¿Qué politica? ¿Qué productos? ¿Cuanto riesgo?

¿Qué politica? ¿Qué productos? ¿Cuanto riesgo? Edward Hugh - Barcelona: Noviembre 2011

Una de cal y otra de arena El diferencial entre el bono alemán y el bono español esta cayendo, la mala noticia es que la causa es mas bien una deterioración en la percepción de riesgo del bono alemán. Contagion : Desde la periferia hasta el “core”.

Este ya no es una crisis de deuda soberana.. Thomas Maier, Chief Economist Deutsche Bank, Bloomberg TV Es Una Crisis De Confianca En El Futuro Del Euro

Contagion Se Extiende A Los Paises Del Este

No Es Solo Europa Todos Los Paises Desarrollados Se Enfrentan A Un Ajuste Importante

El Tema Numero Uno Es Deuda Ahora la gran pregunta es, ¿Cómo volver a bajar los ratios de deuda en el PIB?

Japón Tiene Un Problema Grave De Deuda La economía ha estabilizado, pero solo al precio de un crecimiento constante en el gasto publico.

Otra Problema – Envejimiento De La Población Entre hogares, empresas y gobierno, la deuda ahora esta cercana al 265% del PIB El Caso De Italia

Tercer Problema – La Llegada De Los Emergentes

Pero Europa Tiene Un Problema Especial Debido A La Moneda Única ¿Quien O Que Hay Detras Del Euro?

Soluciones • EFSF • BCE • Eurobonds

EFSF Apalancamiento

BCE ¿Necesitaria El BCE Recapitalización En El Caso Que Hay Quita Sobre La Deuda Publica Italiana? Y Si La Respuesta Es Si, ¿Quien Lo Pagara?

¿Eurobonds? Problema De Guarantias “Joint & Several”, Problema De Crecimiento En La Periferia Y La Creación De Un “Transfer Union”.

¿Euro Crisis Acerca A Un Punto De Inflexión?

Los Mercados Empiezan A Preparar Por El Fin Del Euro

Y Las Empresas Del Sector Empiexan A Dar Información a Sus Clientes Sobre Que Hacer En La Eventualidad….

You can download the presentation here.

The Euro, Demography and Italy's Long Term Growth Challenge

The Euro, Demography and Italy's Long Term Growth Challenge

Presentation To The Italian Demographic Party Summer School
Edward Hugh - Cortona, September 2011 (Revised and Updated)

Summary Points

• The most recent crisis was not an arbitrary phenomenon
• It was not simply a question of stupid and irresponsible financial products
• There are underlying macroeconomic and social process we need to understand
• The worst of the first stage of the crisis may be over, but we could now be entering a new and more dangerous phase
• The Euro itself forms part of the backdrop to the crisis • As do long term changes in Europe’s demographic profile
• The greatest challenge facing any future Italian government is how to maintain welfare commitments in the face of population ageing given the level of accumulated debt.

Italy Suffers From Low Growth ………… And An Ongoing Current Account Deficit Italy’s average annual growth rate has fallen steadily in recent decades. The rate for 2001 – 2010 was about 0.6% and it is not excluded that during 2011 – 2020 it will be negative. And the growth rate has dropped as the current account deficit has widened. There is an obvious connection – international competitiveness.

Italy first fell into recession at the end of 2007 – some months before the other Euro Area countries - and didn’t come out of it again till the start of 2010 , so the economy contracted for two full years. GDP fell by 1.2% in 2008, and by 5.5% in 2009. After an 18 month recovery, the economy again fell into a second “double dip” recession in September 2011, after a surge in borrowing costs forced the government to apply stringent austerity cuts in an attempt to recover investor confidence.

Double Dip Recession

Sharp Economic Contraction Thus the Italian economy continues to demonstrate it long term underlying weakness of short recoveries followed by longer than average recessions. It is now widely expected to contract by around 2% in 2012, and then by another 1% in 2013. It could then grow moderately in 2014 – perhaps by 0.5% - but why should we expect the country not to fall back into recession again in 2016?

Living Standards In Long Term Decline After years of being stationary Italy’s population has risen sharply over the last decade – from around 57 to just over 61 million - but GDP hasn’t changed. The result has been a large fall in GDP per capita. This fall has been in absolute terms, but in relative terms the change is also clear. Germany’s relative position fell steadily in the 1990s, then stabilised, and has even improved since the crisis. Italy’s fell slowly in the 1990s, then, since the turn of the century, the rate of decline has accelerated.

The outlook is not appetising As the population ages domestic demand moves into long term secular decline. Retail sales, for example, are now around 94% of the 2005 level. And as public debt is paid down, government consumption will simply get less and less.

Italy Didn’t Have A Housing Boom Pre 2008......... Yet Construction Continues To Decline This trend is not likely to change. The winter 2011 Monti measures involved a substantial rise in property related taxes, implying lower property values in the future. In addition Italy’s demographics are not favourable to housing booms.

So Now It Is All About Exports GDP = Household Consumption + Investment + Government Consumption + Net Trade (Exports – Imports) Now if household and government consumption are falling systematically, the only factor which can give a direct boost to GDP is the relative movement in exports and imports.

Positive movement here can stimulate investment in the export (or tradeable) sector as expectations build for increased demand. Total Investment = Investment for Exports + Investment For Domestic Demand. While Italian exports surged back after the financial crisis recession they never in fact attained their pre- crisis level, and now they are once more declining again. In addition, even though Italy’s goods trade deficit has reduced substantially over the last 12 months, it is still a DEFICIT. Just Not Sufficiently Competitive? As we can see in the chart on the right, the Italian economy was on an unsustainable path from the end of 2009 to mid 2011, as excessive government spending fed an import surge. As government spending was cut this import boom burst, and domestic demand collapsed, taking the country deep into recession.

How To Define Competitiveness?

The REER (or Relative price and cost indicators) aim to assess a country's (or currency area's) price or cost competitiveness relative to its principal competitors in international markets. Changes in cost and price competitiveness depend not only on exchange rate movements but also on cost and price trends. The specific REER for the Sustainable Development Indicators is deflated by nominal unit labour costs (total economy) against a panel of 36 countries (= EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, New Zealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculate REERs, reflecting not only competition in the home markets of the various competitors, but also competition in export markets elsewhere. A rise in the index means a loss of competitiveness. (Eurostat Definition)

The issue of competitiveness has become one generating more heat than light in debate during the current crisis. The validity of one commonplace measure (REERs) widely used historically has been repeatedly questioned. In my opinion such questioning has been largely motivated by ideological and political motives in contrast to scientific ones. In fact the evidence is clear enough. Output & Productivity High output per worker and high wages are perfectly compatible. The road to achieve this win-win combination is through raising productivity, thus maintaining unit labour costs constant, or even reducing them. As can be seen from the accompanying charts, Germany achieved this combination between 2000 and 2008, while Italy didn’t. In Italy productivity stayed pretty much constant while unit labour costs rose, meaning salaries rose without the accompanying productivity, while in Germany unit labour costs stayed constant while productivity rose. This also gived the lie to the “cheap German wages” argument, since if wages hadn’t risen then ULCs would have fallen, which they only did briefly between 2006 and 2008.

The problem in part is that value added is often a sectorial issue. For example agriculture and construction have historically been low value added and often high unit labour cost sectors, whereas petrochemicals or biotechnology are high value added but also often low ULC sectors, despite the fact that wages are higher. Naturally most societies would like to have a large proportion of high value added activities, and a comparatively small proportion of low value added ones. But this isn’t as straightforward as it seems, since the transition from agriculture to biotechnology doesn’t move along what we could call a smooth production function. Namely you can’t simply transfer workers from one section to the other. It ain’t that easy. The large number of construction workers recently displaced in Spain can’t simply move into machine tool manufacturing, for exemple.

A countries ability to engage in what are high value activities at any moment in time depends on key factors like the skill, education and experience levels of the workforce, and these change only slowly. Critically the distribution of these factors depends to some extent on the age structure of the population.

But in part the level of unit labour costs depends on the level of international competitiveness, which in part depends how much of the economy is in the tradeable sector and how much in the non-tradeable part of the economy. By tradeable we mean in competition with other producers or service providers beyond the national frontier. The key mechanism assumed here is that the tradeable sector, being exposed to external competition, by definition needs to be more competitive to survive. So a measure of a country’s lack of international competitiveness isn’t only that exports are too small, it is also that imports are too big, which is another way of saying that the domestic tradeable sector isn’t big enough. Normally this loss of competitiveness is associated with a growing trade and current account deficit, which means the process of non productivity supported rising living standards can only continue as long as some external agent is willing to finance it. When confidence that the process is sustainable subsides, people cease financing, and a crisis occurs. This is what happened to Italy in the summer of 2011.

Population Ageing – A Unique Historical Challenge

We live in a world of rapidly ageing populations, not just in the economically developed societies, but in many emerging nations too. Due to the one child per family policy China will be one of the fastest ageing societies on the planet in the 2020s. The economic and social implications of such a global ageing process are bound to be profound. Two points stand out: • the process is seemingly irreversible. • No other single force is likely to shape the future of national economic health, public finances, and policymaking over the coming decades. Strangely, this issue receives only a fraction of the attention that has been devoted to global climate change, even though, arguably, ageing is a problem our social and political systems are, in principle, much better equipped to deal with. In particular it would be interesting to discover why so many mainstream economists seem oblivious to the problem despite the fact that the developed world sovereign debt crisis seems so self evidently associated with the phenomenon.

Life Cycle Effects – Franco Modigliani Children are dependents, and hence net dis-savers for their families, which is why so many high fertility societies have such low savings rates. The secret to raising the aggregate saving rate is having less children. In terms of a person’s adult life, those in their twenties and early thirties tend to be net borrowers as they are relatively low earners at the same time as they look to establish a family, buy housing, educate children etc. Societies with many people in this age group tend to see rapid credit growth. At some point around middle-age the person then tends to move from being a net borrowers to becoming a net investor at just the time they enter their economic prime and accumulate financial assets to fund their retirement. After retirement people tend to maintain their living standard by gradually shedding the financial assets they’ve been accumulating to fund their nonworking days. This process is not uniform, and older people generally tend to consume less and conserve their savings. Modigliani’s life cycle hypothesis suggests that a population’s aggregate financial behaviour - just like that of an individual - changes depending on age.

So Could Something As Simple As Movements in Median Population Age Help Us Understand How Economies Evolve?

Ours is an age of rapidly ageing societies, but not all societies are ageing at the same rate. The United States for example is a very young society. And indeed even in 2020 will still be younger than Japan was in 2000. Societies are in some kind of homeostatic “bad” equilibrium when they have fertility levels of five children plus per female. As fertility falls societies develop economically, and start to age through population structure impacts. What is so modern about our current situation is not the ageing itself, which started in Europe with the industrial revolution, but its velocity, and its global extension.

As far as we are able to understand the issue at this point, population ageing will have major economic impacts and these can be categorised under four main headings: i) ageing will affect the size of the working age population, and with this the level of trend economic growth in one country after another ii) ageing will affect patterns of national saving and borrowing, and with these the directions and magnitudes of global capital flows iii) through the saving and borrowing path the process can influence values of key assets like housing and equities iv) through changes in the dependency ratio, ageing will influence pressure on global sovereign debt, producing significant changes in ranking as between developed and emerging economies.

While population ageing is universal the short term impact will be much more localised. The pace of aging varies greatly across countries and regions. The effects of the process are expected to be most pronounced in those countries that remained complacent in the face of ultra-low fertility rates (total fertility rates of 1.5 and under), which in effect means Japan, the German speaking countries and much of Southern and Eastern Europe.

Another way of looking at these demographic changes is in terms of the dependency ratio, which can be defined in a number of different ways depending on the problem being addressed. For present purposes what matters is the old age dependency ratio. In Germany total population is expected to fall from its current level of 82 million reaching anything between 69 and 74 million by 2050, depending on the future course of life expectancy, immigration and fertility. And the proportion of people aged 65 and older is projected to rise from just under 20% today to just over 33% by 2050. At the same time, the number of very elderly (those aged 80 and over) will nearly triple to as much as 15% of the total population.

In Italy population is projected to remain more or less stationary, at around 60 million, at least until the 2030s, but the age structure of the population will be constantly shifting. (Data: UN 2008 forecasts, median estimate)

Key Shift In 1970s, As Each Generation Starts To Get Smaller Than Previous One Another Key Decade In 2020s, As Elderly Dependency Ratio Rises Substantially

Italian Fertility Has Fallen To and Remained Around 2/3 Replacement Level Population Has Recently Grown Rapidly, But Only As A Result Of Immigration

There Was A Significant Increase In The Workforce And – Before The Crisis – In Employment But Due To Loss Of Competitiveness And The Strength Of The Informal Economy This Did Not Translate Into Economic Growth

Eurozone Debt Crisis Total Italian Debt Is Not Excessive In Comparison With Some Other Countries in The Eurozone, But Public Debt Is The Second Highest. Despite Normally Having Had Primary Balances Italy Has Run General Budget Deficits since The 1980s The Problem Is The Weight of the Debt, The Interest Payments

Italy Is Poised On A Knife Edge Key Factors: • Growth • Inflation • Interest Charges Hence The Problem Of Market Pressure, And Interest Rates. Any Slippage On Debt To GDP And Debt Restructuring Becomes Inevitable. Investors Are Worried. This is Not Simple Speculation. Hence ECB Support Is Critical. Deutsche Bank reduced its holdings of Italian sovereign bonds from 8 billion euros in December 2010 to 997 million euros at the end of last June.

The Demographics Of Export Dependency As populations age economies transit from being consumption driven to being export driven. Thus the process is not random or arbitrary. We are not talking about choosing between options or “growth models”. There is not a choice here, since there are deep underlying structural dynamics at work, and these dynamics seems to be intimately associated with the dynamics of the demographic transition Worryingly, Italy Still Runs A Trade Deficit And This Deficit Has Been Getting Worse Since The Financial Crisis.

Dangers of Sovereign Debt Default? According to a recent Standard & Poor's report, the timing of the current debt crisis is not a coincidence since cost of caring for the growing numbers of dependent elderly will both affect growth prospects and dominate public finance policy debates across the globe, and for many years to come. Even if most governments have long been aware of the need to prepare for the looming problem, the rapid build-up of government debt over the past three years has effectively heightened the need to do more to advance reforms aimed at containing the risks to sovereign budgets, especially in countries with high expected future increases in age-related spending.

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

A Delicate Balancing Act Reasonable empirical confirmation exists that the recent surge in global imbalances was, in part, an offshoot of slow-moving underlying demographic determinants of global capital flows. The near-term adjustments will mean more emerging market current account deficits and less developed market ones. At a global level, demographic pressures will continue to imply that the increase in desired saving will exceed the increase in desired investment. This has one clear implication: globally interest rates can be expected to remain low.

Longer, Healthier Working Lives In terms of policies to address the pressures of ‘ageing’, the debate in terms of social security and healthcare often focuses on raising retirement ages to reduce dependency rates and alleviate fiscal pressures. Extending working lives relative to the time spent in retirement will not only help address the pension issue, it should also serve to accelerate the tendency towards larger current account surpluses across most developed economies, in particular in those parts of Europe which are in the process of private sector deleveraging as part of their fiscal sustainability programme.


Time To Act – What Can Be Done? Short Term: - Continuing and Continuous Structural Reform • Labour Market Reform • Pension Reform • Heath System Reform • Immigration • Formalise the Informal Economy Longer Term: • Raise Fertility Rates • Global Rebalancing Initiatives • Acceptance that the Modern Growth Era – like modernity itself – doesn’t last forever.

 Thank You For Your Attention

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The Coming Indian Summer?

China is grabbing the headlines, but should we perhaps be looking at India instead ? 

Copenhagen, Thursday 16 June 2011.

The Coming Indian Summer? China is grabbing the headlines, but should we perhaps be looking at India instead ? Edward Hugh - Copenhagen: June 2011

• Unlike China and many Asian growth economies India is largely driven by domestic consumption, not by exports and capital investment. Given its large rural population India’s consumption basket has traditionally had a heavy bias towards food and other essentials, but the share has been declining over time. Since 2000 the share of food in total consumption has steadily declined while services, transport and communications have all increased.

In this presentation I will argue that

• In terms of growth rates and global GDP shares India has been overshadowed by the rise of China. Yet, in the longer run, at least in terms of the demography, the future belongs to India. During the coming decade India will steadily convert itself into one of the key engines of global growth.
• In demographic terms, India is undoubtedly the coming global powerhouse. The overall number of both young and prime age workers is growing rapidly and will exceed those in China over the 2025/35 horizon. And India’s demographic dividend will be operative over a very long period, even as China’s working population ages and declines.

In Growth Economics, Size Doesn’t Matter?

For 25 years our institutions have mis-analyzed such world development problems as starving children, illiteracy, pollution, supplies of natural resources and slow growth. The World Bank, the State Department's Aid to International Development (AID), The United Nations Fund for Population Activities (UNFPA) and the environmental organizations have asserted that the cause is population growth - the population "explosion" or "bomb" or "plague." Julian L. Simon, 1985: “WHY DO WE STILL BELIEVE that population growth slows economic development? “

The Great False Trail In 1967 Nobel laureate economist Simon Kuznets , at the behest of the United Nations, carried out a study of population growth and economic growth using a data set covering a wide variety of countries since World War II. The basic methodology, having assembled the data on rates of population growth and rates of economic growth, was to examine whether - looking at all the data in the sample together - those countries with high population growth rates have economic growth rates lower than average, and countries with low population growth rates have economic growth rates higher than average. The study was unable to find any statistically significant evidence that faster population growth is associated with slower economic growth. Taken on average, countries whose populations grew faster did not grow slower economically. Hence was born the idea that population dynamics were not central to economic growth processes.

Finally, The Truth Revealed, It Is Population Structure That Matters Turkey 1995 Japan 1990 Japan 2030 Adolescent Middle Aged Elderly The demographic dividend refers to the rise in the economic growth rate which occurs due to a rising share of working age people in a given population. The phenomenon is usually observed towards the end of the first phase of the demographic transition when the fertility rate has fallen far enough and long enough for the youth dependency rate to decline. During this demographic window of opportunity, output per capita rises since simple arithmetic tells us the population is more productive (as a whole).

So It’s Structure Not Size, You Silly Billy! Brazil Russia India China Right For The Wrong Reasons? The Idea Of BRICS Is JustToo Simplistic

Definitely The Short Term Is All About China On the global stage, India is still overshadowed by the impressive rise of China since 1997. According to figures from the IMF the share of global output for China, India and Brazil respectively are forecast to be 12.2, 2.9 and 3.4 percent in 2015.

But China Is Getting Old Too Fast By 2040, assuming current demographic trends continue, there will be 397 million Chinese over 65 - more than the total current population of France, Germany, Italy, Japan, and the United Kingdom combined. Median Population Age – A Simple Rule-of-Thumb Measure Of Ageing Key Point: While population ageing is universal the short term impact will be much more localised. We may be all headed to the same destination but the trains in which we are travelling are moving a different speeds.The pace of ageing varies greatly across countries and regions. China is an ageing outlier in Emerging Market Terms.

China Will Be One Of The Most Rapidly Ageing Countries in the 2020s The ageing problem goes well beyond the confines of the EU or the G7. In particular China stands out among developing economies, since the degree of ageing we should anticipate, when viewed in terms of absolute numbers and velocity, is simply staggering. It is during the 2020’s that China’s age wave will arrive in full force. The elder share of China’s population seems set to rise steadily from 11 percent in 2004 to 15 percent in 2015, and then leap to 24 percent in 2030 and 28 percent in 2040. Over the same period, China’s median age will climb from 32 to 44.

So In China Both Working Age And Total Population Will Soon Be Declining and Ageing China’s ageing is characterised by the unusual speed with which it is occurring. In Europe, the population over 65 passed the 10 percent threshold back in the 1930s and is not expected to reach the 30 percent mark until the 2030s, exactly one century later. China, on the other hand, will traverse this same distance in a single generation. The magnitude of China’s coming age wave, is simply staggering. India Has A Much Stronger Demographic Profile Than China In India the whole demographic transition is much more balanced. While the proportion of population in the under 14 age group declined from 41 per cent in 1961 to 35.3 per cent in 2001 (that is, by 5.7 percentage points), the proportion of population in the age group 15-59 increased from 53.3 per cent to 56.9 per cent (that is, by 3.6 percentage points). The proportion of those over 60 increased from 5.6 per cent to 7.4 per cent (that is, by 1.8 percentage points).

The increase in the 15-34 age-group population has been quite dramatic: from 174.26 million (31.79 per cent) in 1970 to 354.15 million (34.43 per cent) in 2000. The youth segment of the population is projected to peak at 484.86 million in 2030.

India’s Fountain Of Youth

According to UN Population Division projections the youth segment (15-34 years) of the Indian population starts to decline in absolute terms after 2030, it started to fall as a proportion to the total population in 2010. But proportionately the rate of decline is marginal (from 35.4 per cent in 2010 to 34.5 per cent in 2020, to 32.4 per cent in 2030). However after 2030 the rate of decline will accelerate (to 29.7 per cent in 2040, to 26.6 per cent in 2050). But even given this there will still be a massive 441.1 million people in the group in 2050.

But No One Is Forever Young

This demographic evolution will have important implications for the labour market. India's labour force, which was estimated at 472 million in 2006, is expected to be around 526 million in 2011 and grow to 653 million by 2031. The labour force growth rate will be higher than the rate of increase in total population until 2021. According to Indian government estimates, 300 million young people will enter the labour force between now and 2025, by which time approximately 25 per cent of the global labour force will be Indian.

In The Moden World Ageing Is A constant Phenomenon

Population ageing is a global phenomenon, driven by movements in fertility rates and life expectancy. Ageing essentially comes in two waves, which could loosely be called the first and second demographic transitions. During the first transition fertility falls from very high levels to replacement levels, the proportion of those in the working age groups rises constantly, while life expectancy increases such that the population in the 65 to 80 age group steadily increases. During the second transition, fertility in many countries falls well below replacement level and stays there for several decades. Life expectancy rises such that the over 80 population becomes a significant part of the total population and the working age population goes into permanent decline in both absolute terms and as a proportion of the total.

As far as we are able to understand the mechanisms involved at this point, population dynamics have major economic impacts and these can be categorised under four main headings: i) demographic processes affect the size of the working age population, and through this channel the level of trend economic growth – for better or worse - in one country after another ii) through “life cycle effects” demographic processes affect patterns of national saving and borrowing, and with these the directions and magnitudes of global capital flows iii) through the saving and borrowing path demographic processes can influence values of key assets like housing and equities iv) through changes in the elderly dependency ratio, demography influences pressure on the sustainability levels of sovereign debt, producing significant changes in ranking as between developed and emerging economies.

Economic Impacts Of Demography

Youth – And Economic Growth – Do Not Spring Eternal! Still, Is India Now Headed For Double Digit Growth?

The Importance Of The Prime Age Groups

Estimates of the exact age extension of the different groups vary, but 25-40 would be a good rule of thumb measure of the borrowing range, 40 to 55 for the peak savers, and 35 to 50 for the prime age workers. Beyond this, the question is an empirical one of measuring and testing to determine more precise boundaries and frontiers. The key groups are prime savers, prime borrowers, and prime productive workers. Where these actual age brackets lie, and the extent to which they may overlap, is still a subject of some controversy, One of the key points to grasp, is that the proportion the population which is to be found in one of the ‘prime’ age groups at a given moment in time, is absolutely critical, and much more important for understanding the processes at work than the mere size of the working age population.

In an ongoing process of trial and error calibration, Claus Vistesen and I have recently been working with the age groups 35-54 and 25- 39 as proxies for the prime age (peak growth) and prime borrowing age groups, respectively. On these measures, India comes out among the economies with largest combined increase between now and 2030.

India’s Win-Win Profile

Yet One More Time India And China’s Paths Cross Credit driven expansions in China will soon get harder and harder to come by, while in India the key group doesn’t peak until the mid 2030’s (should we be worried about a housing bubble??) and even then only tapers off slowly.

As A Result Consumption In India Is Strong And Fixed Capital Investment Doesn’t Reach Chinese Proportions

India’s Exports Are Growing Fast But So Are It’s Imports – It Runs A Trade Deficit (well, someone has to!). India's merchandise exports rose sharply in May, helped by a surge in shipments of engineering and electronic products, giving the government a good start towards achieving its export aim for this fiscal year. India's exports in May jumped 56.9% year- on-year to $25.9 billion and totalled $49.8 billion for the first two months of the fiscal year that started on April 1, up 45.3%, Commerce Secretary Rahul Khullar said at a press conference Friday. However, May imports surged 54.1% to $40.9 billion, touching the highest level in four years and raising worries of a widening trade deficit. The trade deficit was at $15 billion in May - the widest since August 2008

As we have seen, the demographic dividend refers to the period in the demographic transition in which the working age share of the population increases. In India’s case, this period is going to last all the way up to 2040. This is shown then in the fact that the peak growth age group (35-54) will continue growing all the way through to 2040. Generally, the conclusion on India’s demographics based on current projections is that the demographic dividend is set to be stretched over a long period. Yet We Should Always Remember - Nothing Is Automatic Despite the widespread perception of India as a country of thriving entrepreneurs, the cost of starting a business is in fact vastly greater than it is in many other key global economies, even those on a comparable income level.

Endemic Inflation India’s current inflation problem is largely a structural one, in large part due to supply side rigidities and low capacity slack in key sectors. This evidently increases the risks that headline inflation will feed into core prices, since unlike in many developed economies, India’s inflation is, in part, a demand driven phenomenon. Of the main components of the wholesale price index, only food manufacturers have seen an unprecedented in inflation since 2008 while increases in industrial and manufacturing input prices have been large but far more modest.

On The Othe r Hand The Central Bank Does Respond

Governor Duvvuri Subbarao said on May 3 inflation will stay at an “elevated level” until September as he raised the central bank’s repurchase rate by half a percentage point to 7.25 percent. Monetary tightening in India will slow growth this year and help ease inflation to 6 percent “with an upward bias” by March 31, 2012, Subbarao said. India’s economy may expand “around 8 percent” in the year through March from 8.6 percent in the previous 12 months, he estimated. And is willing to sacrifice growth for inflation discipline. Since part of the issue is strong internal demand growth Subbarao has some chance of success.

At The Same Time Governance In India Is A Concern While private sector indebtedness is low in India, government debt is high, and very high by emerging economy standards. This year’s budget- deficit target (the total government deficit is around 10% of GDP) is “difficult to achieve,” Chakravarthy Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, told reporters in Mumbai on June 2.

As A Result India Has Trouble In The Current Account Department India reported a current account deficit equivalent to 9.7 Billion USD in the fourth quarter of 2010. India is leading exporter of gems and jewelry, textiles, engineering goods, chemicals, leather manufactures and services. India is poor in oil resources and is currently heavily dependent on coal and foreign oil imports for its energy needs. Other imported products are: machinery, gems, fertilizers and chemicals. Main trading partners are European Union.

Of Course, Part Of The Problem Is Caused By The Usual Culprit QE2 – aka A Surge In Capital Inflows Net private capital inflows to emerging market economies will keep growing this year and next to reach $1.1 trillion in 2012, attracted by economic growth above 6 percent in those countries, a banking industry group said. The Washington-based Institute of International Finance today also raised its estimates for 2011 inflows by $81 billion to $1 trillion to reflect higher forecasts for Brazil and China. “The strength of capital flows is still presenting policy challenges in a number of emerging economies, especially those already facing pressures from rising inflation, strong credit and asset price growth and rising exchange rates,” the IIF wrote in its research note.

We Should Never Forget India Is Still An Emerging Economy • Despite many difficulties India has remained a democracy since independence • Human rights are by and large respected • Institutional quality is improving • The central bank is becoming more and more independent • Corruption is still a BIG problem, but this has solutions • India is a country of individuals, of creativity and strong entrepreneurial spririt • Lastly, a professional bias: India produces economists of extraordinary quality.

And Finally………

Demography We Know Isn’t Everything

But It Sure As Hell Is A Large and Significant Part Of The Picture “If you look at the world, it would inevitably appear India’s growth is preordained. The world needs working hands. The world needs back offices. India seems to be a natural fit…We are producing a workforce which is not only for India, but a global workforce.” Sunil Bharti Mittal, founder and chairman of New Delhi-based Bharti Enterprises

Thank You For Your Attention

You can download the full presentation here.

Small Nations and the Economic Crisis

Exporting Your Way Out Of Trouble Under A Currency Peg – Open University of Catalonia , Presentation during the Conference “Economic Crisis in Small Countries”, Barcelona, Catalonia, May 2011

Baltic Blues - Exporting Your Way Out Of Trouble Under A Currency Peg 
Edward Hugh  - Barcelona: May 2011

In this presentation I will argue that
• Despite some early encouraging signs, it is far from self-evident that the so called “BELLS” (Bulgaria, Estonia, Latvia and Lithuania) are going to be able to export their way out of trouble.
• Unresolved issues may leave a legacy. One which could weigh down any recovery and lead to more serious problems during the next recession In particular: a) The Existence of a Debt Overhang b) The Impact of Ageing and Declining Populations
• The “internal devaluation” process may have been underambitious and allowed to come to a halt far too soon.

Worrying Signs In Latvia Despite a substantial increase in exports

GDP Growth Is Now Slowing

Consumer Demand Fails To Recover

While Industrial Output Languishes And Investment Also Fails To Recover

So What Is The Problem? Well the first problem is debt. How can heavily indebted societies claw their way back to sustainable growth. The Key Point To Grasp – This Process Is Structural, Not Cyclical

Cheap Interest Rates Supported by the Peg Meant Latvian Households and Corporates Got Themselves Heavily Into Debt But Now The Latvian Economy Is Caught In The Vice Of A Credit Crunch

The Problem Now Is That The Credit Bust Economies Are Now Totally Export Dependent For Growth Simplifying: GDP = Consumption + Investment + Government Spending + Net Trade Which means growth in GDP = Growth In the sum of these factors Growth in Net Trade = Growth In Exports – Growth in Imports

Exports Can Grow Rapidly After A Sharp Drop But Once The Former Level Is Recovered It Gets Harder To Obtain Enough Growth To Drive GDP Forward

In Addition Workforces And Population In These Countries Are Shrinking and Ageing

Why Is This A Problem? It Is A Problem Because Your Underlying Trend Growth May Start To Slow And You Still Have To Service The Debts Accumulated When You Were Growing More Quickly.

It Is Also A Problem Because Growth In A Modern Economy Either Comes From Credit Expansion (internal demand) or Exports (paying the credits back). Consumption out of current income isn’t a huge part of the picture.

Population Ageing – A Unique Historical Challenge The economic and social implications of the ageing process are going to be profound. According to a recent report from credit rating agency Standard & Poor’s: • the process is seemingly irreversible. • No other single force is likely to shape the future of national economic health, public finances, and policymaking over the coming decade Strangely, the issue receives only a fraction of the attention that has been devoted to global climate change, even though, arguably, ageing is a problem our social and political systems are, in principle, much better equipped to deal with.

As far as we are able to understand the issue at this point, population ageing will have major economic impacts and these can be categorised under four main headings: i) ageing will affect the size of the working age population, and with this the level of trend economic growth in one country after another ii) ageing will affect patterns of national saving and borrowing, and with these the directions and magnitudes of global capital flows iii) through the saving and borrowing path the process can influence values of key assets like housing and equities iv) through changes in the dependency ratio, ageing will influence pressure on global sovereign debt, producing significant changes in ranking as between developed and emerging economies.

While population ageing is universal the short term impact will be much more localised. The pace of aging varies greatly across countries and regions. The effects of the process are expected to be most pronounced in those countries that remained complacent in the face of ultra-low fertility rates (total fertility rates of 1.5 and under), which in effect means Japan, the German speaking countries and much of Southern and Eastern Europe.

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

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

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

Time To Act – What Can Be Done? Short Term: - Continuing and Continuous Structural Reform • Labour Market Reform • Pension Reform • Heath System Reform • Immigration Longer Term • Raise Fertility Rates • Global Rebalancing Initiatives • Acceptance that the Modern Growth Era – like modernity itself – doesn’t last forever.

You can download the full presentation here.

The Demogaphic Challenge Facing Eastern Europe

The Stockholm School of Economics in Riga invites you to an open lecture: Eastern Europe and the Demographic Challenges Facing Economic Recovery delivered by Edward Hugh*. The lecture will take place on the 7th of April, 2011 from 15.00-16.30, SSE Riga, Soros auditorium, Strēlnieku iela 4a.

The issues raised in this guest lecture – ‘demographic challenges’ and ‘economic recovery’ are obviously highly relevant for Latvia, and the Stockholm School of Economics in Riga is very happy to be able to invite Edward Hugh to address these topics.

*Edward Hugh is an independent macro economist who specializes in growth and productivity theory, with particular emphasis on demographic processes and migration flows and the impact of these on macroeconomic performance.

He is a regular contributor to a number of economy-related weblogs, including A Fistful of Euros, Roubini Global Economic Monitor, Global Economy Matters and Demography Matters. He is also actively and widely followed on Facebook.

His many writings, including predictions of problems for the eurozone long before these emerged, have made Edward Hugh a household name in the blogosphere and elsewhere.

Leaving One Crisis Behind Only To Come Face To Face With The Next One? The Demographic Challenge Facing Eastern Europe
Edward Hugh - Riga: April 2011

In this presentation I will argue that • The most recent crisis was not an arbitrary phenomenon • There is an underlying process we need to understand • The worst is undoubtedly over in the last crisis • Unresolved issues may leave a legacy. One which could weigh down any recovery and lead to more serious problems during the next recession In particular: a) The Existence of a Debt Overhang b) The Impact of Ageing and Declining Populations

What Was The Last Crisis All About? It was all about debt, and about how heavily indebted societies were going to be able to claw their way back to growth. The Key Point To Grasp – This Process Is Structural, Not Cyclical So Just Why Was There So Much Debt? • Badly Structured Financial Products? • Poor Regulation? • Or Was There Something Else Going On?

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

One Conventional Account The “one size fits all” monetary policy didn’t work. Spain had negative interest rates during the key years of the housing boom. But that still leaves us with a question: why didn’t it work?

Credit Driven Private Consumption Booms In fact both Spain and Germany have had these. The only real difference is in the Timing. Germany 1992 – 1999 Spain 2000 - 2008 Why do some countries have these while others don’t?

Current Account Blues Germany didn’t always run a current account surplus. All through the 1990s the current account was in deficit. And Spain won’t always run a current account deficit, even if that seems hard to believe right now. The Key 25 to 49 Age Group This group peaked in Germany – as a % of total population around the turn of the century. And in Spain it peaked towards the end of the first decade of this century.

In The BackgroundThose Famous “Global Imbalances” But Just Why Did The Imbalances Build Up? Japan, Germany and China – the usual suspects – had substantial current account surpluses. While that other group – the debtors, countries like the UK, the US and Spain – ran substantial deficits.

Could Something As Simple As Median Population Age Help Us Understand? Ours is an age of rapidly ageing societies. What is so modern about our current situation is not the ageing itself, but its velocity, and its global extension. Population Ageing – A Unique Historical Challenge The economic and social implications of the ageing process are going to be profound. According to a recent report from credit rating agency Standard & Poor’s: • the process is seemingly irreversible. • No other single force is likely to shape the future of national economic health, public finances, and policymaking over the coming decade Strangely, the issue receives only a fraction of the attention that has been devoted to global climate change, even though, arguably, ageing is a problem our social and political systems are, in principle, much better equipped to deal with. As far as we are able to understand the issue at this point, population ageing will have major economic impacts and these can be categorised under four main headings: i) ageing will affect the size of the working age population, and with this the level of trend economic growth in one country after another ii) ageing will affect patterns of national saving and borrowing, and with these the directions and magnitudes of global capital flows iii) through the saving and borrowing path the process can influence values of key assets like housing and equities iv) through changes in the dependency ratio, ageing will influence pressure on global sovereign debt, producing significant changes in ranking as between developed and emerging economies.

While population ageing is universal the short term impact will be much more localised. The pace of aging varies greatly across countries and regions. The effects of the process are expected to be most pronounced in those countries that remained complacent in the face of ultra-low fertility rates (total fertility rates of 1.5 and under), which in effect means Japan, the German speaking countries and much of Southern and Eastern Europe.

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

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

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

Importance Of The Prime Age Groups Estimates of the exact age extension of the different groups vary, but 25-40 would be a good rule of thumb measure of the borrowing range, 40 to 55 for the peak savers, and 35 to 50 for the prime age workers. Beyond this, the question is an empirical one of measuring and testing to determine more precise boundaries and frontiers. The key groups are prime savers, prime borrowers, and prime productive workers. Where these actual age brackets lie, and the extent to which they may overlap, is still a subject of some controversy, One of the key points to grasp, is that the proportion the population which is to be found in one of the ‘prime’ age groups at a given moment in time, is absolutely critical, and much more important for understanding the processes at work than the mere size of the working age population.

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

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

Dangers of Sovereign Debt Default? According to the recent Standard & Poor's report, the cost of caring for the growing numbers of dependent elderly will both affect growth prospects and dominate public finance policy debates across the globe, and for many years to come. Even if most governments have long been aware of the need to prepare for the looming problem, the rapid build-up of government debt over the past three years has effectively heightened the need to do more to advance reforms aimed at containing the risks to sovereign budgets, especially in countries with high expected future increases in age-related spending.

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

A Delicate Balancing Act Reasonable empirical confirmation exists that the recent surge in global imbalances was, in part, an offshoot of slow-moving underlying demographic determinants of global capital flows. The near-term adjustments will mean more emerging market current account deficits and less developed market ones. At a global level, demographic pressures will continue to imply that the increase in desired saving will exceed the increase in desired investment. This has one clear implication: globally interest rates can be expected to remain low.

Longer, Healthier Working Lives In terms of policies to address the pressures of ‘ageing’, the debate in terms of social security and healthcare often focuses on raising retirement ages to reduce dependency rates and alleviate fiscal pressures. Extending working lives relative to the time spent in retirement will not only help address the pension issue, it should also serve to accelerate the tendency towards larger current account surpluses across most developed economies, in particular in those parts of Europe which are in the process of private sector deleveraging as part of their fiscal sustainability programme. Time To Act – What Can Be Done? Short Term: - Continuing and Continuous Structural Reform • Labour Market Reform • Pension Reform • Heath System Reform • Immigration Longer Term • Raise Fertility Rates • Global Rebalancing Initiatives • Acceptance that the Modern Growth Era – like modernity itself – doesn’t last forever.

You can find the presentation to download here.

Saying Goodbye to One Crisis and Hello To The Next?

SAYING GOODBYE TO ONE CRISIS?

The keynote speaker on the first morning was Mr Edward Hugh, a macroeconomist and informal advisor to the Catalan Government, based in Barcelona. He began his presentation by arguing that the most recent economic crisis was not an arbitrary phenomenon and that, while the worst was undoubtedly over for now, there was an underlying process (with all its implications for future crises) to be understood. He wondered whether we had actually learned the lessons of what had gone wrong. He believed that the last crisis was structural, not cyclical, and was all about debt. It was important for the future for heavily indebted societies to work out how to “claw their way back” to economic growth.

Mr Hugh felt that, while poorly structured financial products and regulation had contributed to debt, there was an underlying problem – demography. Taking the Eurozone as a case study, he said that during the first 10 years of the euro’s existence, some European countries had borrowed heavily, while others had lent. As a result, Spain’s households had contracted a great deal of debt, while German households had not. The ‘one size fits all’ monetary policy had not worked and Spain had suffered negative interest rates during the key years of the housing boom. Both Spain and Germany had had credit-driven private consumption booms but at different times – Spain’s a boom had been between 2000 and 2008 and Germany’s had been between 1992 and 1999. In Mr Hugh’s opinion, the key to understanding this was to look at the 25 to 49-year-old age group. As a percentage of the total population, this group had peaked in Germany, around the turn of the century and in Spain towards the end of the first decade of this century. Economic growth came from one or two sources – a big growth in either credit or exports – and this was related to demography.

Ours was an era of rapidly ageing societies, Mr Hugh commented. What was so modern about the current situation was not the ageing itself, so much as “its velocity and global extension”. The economic and social implications of the ageing process were likely to be profound. According to a report from credit rating agency Standard & Poor’s, the process was seemingly irreversible and no other single force was likely to shape the future of economic health, public finances and policy-making over the coming decade in the same way. Mr Hugh went on to say that (as far as we have been able to understand the issue at this point) population ageing would have a major economic impact and this could be separated out under four main headings.

1. Ageing would affect the size of the working-age population and the level of economic growth in different countries.

2. Ageing would also affect patterns of national saving and borrowing and the directions and magnitudes of global capital flows.

3. Through the saving and borrowing part, the process would influence the values of key assets, such as housing and equities.

4. Through changes in the dependency ratio, ageing would influence pressure on sovereign debt, producing significant changes in ranking as between developed and emerging economies.

Mr Hugh was of the opinion that, while population ageing was universal, the short-term impact would be much more localized as the pace of ageing varied greatly across countries and regions. The effects of the process were expected to be most pronounced in those countries that remained complacent in the face of ultra-low fertility rates (total fertility rates of 1.5 and under) which, in effect, meant Japan, the German-speaking countries and much of Southern and Eastern Europe. He went on to say that another way of looking at these demographic changes was in terms of the dependency ratio, which could be defined in a number of different ways. In Germany the total level of population was expected to fall from its current level of 82 million to reach anything between 69 million and 74 million by 2050, depending on the future course of life expectancy, immigration and fertility. The proportion of people aged 65 and older was projected to rise from just under 20% today to just over 33% by 2050. At the same time, the number of very elderly (those aged 80 and over) would nearly triple to as much as 15% of the total population. Mr Hugh suggested that, among emerging economies, those in Eastern Europe stood out as being by far the worst case in the short term. In 2025, more than 20% of Bulgarians would be over 65 – up from just 13% in 1990. Ukraine’s population would shrink by a fifth between 2000 and 2025, while the average Slovene would be 47.4 years old in 2025 – making the populations of Slovakia one of the oldest in the world. The ageing problem went well beyond the confines of the European Union (EU) or the G7 , he continued. In particular, China stood out among the developing economies. The very elderly share of China’s population seemed set to rise steadily from 11% in 2004 to 15% in 2015, would leap to 24% in 2030 and then to 28% in 2040.

Mr Hugh maintained that there was a generally accepted wisdom known as the ‘lifecycle hypothesis’ which suggested that a population’s financial behaviour changed depending on age. Those in their twenties and thirties tended to be net borrowers, as they were relatively low earners while they were buying houses and expensive durables at the same time as bringing up young families. At some point around middle age this group tended to move from being net borrowers to net investors as they moved into their economic prime and accumulated financial assets in order to fund their retirement. As they approached retirement this group then began to shed their financial assets to fund their non-working days. Those between 25 and 40 he categorized as ‘prime borrowers’, those between 35 and 50 as ‘prime workers’ and those between 40 and 55 as ‘prime savers’. Mr Hugh felt that the proportion of a population to be found in one of the ‘prime’ age groups at any given moment was absolutely critical for understanding the economic processes at work. With this kind of understanding of the demographic component of saving and borrowing patterns it was not hard to see how demographic forces might have played an important role in the run-up to the most recent economic crisis. The transition of economies from being consumption driven to export driven seemed to be intimately associated with the dynamics of demographic transition.

In order to prevent repeat crises, governments would need to make reforms in the short term in areas such as pensions and health systems. In terms of policies to address the pressures of ‘ageing’, the debate in terms of social security and health care often focused on raising retirement ages in order to reduce dependency rates and alleviate fiscal pressures. Extending working lives relative to the time spent in retirement would not only help address the pension issue, but would also serve to accelerate the tendency towards larger current account surpluses across most developed economies, in particular in those parts of Europe that were in the process of private-sector deleveraging as part of their fiscal sustainability programme. In the longer term, fertility rates would need to rise and global rebalancing initiatives be undertaken.

Mr Hugh rounded off by remarking that one of the standard pieces of economic observation about countries recovering from financial crisis was that their recoveries were export driven. At the same time, many developing countries badly needed cheap and responsible credit lines and access to state-of-the-art technologies and he believed that there was room for some sort of new Marshall Plan initiative to generate a “win-win dynamic”. However, he sensed that tackling global climate change was higher up some politicians’ agendas.

You can download the entire presentation here.

Why Economists Got It Wrong

A surprising feature of economic analysis of the current crisis has been the pivotal role played by a small number of bloggers, often positioned far from the academic mainstream. This event will feature one of the top bloggers on the Euro Crisis who will discuss the role the bloggers have played in our understanding of the current Euro Crisis, and in what ways having more data in our hard drive than the sum total of all previous economists changes our understanding of macroeconomics. Edward Hugh is an independent macro economist based in Barcelona. He studied at the LSE, where he obtained his BSc (econ). He then went to Manchester University where he was awarded an MSc in the philosophy and sociology of science. He subsequently persued doctoral studies there for a thesis which was never completed. He is a regular contributor to a number of weblogs, including A Fistful of Euros, Roubini Global Economics Monitor, Global Economy Matters and Demography Matters. He also has an active and widely followed Facebook community. For more information on Edward Hugh see the recent profile in the New York Times. Luis Garicano is a Professor of Economics and Strategy at the LSE's departments of Management and Economics.

Link to Video - How Life in The Internet Changes the Practice of Macroeconomics

Link to Presentation - Why Economists Got It Wrong

Macroeconomics In The Era Edward Hugh Of The Internet London: February 2011

Why Didn’t Mainstream Economists See The Crisis Coming? Three Hypotheses •Over-reliance on consensus •Excessive Belief That Markets Can Never Fail •They Were Mesmerised By Their Own Models

The Case Of The IMF For a long while after the explosion of macroeconomics in the 1970s, the field looked like a battlefield. Over time however, largely because facts do not go away, a largely shared vision both of fluctuations and of methodology has emerged. Not everything is fine. Like all revolutions, this one has come with the destruction of some knowledge, and suffers from extremism and herding. None of this deadly however. The state of macro is good............ there has been broad convergence in vision. Oliver Blanchard , Chief Economist at the IMF

"Part of the problem was the similar mindset of many mainstream economists working at the Fund, with similar background and training and who were not open to dissenting views. Both in and outside the Fund, there were other economists and policy makers with contrarian views. But their views were not encouraged or closely examined within the Fund.“ IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004-07 Background Paper: Summary of Views of the Advisory Group The IEO View (IMF Independent Evaluation Office)

The Heart of the Problem Excess of Confidence – “Feel-good” Effect Too Much Consensus – Inability To Listen The “Storks on the Wire” – false correlation – effect, years of apparent economic stability and a new generation of macro theories (the era of the so-called Great Moderation) lead to the idea that sound application of consenually grounded theory had had something to do with the apparent stability. This later turned out to have been a mistake.

As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Paul Krugman This is a widely shared view, and is certainly the case. But Krugman goes further, the world of economics as he sees it is divided between those who believe the economic system regulates itself, and those that don’t. In Krugman’s terminology, freshwater economists are, essentially, market purists. They believe that all worthwhile economic analysis starts from the premise that people are rational and markets work. My question is: are these very strong, and scarcely credible, assumptions really needed to get the game of doing useful macroeconomics started? The Freshwater and Saltwater Approach

On the other hand there are those who believe economic systems don’t run smoothly on their own: “Where the freshwater economists were purists, saltwater economists were pragmatists. ... they found the evidence that recessions are, in fact, demand-driven too compelling to reject. So they were willing to deviate from the assumption of perfect markets or perfect rationality, or both, adding enough imperfections to accommodate a more or less Keynesian view of recessions. And in the saltwater view, active policy to fight recessions remained desirable”. Demand Driven Recessions This argument seems more plausible , since levels of consumer and investment demand do fluctuate, but it still leaves us with the underlying issue as to why such shifts in demand occur. In other words, what drives these movements in demand. Is there any identifiable underlying process?

"What does concern me about my discipline, however, is that its current core —by which I mainly mean the so-called dynamic stochastic general equilibrium approach — has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one”. Ricardo Cabellero - Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome The “Core” Versus “Periphery” Argument At this level Caballero’s approach seems similar to Krugman’s statement above, but rather than put the line in the sand between “laissez-faire” and interventionist economists, he tries to differentiate between an increasingly unreal (he uses the word “surreal”) core and a series of “real-world” plug-ins which have been created to in an make the models work by making their assumptions more realistic. As Caballero notes, in fact integration of the plug-ins increasingly poses a threat to the coherence of the models they were meant to rescue. Realism vs Coherence?

But Before Going Further: What Was The Last Crisis About? The recent financial crisis was basically about debt, and about how heavily indebted societies were going to claw their way back to economic growth. In fact mainstream neo-classical economists have often found it extremely difficult to incorporate this deep structural component into their cyclically based models. But Then: Just Why Was There So Much Debt? This is a key part of the puzzle. One of the key parts of the problem is to explain why some societies got into debt, while others didn’t. Spain’s households, for example, contracted a lot of debt. German households didn’t. Why the difference? One theory is that a failure of single-size monetary policy. But is that enough to explain such massive structural divergence?

Then There Were Those Famous “Global Imbalances” – But Just Why Did The Imbalances Build Up? Japan, Germany and China – the usual suspects – had their massive current account surpluses. While that other group - the debtors, like the UK, the US and Spain – ran substantial deficits. So with such mundane macro processes like these as the backdrop, do we really need to start by talking about rare phenomena and “fat tail” events here?

So What Really Are The Problems With Macroeconomics? Surely comprehensive macro theory should be able to handle and explain such general global phenomena. Ricardo Caballero in his paper “Macroeconomics after the Crisis: Time to Deal with the Pretense-of- Knowledge Syndrome” makes some strong assertions, which I think macroeconomics needs to challenge and give a response to. • Complexity Implies Uncertainty • Events Cannot Be Foreseen • Something Is Rotten In The Core of Neo- Classical Theory "The idea is to place at the center of the analysis the fact that the complexity of macroeconomic interactions limits the knowledge we can ever attain. In thinking about analytical tools and macroeconomic policies, we should seek those that are robust to the enormous uncertainty to which we are confined, and we should consider what this complexity does to the actions and reactions of the economic agents whose behaviour we are supposed to be capturing". Does Complexity Really Imply Uncertainty? Really there is uncertainty, and uncertainty. I may be able to identify a housing bubble, but I cannot tell when exactly it will burst (although “x” months after the central bank starts raising interest rates would be a good rule-of-thumb approach - think China now). Multi year GDP forecasts may be the next best thing to useless, but is it completely impossible to identify the level of trend growth for an economy at any given moment in time. Spain’s economy was growing at about 4% a year for the best part of a decade, but would anyone like to bet me we will see average growth rates of over 1% annually between now and 2020? Is The World Really So Uncertain As Caballero Claims?

Really there is uncertainty, and uncertainty. I may be able to identify a housing bubble, but I cannot tell when exactly it will burst (although “x” months after the central bank starts raising interest rates would be a good rule-of-thumb approach - think China now). Multi year GDP forecasts may be the next best thing to useless, but is it completely impossible to identify the level of trend growth for an economy at any given moment in time. Spain’s economy was growing at about 4% a year for the best part of a decade, but would anyone like to bet me we will see average growth rates of over 1% annually between now and 2020? Is The World Really So Uncertain As Caballero Claims?

"In my view, the conviction that one can foretell a severe crisis in advance is mostly a manifestation of pareidolia—the psychological phenomenon. That makes people see faces and animals in clouds and the like.“ Ricardo Caballero Knowing What You Might Know, And What You Almost Certainly Don’t Know In a manner which is extraordinarily reminiscent of the way scholastics treated the move from the closed to the infinite universe, Caballero ridicules attempts to give a predictive edge to economic theory. In Newton’s day appeal to non material forces of attraction (like gravity) was ridiculed as being no better than mere astrological quackery. Today we are faced with a transition in the way we think about things which is every bit as profound as the shift from Newtonian to Einsteinian physics.

But Then What Really Is The Problems With Modern Macroeconomics? "The core approach to macroeconomics, as it is taught in most graduate programs and as it appears in leading journals, begins with a neoclassical growth model. This model is then developed into a stochastic form....“ Ricardo Caballero The Neo-Classical Core So at the heart of modern macroeconomics lies the neo-classical growth model, and the assumption of some form or other of – hard to define – steady state growth. Some notion of this kind has to lie behind all those weird and wonderful RBC models, or the game could never commence. But just how reasonable are the premises which lie behind this assumption?

"All theory depends on assumptions which are not quite true. That is what makes it theory. The art of successful theorizing is to make the inevitable simplifying assumptions in such a way that the final results are not very sensitive.' A "crucial" assumption is one on which the conclusions do depend sensitively, and it is important that crucial assumptions be reasonably realistic. When the results of a theory seem to flow specifically from a special crucial assumption, then if the assumption is dubious, the results are suspect.“ Solow, R. M. (1956). A contribution to the theory of economic growth. Quarterly Journal of Economics 70(February):65-94. Solow’s Simplifying Assumption Now one of those simplifying assumptions for Solow, and the whole neo classical growth approach is based on this is that POPULATION IS AN EXOGENOUS VARIABLE. Just how realistic is this assumption?

What Happens If We Make Population Endogenous? Instead of treating the relative rate of population increase as a constant, we can more classically make it an endogenous variable of the system. Suppose, for example, that for very low levels of income per head or the real wage population tends to decrease; for higher levels of income it begins to increase; and that for still higher levels of income the rate of population growth levels off and starts to decline. Solow: Homogenisis & Steady State Dynamics What Happens If We Make Population Endogenous? Instead of treating the relative rate of population increase as a constant, we can more classically make it an endogenous variable of the system. Suppose, for example, that for very low levels of income per head or the real wage population tends to decrease; for higher levels of income it begins to increase; and that for still higher levels of income the rate of population growth levels off and starts to decline. Solow: Homogenisis & Steady State Dynamics But Do We Really See Homogenisis In Reality? Is there a self correcting “”hidden hand” type mechanism at work here? Do societies converge towards a common steady state income per capita growth rate as they age?

One Size To Fit Them All – Median Population Age Could it really all be as simple as this?

A Simple Model Of Current Account Dynamics Using Demography and Median Age Claus Vistesen If Lions Could Speak, Would We Really Be Able To Understand Them? The Role Of The Internet I – The Arrival of the Sell Side Analyst Nikkei Peak, and Japan Dependents Ratios From The Golden To The Grey Age, Deutsche Bank Special Report. Can Greece Really Pay All That Debt?

The Role Of The Internet II – New Media Universities won't survive. The future is outside the traditional campus, outside the traditional classroom. Distance learning is coming on fast Peter Drucker - I got my degree though e-mail

The Role Of The Internet III – Social Networks

The Role Of The Internet IV – Access To High Volume Data

The Role Of The Internet V – Qualitatative Data Despite the obsession with building robust quantitative models. In real world economics, at the empirical level, Quantitative data – like PMI & Labour Force Surveys – ProvesTo Be Incredibly Useful. The Role Of The Internet VI – Sharing Information & Perspectives The new information technology.. Internet and e-mail.. have practically eliminated the physical costs of communications. Peter Drucker Are There Positive Externalities Associated With Sharing Information?

So What Does The Future Look Like? I’ve seen it, but does it work? The Japanese Case

And What About Spain? And That “Horrid” European Sovereign Debt Crisis?

According to the World Bank, the nine countries that have been attracting the bulk of capital flows since the crisis are Brazil, China, India, Indonesia, Malaysia, Mexico, South Africa, Thailand and Turkey. - World Bank‘: Global Economic Prospects 2011. Can We Really See Nothing In Advance?

Monetary Policy In the Age of A Global Economy Ben Bernanke’s Latest Statement “With regards to commodities inflation in developing economies, Ben Bernanke asserted that central banks there were equipped to deal with it. They could raise interest to quash price pressures and also allow the exchange rates of their currencies to appreciate to counter imported inflation””. Globalization is an ecosystem in which economic potential is no longer defined or contained by political and geographic boundaries. Economic activity knows no bounds in a globalized economy. A globalized world is one where goods, services, financial capital,machinery, money, workers and ideas migrate to wherever they are most valued and can work together most efficiently,flexibly and securely. Richard Fisher , President of the Federal Reserve Bank of Dallas

Thank You Very Much For Your Attention Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past, the ocean is flat again. John Maynard Keynes