Notes on 'The Great Demographic Reversal'

22 September 2022

These are my notes on Goodhart and Pradhan’s The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival.

Their core hypothesis is that the demographic and globalisation factors that have been responsible for disinflation over the period c. 1990-2020 are now reversing.

Further, they believe that the effects of demography and globalisation on economic trends are overlooked and ‘neither financial markets nor policymakers are prepared for a significant rise in inflation or wages or a rise in nominal interest rates’. Such actors are therefore not prepared for a future that the authors believe ‘will be nothing like the past’.

Deflationary forces

A number of deflationary forces are outlined which essentially facilitated low inflation in advanced economies over the c. 30 year period to 2020:

  • The integration of China into the world economy under Deng Xiaoping doubled the available labour supply to advanced economies due to a very large increase in the Chinese working age population coupled with urbanisation
  • The re-integration of Eastern Europe after the collapse of the USSR
  • International trade agreements (Uruguay 1986, Doha 2001)
  • Trade flows grew at double the rate of GDP (5.6% p.a. vs. 2.8% p.a.) 1990-2017
  • Positive supply shock to labour results in weakening bargaining power of labour force, resulting in fall in real wages
    • Associated reinforcing phenomenon of decline in private trade union membership
  • Inflation in advanced economies generally below the 2% target typical of central banks, despite government debt/GDP doubling or more in most advanced economies 1990-2017
    • Low rates of inflation and declining interest rates …
    • … therefore declining real interest rates, with resultant increasing asset prices e.g. in equities, housing

Distributional effects of deflationary forces

These deflationary forces have had an impact on inequality in advanced economies:

  • Wealth and income inequality — where income inequality is defined as the ratio of the income of the top 10% compared to the rest — has worsened within most countries
  • Income inequality between countries has generally improved
  • Slow rate of growth in wages for lower-skilled labour
  • Those who benefit are those with financial and/or human capital in advanced economies, plus workers in China and Eastern Europe

Political effects of deflationary forces

In turn these distributional effects have impacted politics in advanced economies:

  • A greater proportion of voters have less faith in political institutions
  • Many do not see likelihood of improvements in level of material well-being over the next decade
  • Political ‘populism’ and crisis of economic liberalism
  • ‘Great moderation’ of c. 15 years prior to 2008/GFC the best for ‘general economic success in the history of the world’

Inflationary forces

The demographic characteristics of advanced economies will change as societies age, with a relatively smaller working-age population:

  • Healthcare requirements will increase
    • The authors use dementia as an example of a disease which does not reduce life-expectancy but does impact economic production (no longer in work force) and consumption (require care)
    • The care of the elderly cannot be off-shored in the same way that e.g. manufacturing can …
    • … nor can it be automated, with the authors stating: ‘the concerns about the world running out of jobs are likely to be unfounded — there will be more than enough jobs looking after the old’
  • Slowing globalisation e.g. in China reduced numbers emerging labour force due to demographics, also reduced internal migration from western (agricultural) to eastern (manufacturing) provinces
  • Lower cross-boarder flows of goods and services as a result of ‘populism’

Effects of inflationary forces

  • Reduction in growth of real output absent a serious increase in productivity

  • Deflationary bias will be replaced by inflationary bias as the ratio between (net) productive workers and (net) consuming dependents changes

  • The authors’ base case is that pensions will keep pace with real GDP growth and so tax rates on workers will increase in line with the proportion of pensioners to workers

    • Pensioners represent a distinct bloc of voters, and one which is more likely to vote than e.g. young adult voters
  • Expansionary monetary policies have reduced interest rates therefore high public and private debt levels

    • As a result advanced economies are to a greater or lesser extent in a debt trap which reduces the speed at which central banks can increase rates without causing recession
    • To escape the debt trap will require one or more of: growth, unexpected inflation, debt default, debt jubilee (cancellation), debt restructuring, a shift from debt to equity financing — with growth being the only case with no downsides
  • The authors expect such results to read across to trade-offs in policy and state that ‘the idea that there are available structural supply-side policies that could painlessly raise productivity is, alas, a fantasy’

    • They do however state that birth rates have not been going down sharply in the Indian subcontinent / Africa; it is possible that these places could develop per China — which would provide disinflationary forces again
  • As debt ratios have gone up, interest rates have been set lower and lower; ‘central bank policy has eased the path for politicians’; the expectations is that interests will not be so aligned in future