Recent Forum: IF Webinar
Ed Goodchild took the chair for Intelligence Forums’ webinar on 25th of November 2020. Joined by over forty members from across the country, Fran Murray (Associate, Financial Crime Team, Rosenblatt), Ian Birch (Head of Transport Economics, Centre for Economics and Business Research) and Colin Ellis (Chief Credit Officer, Moodys) introduced our speakers.
Our first, Lord Desai is a British economist who became a peer in 1991 and was awarded the Padma Bhushan, the third highest civilian award in the Republic of India in 2008. He is Professor Emeritus of the London School of Economics and the Chair of the Management Committee of City Roads. He has special interests in economic policy, education and development, and is the author of many economic publications. He has served as a specialist with the Department of Agricultural Economics, and as Opposition spokesperson on Health and Treasury and Economic Affairs. He recently quit his 49 year Labour Party membership following the readmission of Jeremy Corbyn.
Lord Desai summarised the causes of the “massive displacement” in the global economy which has occurred over the past fifty years, with the inflation of the 1970’s precipitating an outsourcing of industry from developed Western economies to lower cost economies in the East.
In 1971 the USA unilaterally terminated convertibility of the US dollar to gold, and the UK and other nations followed suit. President Nixon’s sudden and unexpected move caused the US$ to weaken considerably against other currencies, and this particularly hit the purchasing power of the oil producers, whose only source of income was US$. The USA’s subsequent support of Israel in the 1973 Yom Kippur war resulted in OPEC voting to embargo any oil exports to the USA, with the consequence that, over the coming months the price of oil quadrupled.
US inflation which had averaged around 2.5%% p.a. during the sixties, soared to around 9% p.a. during the seventies (peaking around 15%p.a.). In the UK the story was similar, with a seventies average of around 15% p.a. (and a peak of 25%). Strong unions demanded, and achieved above inflation pay rises, and the cost of production in industrialised nations rose dramatically. This catalysed a move of industrial production towards low-cost economies such as Korea and China, with large workforces and low labour costs.
In most western economies, including the UK, employment in manufacturing began its decline as a percentage of overall employment, but in the newly energised economies of the “third” world, the level of manufacturing increased inexorably. A shift facilitated in part by ever improving communications ……. and a massive fleet of container ships.
As developed economies moved towards service and knowledge based industries, work become more technical and workers whose skills were best suited to manual labour were left behind. Prosperity flowed east and west from the industrial centre of the USA towards the knowledge based coastal economies. Access to education was key to allowing workers in western escape the demise of their manufacturing industries and to participate in the newer service economies, but the cost of further education in the USA, in particular, was a barrier to the manual worker. Part of Donald Trump’s success was, Lord Desai suggested, to be able to harness the support of those who have lost out as a result of this job migration. It is this long term shift in demographics, he believes that has led to a rise in populism, and it behoves western governments to implement strategies which ensure that they produce a workforce skilled for available jobs.
So inflation has decreased to almost inconsequential levels since the seventies, not because of the intervention of central banks, but because the world has been able to access a substantial and previously untapped pool of low-cost labour in underdeveloped eastern economies.
But according to our next speakers, this is all set to change …..
Charles Goodhart, CBE, FBA emeritus professor of banking and finance with the Financial Markets Group at the London School of Economics, and its deputy director from 1987-2005. From 1985 until his retirement in 2002, he was the Norman Sosnow professor of banking and finance at LSE. Before this he worked at the Bank of England for seventeen years as a monetary adviser and was appointed Chief adviser in 1980.
Manoj Pradhan, founder of the independent macroeconomic research firm Talking Heads Macroeconomics. Based in London, the firm specialises in the analysis of global and emerging markets macroeconomic trends, and their implications for financial markets. Manoj has a Ph.D. in economics from the George Washington University and a Masters in Finance from the London Business School.
In their book “The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival” Goodhart and Pradhan set out how the ageing of the population has implications for equality, productivity, monetary and fiscal policy, and inflation and they shared with us the main strands of their thesis.
The rise of China to the status of economic superpower has been the dominant narrative of the last three decades of globalisation. Its demographic sweet spot, drove output up and inflation down in the advanced economies. But as its working age population now shrinks, and the ranks of the old expands, its greatest contribution to global growth has now passed.
This great demographic reversal will lead to a return of inflation, higher nominal interest rates, albeit lessening inequality and higher productivity, but fiscal problems will worsen, as medical, care and pension expenditures all increase in our ageing societies. In summary:
Inflation has declined over the past 50 years as a result of Globalisation, such that it is, at present, no longer a significant issue.
Interest rates have been falling for decades. After WWII bank UK base rates climbed steadily, and peaked at around 17% in 1979. Since then, however, interest rates around the world, have steadily declined and currently stand at historic lows of around 0% or negative, in most major currencies.
Working age populations are falling globally. After one of the largest labour increases in history, the global backdrop has become one of diminishing working age populations. Those of the western economies, Eastern Europe and China have plateaued and are falling or expected to fall over the coming decades. Only Africa and to a lesser extent India, are the exceptions.
Dependency ratios are rising because of the elderly. The number of old people is increasing faster than the number of young. The percentage of young people in the workforce has declined over the past 50yrs due the end of the “baby boom” and improved contraception - USA (-9%), UK(-6%), Germany (-9%), Japan (-11%) and China (-22%); while the number of retirees has increased over the same period. USA (6%), UK (6%), Germany (4%), Japan (21%) and China (7%).
Old people are expensive. Caring for those with degenerative diseases such as dementia and Parkinson’s, which have no medical cures, draws labour from the workforce and imposes an increasing burden of cost on a decreasing pool of labour.
Forecasts show that ageing will lead to a massive rise in deficits and borrowing. Over the next over the next 40 years UK Public Sector Net Debt could increase to almost 300% of GDP, to finance the cost of care. Unlike the debt that was taken on to finance WWII and other wars, which normalised after the event, this is a permanent structural problem.
While there has been a marked narrowing of wage inequality over the past two decades there has been an increase in in-country inequality. Those with lower educational attainments have been most exposed to the global labour shock of the past 50 years. Employees with degrees have seen their wages increase in comparison to high school graduates or drop outs, whose cumulative change in real weekly earnings has stagnated.
High and rising national debt will reduce national saving and income, increase government interest payments, limit lawmakers ability to respond to unforeseen events and increase the likelihood of a fiscal crisis.
So what is the endgame? How will governments deal with this massive debt burden? Traditional levers are Growth, Fiscal Policy or Inflation
Economic growth: This looks unlikely. We may achieve some productivity improvements, but in predominantly service economies these are likely to be modest.
Fiscal Policy: Raising taxes is unpopular, and in the post-COVID landscape is likely to be counterproductive.
Inflation: while unattractive this will likely be the ”least bad alternative”
Professor Goodhart believes that we are already in the last phases of Modern Monetary Theory (MMT), whose advocates argue that until full employment is achieved governments can spend what they want, never having to worry about financing, because the central bank will “print” all the money they need. Once an economy reaches full employment, however, inflation is the primary risk, and governments can raise taxes to reduce the spending capacity of the private sector.
During the COVID pandemic the Bank of England has embarked on a programme of quantitative easing, which this year has already reached ten times the 2009 level which followed the financial crisis. Pent-up demand has increased dramatically, and the ratio of personal savings: disposable income has increased to 30%. When COVID uncertainty recedes this demand will be released.
Our speakers argued that it is likely, probable in fact, that we will be in for a large amount of inflation within 2-3 years. Initially this will be welcomed by central banks, but because of the global demographic changes it will not be contained in the way that it has been over the past 50 years. They believe that we are likely to experience 1970’s inflation, but this time there will be very limited deflationary benefit available from globalisation.
With limited appetite to raise taxes, what is the prospect of raising interest rates to contain inflation?
In the seventies, debt to GDP ratios in most economies were around 40%, but following the pandemic these will be over 100%. Finance ministers will resist interest rates rises, because of the increased cost of debt servicing, which would further exacerbate the national debt. Central banks will come under significant pressure not to raise interest rates.Monetary actions will be needed to hold short-term rates low, and measures such as quantitative easing needed to reduce rates across the yield curve. These will cause further inflationary pressure. The risk of a “bad deal” Brexit will be damaging for sterling, further exacerbating the situation for the UK.
Manoj addressed several pushbacks to their thesis.
Firstly - there is a pool of labour in both Africa and India to supplement the diminishing labour pool elsewhere.
While the continent of Africa hosts a large pool of labour (in aggregate the size of India), it comprises over 50 individual countries. This means numerous administrative and organisational structures, some in situations of economic and political distress. Africa is in not in a position to meet the global demand for labour. Even India, as a single country is not sufficiently organised to meet such demand. Neither has the capacity to step up in the way that China has.
Second - older people can do more to reduce some of the demands on society, for example, working longer to defer benefits.
Participation rates for 55 to 65 year olds in developed economies is already high and has been increasing steadily over the past 20 years or more. Workers are staying longer in the work force because of pension degradation. Participation rates in Germany, for example, have risen over the past 20 years from c. 45% to c.70% largely as a consequence of the cut in German retirement benefits. There is insufficient capacity here.
Finally - none of this happened in Japan.
The Japanese experience is not a roadmap for the current global situation. Japan's workforce actually declined when the rest of the world was adding to the demand on the global force, and GDP per worker period increased. Japanese companies also invested heavily abroad. Its labour adjustment was through a reduction in hours worked rather than a higher wage bill. Most significantly however, being on the doorstep of China, which was massively inflating output, reduced deflationary pressure.
In summary, Goodhart and Pradhan are clear in their view, that “Inflation is coming”. It is a very real and present threat, and while they hope to be wrong their coherent thesis says otherwise. The danger, they suggest, is serious enough to require a fundamental reconsideration of our capitalist system.