an alternative to the traditional idea drafted from life cycle theory that global ageing will entail dis-saving on an aggregate level.

List of References

David M. Cutler & James M. Poterba & Louise M. Sheiner & Lawrence H. Summers (1990)
"An Aging Society: Opportunity or Challenge?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1990-1), pages 1-74.

Henriksen, Esben (2002) – A Demographic Explanation of U.S. and Japanese Current Account Behavior, Graduate School of Industrial Administration, Carnegie Mellon University

Higgins, Matthew (1998) – Demography, National Savings, and International Capital Flows, International Economic Review, Volume 39 (1998) Issue (Month): 2 (May) pp 343-69

Bryant, Ralph C (2006) – Asymmetric Demography and Macroeconomic Interactions Across National Borders, Brookings Institute, the paper was presented at a conference hosted by the Reserve Bank of Australia in 2006 (http://www.rba.gov.au/PublicationsAndResearch/Conferences/2006/)

  Borsch-Supan, Axel H; Alexander, Ludwig; and Krüger Dirk (2007) – Demographic Change, Relative Factor Prices, International Capital Flows and their Differential Effects on the Welfare of Generations, NBER Working Paper No W13185

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[1] With the German surplus mainly materializing itself in an intra-European imbalance.

[2] Paul Krugman (2009) – The Eschatology of Lost Decades, NYT blog post

[3] Martin Wolf (2008) – Global Imbalances Threatens the Survival of Free Trade

[4] Which is assumed to be exogenously determined for all involved economies through the equilibrium in this system.

[5] Remember that I am assuming that quantity is fixed and that the entire adjustment takes place on the price. In a more realistic representation the adjustment would of course take place on both the price and quantity.