Our revels are now ended

The unavoidable tide of demographics and globalisation will bring an end to the long economic boom

This article is taken from the August/September 2022 issue of The Critic. To get the full magazine why not subscribe? Right now we’re offering five issues for just £10.

I really hope you enjoyed the past three decades given we’ve never had it so good, because the next few decades are going to be horrendous. Wait, let me rewind: where are we, economically? Not day-to-day; not post-Covid or mid-war or mid/whatever-Brexit, but panning out to a longer perspective. This boils down to two macro factors, two tides you can’t swim against: demographics and globalisation.

“The political divide of the future will be over the elderly protecting their social safety net and the working-age population their real post-tax incomes.” This was Charles Goodhart and Manoj Pradhan in an influential paper written for the Bank for International Settlements (BIS) in 2017, which they expanded into The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival, published in August 2020 before the wheels really fell off the world economy. Life comes at you fast these days.

There is a brief (terse, even) postscript where they try and read the runes on early-doors Covid’s effect on their argument:

The overall impact will be to accelerate the trends we have outlined. China will become more inward-looking and less deflationary globally, and inflation will rise much earlier and faster than anticipated.

This short, punchy book, peppered with simple charts backing their arguments, is distressingly convincing; presumably the next edition will have a chapter on the impact of the “full” pandemic, Putin’s war, etc, but you have to stop somewhere.

Their argument, roughly, is as follows. We’ve just come to the end of history’s largest ever positive labour supply shock. Deng Xiaoping’s reforms in the 1980s — culminating in China being welcomed into the WTO in 1997 — more than doubled the available global labour supply for tradeable goods. Compounding this, since 1990 the Chinese working-age population has increased by 240m (versus about 50m in the US and not much in Europe), and 370m Chinese have moved from the countryside to cities, where they contribute to the international economy. The world’s largest urban centre, the Pearl River Delta, was a collection of villages when I started my first job, and the urban share of the Chinese population has increased from 25 per cent to 60 per cent since 1990.

This colossal supply shock was amplified by 200 million working-age Eastern Europeans joining the available global workforce following the fall of the Berlin Wall in 1989. But that’s not all: there has also been apolitical move to radical globalisation, untrammelled internationalisation of supply chains and general economic liberalism, particularly after the 2001 Doha trade round. Thus, in the 30 years to 2017, trade flows grew by 5.6 per cent per annum while GDP grew “only” 2.8 per cent per annum. China’s share of global manufacturing trebled just in the 15 years up to 2017. It’s unlike anything else in history.

The impact has been to create a world where central bankers could basically do no wrong, but still take all the credit (Goodhart was a member of the MPC for four years, so it’s good of him to admit this). We exported inflation east while our economies grew at home, and Asia’s exploding workforce could soak up all the supply we could throw at it without prices going up. Investors could barely lose, and the inflation accompanying our growth was invisible because it was showing up in somebody else’s accounts.

Inflation in the West has thus been pinned to the floor for nearly four decades, leading to a bull market in bonds spanning two generations (bond prices move inversely to interest rates, which tend to follow inflation): yields on developed-economy bonds have tumbled in a pretty straight line for the past 40 years, from 10-15 per cent in the early 1980s to basically nothing about six months ago, a move amplified by Chinese purchases of Western government bonds to keep their own exchange rate in check, and since these bond rates are the “discount rates” used to value shares it has led to stock markets booming (particularly for tech stocks whose earnings are further in the future) as well as good times for the pension funds that ride on their coat tails.

Globally, outside of economics, this has been overwhelmingly great news. As monitored by the World Bank, the proportion of Chinese living in extreme poverty has reduced from 90 per cent in 1981 to 0.2 per cent now (Deng’s move to “socialism with Chinese characteristics” has arguably been one of the best political moves in history); in India the comparable figures are 60 per cent down to 10 per cent, and even Ethiopia (the poster-child for poverty when I was a child) has reduced from 75 per cent in 1992 to around 20 per cent now and this latter would be lower if it weren’t for their almost continual wars.

So all those cheap garments and disposable plasticky whatsits you’re meant to feel so guilty about buying have lifted unimaginable numbers of people out of unimaginable lives. And the fight against communism also seems quietly to have been won: in the decade preceding the pandemic, the private sector has accounted for 60 per cent of Chinese GDP, 70 per cent of tax revenue and 90 per cent of employment.

Workers have lost bargaining leverage

Politically though, this sharply lower inequality between countries (the ratio of US-to-China worker wages reduced from 35x in 2000 to 5x by 2018) has come at the expense of far greater inequality within countries: workers have lost bargaining leverage by viable threats of international outsourcing, so membership of trade unions has halved since 1980 in the UK, the US, France and Germany even as members’ wages have been suppressed.

This wage suppression has itself supported the profitability and growth of western companies, as pointed out by Anna Stansbury and Larry Summers (the “Declining Worker Power” hypothesis). The working-age working class has borne the brunt: lower-middle-class wages have stagnated (at best) in real terms while the spoils have accrued to the managerial and capital-owning classes, as Thomas Piketty doesn’t tire of pointing out, and this has slowly but surely built a political powder-keg.

Resentment at loss of negotiating leverage has led workers to back populist candidates and movements (often of the right rather than the left, socialists being by instinct internationalists), which is now leading to a withering-on-the-vine of globalisation, the return of inflation and sabre-rattling on trade and other barriers. The future really won’t be like the past: “as labour becomes scarce again, it will recover its mojo”.

In an extraordinary coordination of sweet-spots, this move to globalisation, compounded by a step-change in technology (and its mass adoption) and by very positive demographic shifts in Asia, has been amplified by positive demographic moves in the West. Post-War baby-boomers have passed through western workforces like a pig passing through a python: as the boomers entered the workforce but had fewer children themselves, and as the increase in elderly life expectancy was only gradually working its way into the demographic tables, there was a very helpful hump in the age profile of much of the West which basically meant that proportionately a lot of our people were working, rather than requiring support. I’m really trying not to bore you with too many statistics, but you get the picture

So much for the good times, which will look better and better as they recede in the rear-view mirror. As the consequence of its one-child policy, China is now facing complete stagnation in its labour force — the working-age population ground to a halt in about 2010 and started a steady decline around 2015. The internal migration from farms to cities has also run its course.

Childbirth statistics in most of the developed world have been below replacement rate for decades, and the dependency ratio (children + pensioners as a proportion of working age population) in advanced economies has increased from about 50 per cent in the 1980s to nearly 60 per cent now, and is still climbing steeply.

This puts pressure on taxes, services and social cohesion. China’s dependency ratio, by the way, was 35 per cent in 2010 and is forecast to near 70 per cent by 2050; the People’s Bank of China might be publicly committed to deleveraging, and is letting its tech and real estate sectors go to the wall to prove it, but the Chinese economy will have its snowglobe shaken as the elderly dissave to fund their own retirements in a state with almost no old-age safety net. It will be difficult for Chinese workers to feel too responsible for caring for the elderly “like in the old days” when every overworked labourer now has four grandparents.

What will this mean for what’s coming? Inflation will not prove a temporary blip. The low inflation of the last couple of decades will not soon resume. Wage demands will match or exceed inflation. We shall shortly see how committed central banks really are to fighting inflation when their economies’ potholes open into sinkholes.

There are counter-arguments. The obvious one, albeit vague, is “tech”. We’ll need it, every bit of it and more, and to an extent a steady advance is already priced into forecasts; but the key shortage will be health and care workers where tech has been making fewer inroads.

Another counter-argument: Gertjan Vlieghe (a member of the Bank of England’s rate-setting Monetary Policy Committee) pointed out in a speech last year that the increase in the 50s age-bracket is just where people accumulate wealth most rapidly (they have high earning power and fewer dependents). This will be deflationary.

The other obvious objection is Japanification — the persistent failure of inflation to rear its head in Japan however high their debt goes, as an economy adjusts to gerontocracy. We’re a little behind Japan, but they are forecast to hit a dependency ratio of over 80 per cent by 2040, with a dementia rate of 4 per cent. The key argument is that Japan had an option not open to us: as their demographics went through the nightmare we’re about to encounter, they were able to move production to neighbouring low-cost countries. This has allowed them to sustain a 2 per cent per year improvement in per capita productivity even as their economy barely grows, and a lot of their manufacturing base is now in the near-abroad. Looking ahead, those productivity numbers are figures to envy.

The best counter-argument to most complicated matters are the “unknowns” — how many of the really big events of the past few decades were usefully foreseeable? There are so many possibilities that could change the story: a cure for dementia, cracking the nut of fusion power, a really nasty pandemic, political upheaval, but it’ll probably be unknown unknowns invisible from where we stand. Helpfully vague.

To bring the story bang up to date, the ONS have just released their 2021 census, which revealed nearly 2 million more pensioners in England and Wales compared to a decade ago but a quarter million fewer under-4s, 350,000 fewer people between 15 and 24, and 650,000 fewer people in their 40s: these age-groups should have been the engine-room of our economy over the next decades.

It might be worth panning out again to put this in context: retirees made up 13 per cent of the UK population in 1970, 16 per cent by 2010 and as of the 2021 census that figure is now 19 per cent. (For reference, a third of Japan is now over 65, and they sell more nappies for the elderly than for babies.) As this trend continues, the number of high-dependency over 85s in this country is expected to double in the next 20 years and the proportion of the UK population living with dementia is forecast to increase from 1.5 per cent to 2.5 per cent of the population, putting huge pressure on social care and healthcare.

The scarce resource of the future is going to be labour

We aren’t enormously out of step with the rest of the world; the global population with dementia is forecast to treble in the next 30 years, and it’s going to be the biggest problem that nobody is talking about. Theresa May thought that being honest about the need to grasp the funding-of-social-care nettle would be a good thing to mention to an electorate. But regardless of the current arguments on immigration policy, it is looking like the scarce resource of the future is going to be labour — workers to look after us in our dotage.

Inevitably, having such a top-heavy demographic profile is starting to get seriously expensive; our NHS consumes around 44 per cent of day-to-day public spending from departmental budgets, up from around 27 per cent a generation ago. The recent increase in National Insurance will disappear into its gaping maw without trace; there is already talk of healthcare workers striking. Social care is now, infamously, so lamentably underfunded that hospitals grind to a halt because there is nowhere to discharge recovered elderly patients.

The amount of money required is close to unfathomable. It will have to come primarily from tax increases because assuming that the Bank of England will allow real rates to remain negative to steadily deflate the impact of continued borrowing on public debt, the appeal of government bonds for international investors withers.

Workers and pensioners both have leverage, increases in tax rates are themselves inflationary. We are in a debt trap after the profligacy of our response to the financial crisis and Covid. Even before the pandemic, the OBR forecast that public sector net debt would increase from about 80 per cent of GDP to nearly 300 per cent of GDP over the next 35 years. No politician has plausibly explained how this will be funded. Perhaps we need to send tugs into the Channel to tow unsuspecting boats of workers towards our grateful shores; perhaps we could repurpose Nigel Farage’s “Breaking Point” poster as a job advertisement in the red-hot carer market for an increasingly geriatric population. If the alternative is 50-year mortgages and taxes on the childless, then we are already in crazy policy territory.

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