GEM, The New Global Economy Weblog

I have been a little quiet in recent days as I have been working away on a new project. It has a name: Global Economy Matters.

GEM is a group weblog devoted to following issues related to the global economy. Participants in the main are macro economists. The participants on the blog have really come together around the idea that understanding individual country economies increasingly involves understanding the global context in which they operate. Hence the name.

Posts to date are:

Devil May Care: Can Heterodox Policies Co-exist With or Become a Limited Part of Free Market Systems? by Aninda Mitra

The US Economy In Perspective by yours truly, and...

Structural Drivers of Global Macroeconomic Imbalances by Claus Vistesen

Japan in a Quandry

To raise or not to raise, that is the question, for the BoJ at least. This seems to be just one more between a rock and a hard place situation. According to Bloomberg:

The Bank of Japan may raise its benchmark lending rate from 0.25 percent, stepping up efforts to head off an investment bubble.

The reason for the fear is not a sudden and excessive rise in consumer related activity (like construction) but a rapid build up in investment (which means more capacity, capacity for which the demand may be lacking in sufficient quantity):

Large companies plan to increase investment in the year ending March 31 by the fastest pace since 1991, the central bank's quarterly business survey showed in December.

``Short-term interest rates are exceptionally low in Japan, in particular against the backdrop of the much improved structural situation of the economy,'' said Jan Lambregts, head of Asian research at Rabobank International in Hong Kong.

Now it is important to keep in mind here that Japan's recent growth spurt is largely driven by export demand, and the investment activity needed to sustain this dynamic. Domestic consumption still remains extraordinarily weak (and the reason for this may well be the age structure of Japan's population, as I attempt to argue here):

Some economists said the bank may postpone a rate increase until February so that it can confirm a revival in consumer spending when the government releases its gross domestic product statistics in mid-February. The 0.9 percent drop in consumer spending was the main drag on growth in the third quarter.

Now obviously containing animal spirits on the investment side is important, but what of the impact of any coming rate hike on domestic consumption, the deflation issue, and of course the costs of servicing Japan's enormous public debt?

A one-percentage-point gain in the yield on Japan's benchmark 10-year bond would increase the country's debt-servicing costs by about 1.6 trillion yen next fiscal year, the finance ministry estimated in December.

The deflation isssue should not be treated lightly, in particular since, as MS's Takehiro Sato pointed out last Friday:

Fundamentals are favorable, but there are a number of headaches for policy makers. Since oil prices are dropping faster than expected, the possibility of a drop into negative territory for the CPI is moving beyond just a risk and becoming the main scenario.

All in all, confrontation may well be looming, between the Japanese government and the BoJ, and if it is not very careful the bank may gain short term advantage by damping down excess investment only at the price of provoking a return to deflation and a loss of its credibility and independence in the longer term.

Euro Bond Markets

According to the FT this morning:

The euro has displaced the US dollar as the world’s pre-eminent currency in international bond markets, having outstripped the dollar-denominated market for the second year in a row.

The data consolidate news last month that the value of euro notes in circulation had overtaken the dollar for the first time. Outstanding debt issued in the euro was worth the equivalent of $4,836bn at the end of 2006 compared with $3,892bn for the dollar, according to International Capital Market Association data.

Outstanding euro-denominated debt accounts for 45 per cent of the global market, compared with 37 per cent for the dollar. New issuance last year accounted for 49 per cent of the global total.

Now this is all fine and well, and as it should be, but given the importance that euro denominated debt has now assumed we had all better keep our fingers crossed that there is no major crisis in the Italian government's willingness and ability to maintain its sovereign debt obligations.

Recycling Imbalances and FDI

This news is interesting:

The South Korean government on Monday unveiled its much-heralded measures to encourage companies to invest more abroad, exempting domestic investors from capital gains tax on overseas equity earnings and easing restrictions on foreign real estate purchases.

It also fits in with a point Stephen Jen made on the MS GEF last Friday:

‘Sovereign wealth funds’ increasingly important

China has recently announced that its Hueijing Holding Company, which is managed by SAFE, will start to invest some of the reserves in a broader portfolio of foreign assets than sovereign bonds and publicly guaranteed mortgage instruments. Further, it is likely that Japan will also start to deploy the investment earnings on its stock of reserves (leaving the principal untouched) to more aggressive investments. We have argued for a while that central banks, as they accumulate reserves that they don’t need for liquidity purposes, will start to invest the ‘excess reserves’ in more creative ways. This process is likely to take a major step forward this year, we believe, with some official reserve money being allocated to equities and non-G3 markets.

This is rather different from the kind of plan which is being currently considered by the Indian government since the excess reserves will be recycled externally, while the Indian proposal would seem to be for an internal recycling, which would hardly, I think, address the main problem:

India is exploring whether it can use a part of its near-record foreign-exchange reserves of $175.5 billion to fund the nation's bid to modernize roads, ports and airports, the finance minister said.

Prime Minister Manmohan Singh said in October that the nation will need as much as $320 billion over the next five years to improve roads, ports and other infrastructure, underscoring the key nature of public works in attracting companies, generating jobs and speeding up economic expansion to cut poverty. India's economy has grown by an average of about 8 percent in the past three years.

Now while these external recycling proposals would undoubtedly help ease the internal problems generated by the imbalances for the countries concerned, they would, in effect, simply displace the problem as they would add to the already high levels of global liquidity. As the above-linked FT article notes, in the Korean case:

The cap on investment in overseas real estate was raised from $1m to $3m (€2.3m, £1.5m), and the finance ministry signalled the limit would be scrapped within three years.

So this could well be a policy to help ease the rising won issue, but could have the knock-on effect of sending even more cash into already over-heated property markets in Shanghai, New Delhi, Berlin or downtown Tokyo. In other words all of this will do little or nothing to get to grips with the outstanding imbalances problem. If there is a dearth of real investment opportunities (the reverse face of the savings glut) then sending more cash in to fund them does not necessarily help much.

US Labour Market

The above summary of US births 1905 - 2002 comes courtesy of the US National Center for Health Statistics via Ken Gronbach's excellent US Demography and Generational Marketing blog and serves as an useful introduction to a recent speech from Chicago Fed President Michael Moskow (thanks to John Booke in comments for drawing this speech to my attention).

This data point is a useful first reference:

About two-thirds of household income comes from employment income, and employment expenses make up about two-thirds of business costs. So the analysis of labor markets plays a key role in assessing the spending and growth prospects for the economy as well as cost pressures on inflation.

Moskow, as is obviously perfectly normal and reasonable, is concerned with sustainability and employment and inflation levels. In this context he makes the following very interesting point:

The demographics of the workforce are constantly changing. New labor market institutions have altered the way firms hire, organize, and pay their employees. Monetary policy could go off track if we don't recognize the impact of such structural changes on the economy and the benchmarks we use to evaluate the incoming data.

Now as he also states in order to assess sustainable growth levels it is necessary to estimate the number of available workers, and thus economists need to understand the underlying trends in population growth and labor force participation. He then goes on to make the following point:

the working-age population grew rapidly in the 1960s and '70s, averaging two percent per year, as the baby boomers finished school and entered the labor force. But starting in the early 1980s, working-age population growth slowed to a little more than one percent per year. And it's projected to fall a bit further over the next decade, given the size of the younger generation entering the workforce relative to the size of the retiring baby-boom group.

The labor force participation rate is also changing. From the early 1960s until around 2000, the labor force participation rate increased steadily, as a rise in the fraction of women who work outside the home offset a slow decline in the fraction of men in the labor force.

Now as Moskow says labor force participation declined considerably during the recession of 2001 and has not returned to its previous levels. The search for the reasons that lie behind this has given rise to a good deal of debate inside the US. One interpretation was that this lower participation rate was a sign of an economy that remained weak long after the official end of the recession. This interpretation assumed that many people who couldn't find work gave up looking and withdrew from the labor force. The Chicago Fed President has another interpretation: that the decline in US labor force participation was mainly a manifestation of long-run changes in US demography as well as a number of ongoing cultural trends.

One of the demographic trends relates to the aging baby boomers. There's a lot of focus on them approaching the traditional retirement age of 65, but people tend to scale back their participation well before that. Indeed, more and more boomers are past the age at which people are most likely to participate in the workforce.

Furthermore, the increase in female labor force participation seems to have run its course. The women of my generation entered the labor force in greater numbers than the women of my mother's generation. And the women of my daughter's generation participate in greater numbers than the women of my generation. But these increases no longer appear to be occurring. It's likely that the women of my granddaughters' generation will participate at the same high rate as my daughter's generation.

The age distribution of the US population has implications for the number of jobs the US economy needs to create. As Moskow notes, during the 1990s the economy needed to create 150,000 new jobs a month just to mark time on the unemployment rate, but with the looming retirement of the baby boomers, this figure may drop to something nearer to 100,000.

He then goes on to point out that a number of social and cultural factors could change this picture, like a decision by boomers to work longer than has previously been the norm, and then comes a most surprising and interesting statement:

Of course, the proper benchmark depends on other factors as well, including growth in household wealth, the long-run health of Social Security and Medicare, and trends in fertility, life expectancy, and especially immigration.

Now I think this is the first time I have seen these factors - immigration, fertility and life expectancy - linked in this way. Could he, I have been asking myself, have been reading Democracy Matters? Joking aside, I think he is absolutely right, you cannot make a worthwhile evaluation of sustainable growth for en economy over the longer term without incorporating these three parameters in your model (and this is, of course, only one simple supply side issue (and only labour at that, without thinking about life cycle savings). But I would say there is enough with what MosKow says, once you incorporate these three simple parameters in your model, the neo-classical theoretical postulate of steady state growth is DEAD, stone dead (thanks John).

Of course Moskow is a very intelligent commentator, and he is quite clear that it is not only the quantity of workers that matters, but also their quality, since this affects productivity growth.

And here, of course, the evolution of education levels is important. In the US context he is not exactly positive about the current situation:

Gains in education and other workforce skills by new entrants, and skill improvements by remaining workers, could allow us to avoid much of this decline. But if we consider recent education trends, I'd say we have our work cut out for us on this. College graduation rates are growing, as families have noted the very high and climbing economic returns to education. But high school completion rates have stalled, and there is a great deal of dissatisfaction with the results in our public elementary and secondary schools, especially given our already enormous investment in education. Clearly, more systemic changes are needed to achieve better educational outcomes and boost the growth in worker skills.

So one of the concerns in the present US conjuncture is that labour quality may be negatively affected by the rapid retirement of boom generation workers. Another level at which feedbacks may operate is via birth postponement, and its consequences for fertility if the mentioned increase in College graduation rates is substantial. That is the flow of workers into the labour market may be reduced in the short term by the decision by large numbers of young people to obtain more education, and in the longer term by the reduced flow of children which may be produced via birth postponent and the impact of this on fertility (both in timing and final quantities).

Also in terms of the short term evolution of productivity he draws our attention to the following:

"In the late 1980s, about 15 percent of the labor force was 45-54. This share has since trended up and now appears to be peaking at 23 percent."

Now since many workers in this age group have historically been regarded as among the most productive (so called prime age workers) the fact that they may now have peaked as a percentage of the labour force might be considered to contain some implications for potential future productivity growth.

All in all, a very interesting speech, which is well worth reading in full.