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Wednesday, January 30, 2008

Tomas Sobotka on Fertility Trends in Europe

Today I would like to recommend to you a power point presentation by Tomas Sobotka, entitled Fertility Trends in Europe, and I want to recommend it because it gives a really clear and accessible summary of the state of the art in the ongoing debate about the whys and wherefores of contemporary European fertility. In this sense this post is really a companion and follow up to my earlier review of European fertility (and here, and here) which was basically itself a review of an extensive article in the Economist on the topic.

Sobotka's interest in the presentation is primarily in what has come to be known as the Second Demographic Transition (SDT), and the principal question he wants to ask is whether below-replacement fertility an inevitable outcome of this transition? His conclusion is that it isn't. My feeling is, however, that at this point in time this is an almost impossible question to answer, since we are still a long way from knowing what will be the ultimate resting point of both the mothers age at first childbirth and long term completed cohort fertility. Sobotka gives a very extensive and exhaustive summary of many of the current arguments about the SDT, and some of his findings are even surprising, but in this post I would like to neatly sidetep such issues and instead focus on two major topics which also feature prominently in his exposition - a) "missing births" and "replacement migration" and b) "differential fertility" between the different regions of Europe and the uneven economic impacts of these.

Birth Postponement and Missing births

Now Tomas Sobotka is an extremly able and interesting young demographer, and his recent PhD Thesis "Postponement of childbearing and low fertility in Europe" (which is very readable for a piece of academic research and is online in its entirety here) is the best general introduction available to this important topic which lies at the heart of the whole low fertility problem. Postponement, we should recall, is simply the process whereby mothers start having children at ever later ages. During the years in which this process runs its course (and we still do not really know yet where the upper limit is here), a phenomenon known as the "birth dearth" occurs, since considerably fewer children are actually born and unusually low readings are registered on the "period" Total Fertility Rate indicator.

You could think of this process as being in some ways similar to the recent structural rise in energy prices (if thinking like this helps you at all), since annual inflation rates have registered very high readings as energy prices have become steadily more expensive when compared with other goods, but of course, once they reach their new higher levels (assuming they stay there) the sheer fact that they are high is not in itself inflationary (although, and as with the high first birth ages, there may be other consequences) so the monthly year on year CPI readings once more settle down again (in this case to their old lower level) after the structural transition is completed. And so it is with the period (which just means as measured during a certain period of time) TFRs.

As is illustrated in the chart below - which comes from Wolfgang Lutz - an increase in the mean age of childbearing results in a lasting loss of births, unless the childbearing age for some reason were to decrease again, and it is this lasting loss of births that causes so many structural problems in shape of the population pyramid. The resulting need to compensate in some form or another for these missing births has lead Sobotka to slightly redifine the idea of "replacement migration" as it was originally advanced by the UN population division (and here) to mean a short term injection of people into the 25 to 40 age group to both make up for earlier "missing births" and to compensate for the current deficit since people in this age group are liable to have chiuldren (more on all of this below). Since immigration is such a politically sensitive issue this may be a much more plausible and palatable way of presenting the problem of correcting structural population damage.

Now I have gone on at some length about all this "birth postponement" rigmorole, since if you don't "get" this bit (ie that women are having children later, and that this affects the shape of the population pyramid regardless of the level at which cohort fertility ultimately settles down) then you are going to struggle with the rest of the arguments in the Sobotka presentation and you are not really going to see why having reduced fertility over an extended period of time is any sort of big deal at all.

Three ‘stylised facts’ on European fertility

As is by now reasonably well known, at the present point in time the United States and France are the only two developed countries which have managed to recover something near the magic 2.1 Tfr replacement number. We have therefore few strong reasons to believe, and indeed we may well have a good many reasons to doubt, that a significant number of countries globally will finally prove capable of retaining replacement fertility. However, as I suggest above, any conslusions we reach here need to be extremely tentative, since in the longer term "path dependent" processes may well come into play, whereby what happens tomorrow and the day after may well exert significant influence on what gets to happen in 2030 or 2040, and given that none of this has ever happened before, and that we therefore have no precedents, all conclusions need to be very guarded and open to continuous modification.

It is really for this sort of reason that we on this blog tend to focus on the here and now, and try to analyse and interpret the impact of low fertility on the present dynamics of those countries which have had below replacement fertility over an extended period of time, and especially on the economic and social dynamics of the countries in question. Whatever the impact of below replacement fertility in the longer term, our present experience shoud be able to offer a useful yardstick with which to guide and orient our deliberations.

In this context Sobotka offers us three "stylised facts" about European fertility. These are:

1/. Fertility rates in Europe are very low and further declining

2/. Current low fertility will necessarily lead to a rapid population ageing and to a decline in population size

3/. These trends are unsustainable in the long run and constitute serious threats to economy, labour market, welfare system, and thus also to the foundations of European societies

Truth be said, Sobotka is none too sure about any of these, even if, as he notes, ideas such as these have served as the justification for many of our present concerns about the longer term consequences of low fertility, leading to the use of expressions like “fertility implosion,” “baby deficit” and fears of a longer term ongoing population decline. Such concerns about lew fertility and its consequences are really nothing new, since similar concerns were already being expressed about low birth rates and their consequences in the 1920s and 1930s in a variety of countries ranging from France and Sweden to the United States (indeed to some extent it was this early arrival of below replacement fertility which lead France and Sweden to introduce the early versions of their pro-natalist policies). These early concerns were largely to disappear with the arrival of the post WWII baby booms.

Essentially Sobotka questions the usefulness of such stylised facts since he argues that, in the first place European fertility rates are not uniformly low - and even less is is it the case that lowest-low fertility is "spreading" across Europe (although it may be spreading out of Europe to other parts of the globe, and especially Asia). In particular there is strong regional variation in fertility patterns across Europe - and it is not at all clear that the longer term measure of completed cohort fertility is still declining in many European societies. Given this, the second stylised fact becomes questionable, since although ageing is a given for all developed economies as life expectancy rises, the rapidity of this ageing depends on the levels of achieved fertility and the levels of inward "replacement" migration, and neither of these are givens. So we don't necessarily simply have to sit back and accept that we are - as societies - ageing rapidly. Of course if we have ongoing low fertility, and we do simply sit back on our laurels and fail to react - as Germany, Italy and Japan are discovering to their cost - rapid ageing is the more or less inevitable consequence.

Lastly Sobotka would like to challenge the third idea - that such rapid ageing processes represent severe challenges to our economies, our labour markets and our welfare systems. Here his argument, such as he presents it, seems to be on much weaker ground, and looking at the three leading rapid agers it is hard to argue that their economies and institutions remain unaffected, even if a good of time and energy could be expended arguing about whether or not these countries are on sustainable paths in the long run.

In order to challenge the first two stylised facts Sobotka lists a number of hypotheses which he considers to be worth testing in order to examine the validity of the stylised facts under review. He suggests that:

- Extremely low period fertility rates are linked to fertility postponement and are likely to be temporary

- Pronounced regional differences are likely to prevail

- Second Demographic Transition is not necessarily linked to below-replacement fertility

- Immigration can substitute most or all of the births ‘missing’ due to below-replacement fertility

- Very low fertility and the prospects of population decline do not constitute an all-European problem.

- as a consequence fears of a European population implosion seem exaggerated

To illustrate his case Sobotka divides the old European Union 15 into four regions -North, South, German Speaking and West. As he shows in the following chart, we can discern very pronounced differences in fertility across the regions of Europe.

It is clear that treating the European Union as a single entity for demographic purposes is a rather dubious procedure to say the least. Southern and German-speaking Europe stand out as having a very different fertility pattern from Northern and Western Europe, and the principal difficulty arises in determining why this should be. The position becomes even more complicated if we add-in Central and Eastern Europe, where the ferility pattern, at least on the surface, resembles that of Southern and German speaking-Europe.

One of the problems we encouter at this point is that of getting one single theory to fit all the available known facts. One possible way forward, as Sobotka suggests, is to try to link the arrival of very low fertility (let's say here below Tfr 1.5) with the spread of the one-child family model. This seems to work in some cases, but runs into the important exception of the German-speaking countries and some parts of central Europe (and possibly outside Europe with Japan) where what also seems to be important is the number of women who never have any children.

Clearly the Chinese case would fit this model, but since there are very unusual factors at work in the Chinese case I would not be in any hurry to draw any important conclusions from this. On the other hand a comparison of societies in terms of the proportions of women having children in the higher birth orders can also prove to be revealing. In some countries the number of women who now have one child, and one child only is now quite high, while in others (Scandinavia, for example, as exemplified by Norway in the chart below) it has fallen rather than risen in recent decades.

If we look at the Spanish case a bit more closely, and compare it with the Swedish one, we can see some interesting details. One of the questions which confronts us when we come to look at birth postponement and longer term completed cohort fertility levels is the question of birth "recovery" - or how many children women in the higher age groups actually have. Here Sobotka presents some interesting data, since we find that what makes the big difference between the near replacement fertility countries and the lowest low fertility ones is very often the number of children women over 30 actually have. So if we look at a comparison of the lifetime probability of having (nother) child among women aged 30 as between Spain and Sweden we see that the evolution of this probability has not been very different between one country and the other.

But if we then go on to examine the same question in terms of the probability of having second and third children a very different picture emerges. In both the transition from the first to second child and the transition from the second to third one Spain dropped below Sweden in the mid 1980s and - even though there has been some slight recovery since the late 1990s - has remained significantly below ever since.

Is European Fertility Declining or Rebounding?

The next important question is to determine whether or not longer term fertility - the so called completed cohort fertility, as opposed to the shorter term, period, Tfr) - will continue to decline, or has actually stabilised. The answer to this difficult but necessary question is that it is still too early to say. We need to see data from at least one or two more cohorts to get a better picture, and since one cohort completes every five years, we are not going to get any definitive indication anytime soon. But we also know that - such concerns apart - longer term completed cohort patterns are not the same across countries, and once again Southern and German-speaking Europe seem to show a different, and more worrying, pattern to that of Western Europe and Scandinavia.

Sobotka enters into quite a bit of detail on the various techniques that have been developed to try and get a better measure of real period fertility (and this is hardly surprising since this is one of his specialist areas). There is no real consensus on techniques at the present time, but we do have some sort of reasonable idea of the order of magnitude of the tempo effect.

(click on image for better viewing)

The upshot really is that what is important is the depth and duration of the postponement transitition. As Sobotka himself points out the gap between the period TFR and the cohort CTFR may persist for a period of anything up to 30-40 years, and as such this is hardly a mere blip. We need to think seriously about the population structure effects of such a long drawn out process. And we still don't know how high average first birth ages can rise, so it is hard even to reach any form of meaningful conclusion about duration of the tempo effect as between countries, although we obviously do know that the effect is present and may well not be benign.

So much for the great unknowns. But what about what we already do know? Well we know that during the years of the postponement transition we have a phenomenon of "missing births" (which makes its presence felt at the level of maintaining a replacement-fertility-driven stable population pyramid), and we do know that one way of adressing this deficit is via increased immigration.

It is clear that immigration has an impact on childbearing trends and patterns in the receiving countries. Among other considerations it is obviously hardly coincidental that the two countries who have come closest to achieveing replacement fertility - France and the United States - have both experienced significant levels of inward migration (although, of course, in both cases migration alone is far from providing a complete explanation of the high levels of achieved fertility). Immigration may operate on fertility via two mechanisms: the migrants themselves may come from countries with higher fertility levels, and the new migrants may be strongly concentrated in child bearing ages. This latter factor clearly does not have a direct impact on the period Tfr in and of itself, but it does affect the annual flow of births, and in this sense may have a direct impact on the birth deficit.

Thus while the volume of migration at the levels postulated in the original UN proposal may be so large as to be politically and culturally unthinkable (and is in no case a substitute for addressing the underlying phenomenon of low fertility) it may well be that ‘replacement migration‘ in this more restricted sense could be very valuable, especially since the impact of immigration acts not only on fertility but also on population size, slowing aging and reducing the pace of any decline.

One big problem in determining the size of the impact of migration on fertility is that there is a lack of comparative cross-country data, since comparatively few studies have been carried out. Also there is a problem of definition. Who should be included, (all) immigrant women (or men), foreigners only, first generation, or second and third generation, legal and illegal etc? The use of data equating immigrants with foreigners is also problematic, especially in countries with high rates of naturalisations .

Measurement of Tfrs and age-specific fertility rates may also be problematic, especially for recent immigrants (and hence also for the 'foreign'nationality women). Also the event of migration is frequently interrelated with family formation and childbearing: immigrant fertility is also strongly dependant on timein the receiving country since immigration. Migrants period fertility rates may often be particularly high when short-duration stays are involved.

The net impact of immigrant women on Tfrs is hard to determine, but key factors are clearly the proportion of total births which are to immigrant women and the extent of fertility differences between immigrant and ‘native born' women.

So advancing the discussion somewhat since the times of the UN report - Replacement migration: Is it a solution to declining and ageing poplation (2000) - we could say that a new consensus may be emerging that migration cannot stop population ageing (since there is only a modest impact in slowing-down the process ) but that immigration may well be able to substitute for most of the birth-deficit even in countries with very low fertility (Spain, and even Italy?). Clearly the role which immigration can play depends crucially on the fertility rate in the migrant sending country. Thus migrants arriving in Spain from relatively high fertility Latin American countries like Ecuador or Brazil may have much more impact on the Tfr than those coming from very low fertility countries in Eastern Europe like Bulgaria and Romania. A French-German comparison might well prove useful here, since from the mid 1980s onwards Germany may well have received more migrants than France, but given that the origin countires of most of these migrants have themselves had low fertility, this has had only a limited impact on the fertility readings.

This factor needs to be thought about carefully in those Eastern European societies who themselves are looking presently for replacement inward migration to bolster up their limited local labour forces, since often it is assumed that migrants from countries further east like Russia, Ukraine or Moldova might plug the gap, but all these societies are themselves very low fertility ones.

What about European global demographic and economic marginalisation?

Surprisingly, having made such a strong case that what is most important about the European fertility picture is the extent of the regional varaince, Sobotka goes on to suggest that in terms of population and global influence an EU-US comparison is not only useful, it is also meaningful. Especially is this surprising when he goes on to argue that territorial expansion rather than fertility has enabled the EU to surpass the US in terms of population growth and (and I quote) "to keep pace with its economic power". Personally I think this kind of comparison is virtually useless, and doubly so in the context of a fertility analysis.

And the comparison becomes doubly problematic when it is applied to economic prowess. If I reproduce his arguments here, then it is only because they are sufficiently widespread to at least merit being refuted. If we look at the chart below, which in some sort of spurious way makes a PPP EU-US comparison, I am quite happy to say that this type of comparison has no worthwhile interpretive reading whatsoever, even if some of the people based in Brussels are fond of hearing it.

The whole process that Sobotka gets into here, and as I emphasise I respect him greatly as a demographer, and as an analyst of the postponement process, seems to me to be at best well off the point (since it seems to open up some of that good old EU-US football rivalry, when what we should be trying to do is understand what is going on in all our interests) and at worse totally illegitimate, since he had just spent the best part of his presentation stressing the strong regional differences across Europe, and how, in this sense, and idea of Europe-wide anything is likely to be pretty much a useless piece of information. And so it is in this case, as I will now argue on the basis of the charts below.

As Sobotka has stressed we have very significant differences in fertility levels between advanced countries at the present time, and these fertility differences tend to translate themselves into very different dynamics when it comes to population growth and ageing rates. So it is here that the inter-country (and possibly inter-regional within-country) differences appear to matter. If we look at a comparison of population growth rates as between Germany, Japan and the US the reason I am saying this should begin to become clearer.

The same sort of comparison may be made between the UK, France and Italy.

Or between Germany, the UK and France.

What is clear is that while population in the UK, France and the US is still growing significantly, in Italy, Germany and Japan it has become almost completely stationary. And the reason why we are seeing such differences in population growth rates is not that hard understand, since the UK, France and the US are all ageing much less rapidly than Germany, Japan and Italy, and the principal explanation for this slower ageing is the relative fertility between these countires.

And this inter-country comparison is interesting, since, when we break per capita GDP growth rates down by country, we find a rather surprising result: those developed countries who have the highest population growth rates also have the highest per capita GDP growth rates. So in economic terms arguably differential fertility does matter, and much more than Sobotka seems to imagine. Lets look at the charts.

The position is pretty clear: since the mid 1990s the relative position of Germany, Italy and Japan in terms ofg PPS per capita has deteriorated considerably. But if we come to the UK, the US and France we find something very different, they all reveal a pretty similar pattern, barring the odd detail here and there, and that is that they have more or less maintained there relative position, and in any event they have all done much better than any of the previous three.

These charts are based on data prepared by Eurostat, and show the volume index of GDP per capita as expressed in Purchasing Power Standards (PPS) (with the European Union - EU-27 - average set at 100). If the index of a country is greater than 100, then this country's level of GDP per capita is higher than the EU average and, below 100 the position is vice-versa. The basic data is expressed in PPS which thus becomes a kind of common currency eliminating differences in price levels between countries in the process making possible meaningful volume comparisons of GDP between countries. Please note that the index, since it is calculated from PPS figures and expressed with respect to EU27 = 100, is valid for cross-country comparison purposes rather than for individual country inter-temporal comparisons. Nonetheless these charts are extraordinarily revealing.

As we can see the high-population-growth (near replacement fertility) group maintains its relative GDP per capita position reasonably intact, while in the the case of the low-to-declining-population growth (lowest-low fertility) group it steadily deteriorates. As we can see, in PER CAPITA income growth terms all three of the former hold their comparative position much better than all (or any) of the latter three.

The implications of all this are really quite profound. While - for catch up growth reasons - we should only expect that developed societies should lose their relative standing vis a vis emerging economies, we would never have imagined that one group among the more established economies should be losing impetus when measured against another group, and that this difference should be reasonably correlated with both population growth and rates of ageing. This should I would hope strike some at least among those of you reading this as a rather interesting result. It appears then population median age does seem to matter, and is going to be an important conditioner on the way in which relative living standards evolve. I clearly cannot go into this more here, since the post is already way too long, but I am chipping away at getting through to the underlying economic theory which is involved here in this post.


1/ Very low fertility is not an all-European problem, nor is it of course an exclusively European one.
2/ A new heterogeneity and new cleavages are emerging in Europe
3/ We have a comparatively high fertility belt‘ - the Nordic countries plus North-western Europe (Benelux, FR, UK, IRE) with Tfrs in the 1.7-2.0 region, and adjusted Tfrs and cohort CTFRs around 1.9, with replacement or above-replacement migration levels.

Then we have a low fertility-high, comparatively high recent migration group in Southern Europe (Italy, Spain, Greece).

Then there is a very long term low fertility, medium migration group, with the special characteristic that much of the migration has been from societies which themselves have low fertility (Switzerland, Austria, Western Germany).

And finally a very low fertility (adjusted TFR 1.5) - emigration group. This is a very dangerous mix, suggesting strong negative population momentum and rapid population decline (East Germany, Baltic countries, Bulgaria, Ukraine, Belarus, Moldova, Russia)

All countries face longer run ageing problems which will in no case be negligable. The first group should however be better equipped to handle the problems posed. The intermediate group will be faced with important welfare sustainability and economic growth issues which it is not clear at this point how they are going to resolve. In the case of the last of the above group of countries and region very low fertility may seriously undermine social dynamic and prosperity in even the relatively short term.

Tuesday, January 29, 2008

Emerging Market Correction and Pressure on the Forint

Unfortunately Hungary's coming correction seems to be getting very near now. Portfolio Hungary reports this morning on the latest readings on the Calyon Risk Aversion Barometer. Caylon reported on Monday that global equity gyrations continue to dictate the direction of emerging market currencies, with risk aversion remaining high and European equities closing lower again on Monday. Indeed many currencies remained under pressure throughout the trading session yesterday. Budapest Economics also said yesterday that the HUF continued to be the most vulnerable currency in the region, with the currency temporarily hitting 259 against the euro yesterday, although it did finally manage to stabilize at slightly stronger levels by the end of the session.

Mitul Kotecha, head of global FX research at Calyon, confirmed the Budapest economics view, saying Hungary's forint appeared to be highly exposed to rising risk aversion. “Reflecting the vulnerability to risk aversion, correlations between the Calyon Risk Aversion Barometer and some emerging currencies are quite high at present," Kotecha is quoted as saying, adding that Hungary's forint “appears highly exposed to rising risk aversion, with the 1-month correlation between the Barometer and EUR/HUF at a strong 0.85." Of course, the HUF is also suffering from deteriorating domestic fundamentals, an aspect which of course he did not ignore.

Stefan Wagstyl, picks up the theme to some extent, and has another long and relevant piece in the Financial Times this morning, reflecting just how a change in tone is taking place even as I write.

The turmoil in financial markets is turning into a nerve-racking test for the economies of central and eastern Europe and the former Soviet Union. Economists have said the fast-growing region faces a slowdown following the financial shockwaves reverberating around the globe. But the precise impact is uncertain, especially on weaker economies.

The differences are registering in the financial markets. As investors reconsider their strategies, they are becoming more risk averse. Some have turned against emerging markets, including the ex-communistregion. Others are discriminating more between countries.

The spread on five-year credit default swaps (a measure of risk) has widened by 26 basis points for the Czech Republic since last June and by 44 basis points for Poland. But for Serbia and Ukraine the increase is 151 basis points; for Kazakhstan it is 218 basis points.

Given the recent unprecedented credit-fuelled growth surge, this slowdown could be welcome in countries trying to cope with inflationary pressures, including Ukraine, Kazakhstan and Russia, and those facing labour shortages, such as Poland.

The benefits could be even greater in economies facing yawning current account deficits, notably the Baltic states, Romania, Serbia and Bulgaria. As Leszek Balcerowicz, the former Polish central bank governor, told a business conference this month: "We should welcome some amount of a slowdown, especially in the Baltic states, which have been growing the fastest . . . We don't have the information that would make us predict a hard landing. Based on the current information a soft landing in the countries which have been growing fastest is more likely."

I am not as optimistic as Wagstyl is here that we will see soft landings. The existence of virtual currency pegs - which will need to be broken during the correction - virtually guarantees an abrupt change, as does the level of household debt in non local currency .

Wagstyl had an earlier FT piece where he drew attention to the way in which ageing populations and labour shortages were playing their part in this emerging crisis.

Fuelled by strong economic growth and soaring foreign investment, employment is increasing in availability just as emigration has sucked around 5m workers from eastern to western Europe. According to Eurostat, the EU’s statistics agency, labour costs are growing at their fastest rate since the end of Communism – with a 30 per cent increase in nominal costs in Latvia in the year to last September and rises of more than 20 per cent in Romania, Estonia and Lithuania. In Poland, the largest new member, the rise was just under 12 per cent.

In real terms, average gross wages in Poland rose more than 7 per cent in the first nine months of 2007 and in Romania by nearly 16 per cent, according to the Vienna-based Wiiw research institute.

While unemployment levels in western Europe have stayed at around 8 per cent since 2002, in the east they have slid from 14 per cent to under 9 per cent. In the region’s booming capital cities, almost everybody who wants work has a job. Leszek Wronski, head of the central Europe division of KPMG, the accountant and management consultant, says: “We have a job market controlled by employees.”

Even if labour markets ease a little, there will be no return to the super-abundance of workers of five years ago. The region’s populations are ageing even faster than in western Europe and, with the added effects of migration, the number of working-age people is falling in the Baltic states and central Europe. Eurostat predicts that the population of the new member states will decline from 103.6m in 2004 to under 100.6m in 2015, with particularly sharp drops in working-age people.

However, for governments and companies alike, rising labour costs and growing skills shortages raise big questions about the region’s future competitiveness. Everything from decisions on investment location to education, migration and population policies is coming under scrutiny.

So even while he doesn't directly go into how long term fertility may be playing a role in the drama we are watching unfold before our eyes, his mention of "population policy" seems to be a euphemism for this very topic. And if fertility isn't an important determinant in what has been happening, I would be grateful is someone could explain to me why we aren't seeing similar sorts of labour shortages in places like Thailand, Turkey, Chile, Brazil or Argentina, all of whom are growing - or have been, Turkey has slowed recently - very rapidly at the present time.

Back on the 28 August 2007 - just after the financial "turmoil" started - I posted the following, in a piece which still looks extremely good when looked at in the cold light of today, on Global Economy Matters:

"But any looming "credit crunch" is also likely to affect the so called "risk appetite" (that is the willingness to invest in riskier areas or activities) and the place where this is most likely to be felt is in the emerging market area. Those emerging markets which are considered to be most vulnerable will undoubtedly have the hardest time of it, and this brings us directly to Eastern Europe I think and to economies like those in the Baltics, Latvia, Estonia and Lithuania), to Hungary, and then maybe (if there were to be contagion) to the larger economies like Poland and Romania. Alarm driven reports about the dangers of a hard landing in the Baltics have been floating around for some months now (I say alarm driven not because the danger isn't real, but because most of the reports are quite superficial, and don't really appreciate the magnitude of the problem). Whatsmore, as the Bank for International Settlements pointed out in the June edition of its quarterly review , in 2006 Eastern European economies accountedfor a staggering 60% of new emerging market credit:"

At the start of September, and as part of an in depth analysis of Turkey, I posted the extract you will find below. The issue here is foresight, and our ability to see things coming. What is happening now has been obvious for some time, completely obvious, even if many people have had difficulty in seeing it. I completely resist the idea that economics cannot be scientific. I think it has to become much more of a science. But if we are to get from here to there we first need some paradigmatic models which enable us to see things coming rather better than we appear able to do right now.

In a much quoted paper - published back in 2004 by two UCLA economists (Schneider and Tornell) - it was argued that:

"In the last two decades, many middle-income countries have experienced boom-bust episodes centered around balance-of-payments crises. There is now a well-known set of stylized facts. The typical episode began with a lending boom and an appreciation of the real exchange rate. In the crisis that eventually ended the boom, a real depreciation coincided with widespread defaults by the domestic private sector on unhedged foreign-currency-denominated debt. The typical crisis came as a surprise to financial markets, and with hindsight it is not possible to pinpoint a large "fundamental" shock as an obvious trigger. After the crisis, foreign lenders were often bailed out. However, domestic credit fell dramatically and recovered much more slowly than output."

In starting off with this quote I really want to draw attention to two things.

First off, the way in which the current sub-prime liquidity problem in the banking sector of many developed economies is now steadily extending itself into a credit crunch in several emerging market economies. We are now beginning to see a clear and all too familiar pattern. There has been a lot of talk about the Asian crisis, and evidently there are some similarities with the pre 1998 situation, especially, as I shall be arguing over the coming days, in the emerging economies of Eastern Europe.

Secondly there is the "typical crisis came as a surprise to financial markets" argument, since it puzzles me why exactly this should be, or better put, why it should be assumed as a "stylised fact" about currency crises that such major events are in principle not forseeable. I find this very hard to accept. Are we really so inept we are not able to see trouble coming when it finally does come? Is economic theory really so useless in the face of complex "on the ground" facts. Something inside me resists this view. We ought to be able to see things coming, even if we need to distinguish between the where and the when. What I mean is that it should be possible, if the theories you are working with are worth any sort of candle, to pinpoint the areas of likely vulnerability. On the other hand, given that often seemingly random events precipitate the ultimate unwind, it is pretty well impossible to say in advance which random event will turn out to be the detonator on any given occassion.

The sub prime debt issue in the US is a good case in point here, since only at the start of August the Federal Reserve were assuring everyone that problems associated with the US housing market were well under control, while obviously they weren't and aren't, and equally obviously, now, such problems will be seen from the vantage point of hindsight to have played a key role in the events which are now unfolding before our eyes.

So even with this caveat, and with due regard for the well known problem of human fallibility, lets see if this time any of us are able to do just that bit better than normal, and in attempting to see things coming lets see if we can learn something which may make us better able to handle and foresee macro economic problems in thefuture.

For a fuller analysis of the specifics of Hungary's present crisis see "Just Why Is Hungary So Different From The Rest of the EU10?", "Hungarian Central Bank Leaves Interest Rates Unchanged" and "The EU Comission Warns Hungary on 2008 Budget Deficit".

For e theoretical exposition on why fertility matters to the EU10, see Claus Vistesen "Catch Up Growth and Demographics - Evidence from Eastern Europe".

Tuesday, January 22, 2008

Italy's Job Rich Recession?

Italy is currently entering into what offers all the indications of being a major political gridlock. Manuel Alvarez perceptively entitled his summary and analysis of Prodi's first resignation offer in February 2007 "A crisis is born in Italy", could it be that the subsequent the crisis he then anticipated is now finally about to arrive?

Whatever the outcome of what is going to be the 32 confidence vote in only 21 months the social and economic backdrop to the crisis will remain. The Italian economy is now slowing visibly, and the Bank of Italy only last week lowered their growth forecast for the Italian economy to a mere 1%. Given what is happening even as I write in global stock markets and (whatever the immediate upshot to tomorrow's vote) Italy's obvious political instability even this may be an optimistic estimate (see my 2008 forecast here). Italy's real problem is, however, neither so immediate nor so dramatic, since if we look at the chart I present below what we can see is that Italy has been suffering from a process of congenital slow growth in the much longer term.

In what follows I intend to step back from the precipice a bit, and take a rather longer term look at one feature of Italy's economic performance, its labour and employment market. In this sense this post is going to form part of a "tripple whammy" I am working on, where I will attempt to carry out an in depth examination of possible connections and interconnections which may exist between population ageing, rapid job creation and weak internal consumption in three key G7 economies: Italy, Germany (see here) and Japan.

Rising-Employment Falling-Consumption?

Well lets start by looking at the story so far, at least as far as Italy goes. Fortunately we do have a number of key stylised facts at our disposal. First off, unemployment has been steadily - I could say relentlessly - dropping in Italy over the last two or three years:

and new jobs have been created, lots of them:

Yet at the same time domestic demand has not been revived to anything like the extent that might have been expected. Retail sales have been in decline for most of the last year as you can see from this retail-sales purchasing-managers-index for Italy (remember that on the PMI reading, anything below 50 represents a contraction).

Meanwhile private household consumption, despite some early strengthening, could hardly be said to have been booming. We did see a couple of (in Italian terms) comparatively strong quarters in the first half of 2007, but then, surprisingly - as can be seen in the chart below - the rate of increase began to weaken in Q3, while, curiuosly, in the position in the Italian labour market remained, more or less, stable.

So how can we account for this apparent paradox of a steadily tightening labour market and deteriorating internal consumer demand? One explanation for this could, of course, be that labour market performance is a lagged indicator (that is that it only registers economic deterioration after other indicators have been pointing to red for some time, and this is surely true), but could there not be something more going on here? Especially since this kind of pattern is being repeated in Germany and Japan, and these two countries have, along with Italy, the highest global median age, and as a result the highest proportions of potential workers in the older age groups. There is something very different about the labour market tightening we are seeing in Italy, Japan and Germany, for example, and the kind of inflation generating labour market tightening which we are observing in Eastern Europe. So why this difference?

Italy's Age Structure

But first off let's take a look at one of the younger age groups for a minute, the 15 to 24 one. As is well known this group is now in historic decline as a proportion of the total Italian population. The decline has been very rapid, with a drop of around one third (from 15% to 10% of the population) since 1990.

What this means, logically enough, is that there are steadily less and less people in this age group to fill places in the labour market. To this numerical decline we need to add theongoing secular decline in economic activity rates among this group, as more and more of Italy's - now scarce resource - young people delay entry and seek to improve their education, their human capital rating and hence their future earning capacity.

Thus the proportion of this group which is economically active has been declining steadily, as have the absolute numbers of those who are active, and the numbers of those who are actually employed. It is perhaps worth noting that the absolute size of this age group has been virtually stationary over the last 3 or 4 years (a statistical effect), but it is now set to fall steadily.

So if new employees will be hard to come by in this age group as we move forward, where can employment growth come from? Well basically there are two evident potential sources of labour, immigration and older workers. It is hard to envisage any large increase in employment in the 25 to 34 or the 35 to 54 age groups since - as can be seen from the chart below - activity rates among these groups are already fairly high, and even the slight fall-off which can be seen to have taken place recently in the 25 to 34 age group seems to be the result of a decline in female activity rates, and this is almost to be hoped for if Italy is to do one thing which is very important for its long term future, and that is have more children. Squeezing this particular lemon too hard at this point in time is only likely to obtain short term benefit in return for substantial negative long term outcomes.

Turning now to the principle sources of potential long run labour supply, in the first place it is obvious enough that there has been a significant surge in the size of the immigrant workforce in recent years (see chart below, and my other post for more details).

The other main potential source of additional labour in an ageing economy is the over 55 age group (and as we move forward of course increasingly it will become the over 65 one). Now many international agencies (the World Bank, the OECD, the IMF, the EU Commission etc) are pinning their hopes on the idea that the effects of population ageing may be to some extent offset by increasing the participation rates of these older workers, presenting impressive looking projections all the way out to 2050 to back their view that this is a workable solution. Yet since we have, in the here and now, a number of examples of societies who are trying quite hard to follow recommendations here, I do think it is important to examine in detail what is actually happening in these societies and try to really start to estimate the longer term macroeconomic consequences of this shift.

Now the important thing to bear in mind when we speak of older workers is that the important decision they need to take is about whether or not to continue working, and what is very clear in the Italian context is that workers in the 55 to 64 age group are increasingly taking the decision to stay at work, in some form or another.

Not only is the activity rate - which has, it must be said, been ridiculously low for this group, especially given Italy's very high life expectancy level - on the way up, the unemployment rate is on its way down, and the number of those employed is steadily rising.

More Work, Less Pay?

What is also significant about this trend is that it is also associated with a significant growth in part time and temporary work. The question really is who is doing this part-time/temporary work? In Japan it has become clear that many people now leave their "lifelong" job at 55, only to continue working in some way shape or form for another 15 years or so (both the Economist and the Financial Times have recently run articles about this trend in Japan - see here - although they fail to explicitly lock-it-in to the ageing population issue, which I think is where it belongs) . The work ethic in Japan is probably quite different from the one in Italy, but the similarities in the way the labour markets are evolving are really quite striking . In the German context it is also clear that the growth in part time and in non-social-security covered employment has been significant. And of course, in Germany, as I explain at considerable length here, the big increase in employment is in comparatively low skill, low wage work, which very often draws the over 55s into employment in much the same way and for much the same reasons as it does in Italy and Japan.

So what IS observable in the case of all 3 of these economies is that they are experiencing at one and the same time skill-shortages in some key areas of economic activity (due to the growing population crunch among the young - Japan for example is notoriously short of nurses) and generating large volume employment in more tenuous and lower skilled categories of work, since such work meets the skill and performance profile of the workforce they really have available. Thus, even as these labour markets tighten we find NO real evidence of significant wage-squeeze push.

From this point in we are left guessing until someone does some really systematic research, but it isn't a bad guess to suggest that the pressure on wages in the more skilled areas is being offset by a downward movement in wages in those less skilled areas where a mixture of lower skilled migrants, retirees and older workers are offering themselves for work in increasing numbers.

One other conjecture about Italy is that migrants are doing jobs in Italy which retired or semi-retired workers are doing in Germany and Japan, and hence we find that the participation rates in the 55 to 64 age group are still pretty low. At the moment I'm not quite sure what the macro economic consequences of this are going to be.

My feeling is that since people reaching 60 can now expect to live quite a long time, and since nowadays there is no great certainty attached to current levels of retirement benefit as we move forward, then older people, who are normally more prudent, will be protecting their current savings - in whatever form they may hold them - as best they can, and supplementing pensions with bits and pieces of work to maintain living standards so as to not run down their capital.

Another point here is that many retirees in Italy have a lot less in the way of accumulated wealth (and imagine the situation in a country like Hungary, which is the next one coming in this group as far as I can see, even though the median age is somewhat younger, but the male life expectancy is also much lower, and the population is already falling) in comparison with Germany and Japan.

This is why the recent deal Prodi struck with the Italian unions about postponing raising the retirement age was such a negative when viewed from where I am sitting.

So what I am suggesting is that the very weak internal consumption we are seeing in these three countries (and I would drop-in that Hungary is "coupling" here perfectly with the others, in terms of the model I am working on) is not ONLY associated with a higher propensity to save associated with older people, but also to do with the earnings profile associated with the new kinds of low level work older people are doing. In other words you can't just take the large number of new jobs being created and translate this into more consumption (as I think most of the conventional analysts are doing) since more things are happening here.

North-South Regional Stresses and Imbalances

But in any event the data we have is fascinating. The regional disequilibrium in Italy seem to be once more becoming really important (just like East-West one in Germany, and Tokyo vs the rest in Japan). While the national participation rate for the 55 to 64 age group went up from 28.9% in Q1 2004 to 33% in Q3 2007, in the mezzogiorno it has gone up from 31.8 to 35.3 over the samer period, so the South is keeping pace here, but if we look at the 65 plus group, while participation has gone from 3.4% to 4% nationally over the same period, in the mezzogiorno it has gone DOWN from 2.4 to 2.1%. The 15 to 64 participation rate also dropped from 54.1 to 52.5 over the period in the mezzogiorno while in the North it went up from 67.8 to 69.2 %. And this situation is reflected in the relative job creation performance between the North and the South.

Basically, given the very strong fiscal pressure which is about to come in Italy, and the danger IMHO of a sovereign default at some point if nothing is done to correct this very weak growth trajectory, Italy can be almost literally torn apart by this disequilibrium, especially given that it is reinforced by the unequal distribution of migrants. We have an ongoing polarisation of wealth, employment and people, and we really aren't giving sufficient consideration to the longer term political implications of the underlying economo-demographic process.

New Forms of Employment: Temporary and Part-Time Work

I have also found a limited breakdown for part time work by age. The two categories which the Italian statistics office use are "15 to 34" and "35 and over". Now strange as it may seem the number of part-time jobs for the 15 to 34 age group actually went DOWN between Q1 2004 and Q3 2007 - from 1.107 millions to 1.102 million - while among the over 35s it went up from 1.74 to 2.121 million. So Italy's new part-time workers are by-and-large not young, and it is a good bet that the majority of these new workers come from the over 55 group, and that it this kind of work which is responsible for the increase in the participation rates at the higher ages.

Of course, when we come to look at TEMPORARY work the pattern is rather different, there are an increasing number of young people (and since the number of such people is steadily declining, a rising proportion) working on temporary contracts. The number has gone up from 1.035 million in Q1 2004 to 1.368 million in Q3 2007. Over 35s (which we can pretty much imagine as over 55s, since the 35 to 55 age group is normally pretty robust in employment participation terms) goes up from 679,000 to 993,000.

By Way of a Conclusion

Basically the macro economics of all this are hard to assess. Italy's working age population - ex migration - has touched the ceiling, and without immigration it will go down and down. So everything depends on raising the productivity of those employed. But raising productivity today is pretty much synonymous with raising the human capital component and if in volume terms the numbers of older but less qualified people working - and working in more and more fragile and less and less well-paid occupations - swamps the number of new highly educated workers in highly productive jobs (we are talking about aggregates here) then the new value created by the society in question won't compensate for the contraction in the workforce. This is particularly true when it comes to raising participation rates in that oft quoted potential labour supply, female workers over 55. Many of the women in question are excellent wives and mothers, but given their often very low level of formal education, and given their lack of real experience of work out of the home, the economic worth in value added terms of their formal labour market participation may be much lower than many expect, and certainly this is where the evidence to date is leading us.

I also feel that the Italian experience is very similar and comparable with what we have been seeing in Japan and Germany, so it seems to me that there is now strong prima facie evidence that we need a big and really systematic research programme into the details of all of this, and rather less of that "gung-ho", we haven't got a problem approach, which has prevailed up to now, and which - at the end of the day - is based on the idea that raising participation rates will do the trick. As we are seeing, and unfortunately, it may well not do. It will do something, but that something may well not be enough.

Sunday, January 13, 2008

The German Economy, Employment, Export Shares and Age Structure

Ok, well I have recently written extensively about the state of the German labour market, and why the recent drop in unemployment isn't everything it seems to be, why German wages have deflated, rather than inflated, during the current economic expansion, and why we may now be seeing reform fatigue setting in as the German economy once more slows. Here I am going to step back a bit from the day to day, and what follows will be an attempt to describe how the German economy, as we find it today, actually works structurally.

First off, and as is well known, German society is ageing, and the German population is declining. Here is a chart - thanks to Claus Vistesen who has been doing this part of the work (and see also this very important recent post from Claus on DM) - of the German population evolution:

As can be seen, after the late 1990s the rate of population growth in Germany began to decline rapidly, and then more recently the population actually started to decline.

This changing population pattern has also been accompanied, as is again well known, by an important ageing of the population. This can be seen clearly from a chart - again from Claus - for German median ages:

Now this rapid recent rise in the median age of the German population makes Germany a much older society than many other OECD countries. In particular the United States is much younger (as are the UK, France, Ireland, Iceland etc) as can be seen from a comparable chart for US median ages (again thanks to Claus).

As can be seen the US is an incredibly young society, having attained median ages during the 1970s and 1980s more typical of a developing than a developed society, and even today the US is only where - in median age terms - Germany was some 30 or so years ago. So when we talk about "ageing societies" we should remember that while all our societies are ageing, some of them (Japan, Italy, Germany) are doing so much more rapidly than others. This difference in fact has profound implications, ones which were never foreseen, and given what we now know it should not be surprising to see these age structure differences expressed - as we will see below - in very different core characteristics in each of the societies concerned.

Now, not only is Germany's median age rising, the proportion of the population in the key 25-49 age group is now falling. Let's look at the chart:

As can be seen from the chart this crucial age group touched its highpoint in 1997/98. This could be imagined as the moment of maximum capacity for the German economy. This is the case for two reasons. Firstly the 24 to 49 age group includes the crucial 25 to 49 household-former, first-time-homebuyer group. In terms of credit expansion, it is this group which drives a significant part of internal demand, since this is the group with the greatest propensity to borrow forward, and this is vital.

The 25 to 49 age group also includes another important group, the 35 to 50 one. It is this group which drives an economy in productive terms, since these are the prime age workers. So if you think of a society as a 100 metres sprint athlete, then there is an age when this athlete is at the maximum of his or her running potential, an age after which each time they can only run the 100 metres more slowly. Well a society is the same in terms of its collective economic potential, after the 25 to 49 age group peaks an economy can only move forward more slowly, and logically, since without addressing either fertility or immigration, every time more and more slowly, as this group declines inexorably as a % of the total population.

Is there any evidence for this kind of assertion. Well, yes, as it happens, there is actually.

Lets have a look at German GDP. First off a long term chart.

As we can see, and as is well known, German GDP growth has been very weak since the turn of the century. As is also well known 2006 was a very good year for the German economy, which is what lead all the commentators to cry - at last! There is a German recovery. But have they been too quick in drawing this conclusion? There are good reasons to think that they may well have been (and of course, in reality we are all about to find out as we go through the coming winter). Let's have a look at the evolution of the composition of German GDP over the years.

Now, there is a lot to be seen in this chart for the careful observer. The first thing that strikes the eye is the way private consumption has hovered pretty close to the 60% mark for many years now, while government consumption - after moving sharply upwards as a total share in the first half of the 1970s has subsequently remained pretty constant, moving around the 19% of GDP mark. The big difference has been in the importance of fixed capital formation (GFCF) which reached a local peak around the 22 - 24% of GDP mark - guess when - just when the 25 to 49 age group was reaching its historic peak, in the years 1992 to 1995. So why should this be significant, well quite simply since fixed capital formation includes the HOUSING share, and it is this component which has steadily declined as a share of German GDP since the mid 1990s, and which is why there is a "hole" in German (and Japanese, which is the same story, only told a little earlier) GDP, a hole which can only be compensated for by exports. It is now interesting to ask whether in Spain, where the age group in question has just peaked, and the property market may be in the process of a historic bust, we may not soon see the same process at work.

So what we could propose is the idea that the years between, say, 1974 and 2000 (when GFCF fluctuated around a more or less constant share of GDP) constitute - to use the language of neo-classical economics - the constant growth period of the German domestic economy. The years prior to 1975 were the convergence, or "catch-up" years - especially those of the 1960s, after Germany finally broke out of the destruction and devastation of WWII - while the years after 2000 constitute what the neo-classicists would call the "balanced growth period", although as we can see, growth isn't very balanced, and there certainly isn't a steady state. This is because the ageing population components in German growth are now coming to dominate over the shifting age structure components of the constant growth period, and we are seeing an effect which is very similar to what is known as the "demographic dividend", only it is acting in reverse, which is why I call it the demographic penalty. Basically the majority of economists want to argue that what I have just said isn't the case, but I would simply suggest they look at the data, as I have been looking at it, and explain why it isn't the case, since the facts and the correlates seem pretty clear to me, once you "parenthesise" (or put in brackets) traditional steady state growth expectations and take a fresh look at the data. Simply saying that what is happening, isn't (the denial stage) since that won't change things, and it would seem to me to be more sensible to accept reality and to devise policies which try to address the real issues.

If we now move on to look at exports we also find something interesting. While fixed capital formation declined as a share of GDP from 24% in 1991 to 17.76% of GDP in 2006 (ie a 6% drop), the German trade balance moved from a DEFICIT (yes, you heard right, deficit) in 1991 of 0.4% to a surplus of 5.44% of GDP in 2006, ie a rise of 6 percentage points. The comovement in the two shares match each other in virtually symmetrical fashion. Incredible, and facsinating, isn't it? Here is the time series chart for the two components.

As I say, the correlation of these two since the mid 1990s is really quite striking.

Right two last charts just to finish up. Firstly annual private consumption growth in Germany (in percentage change terms):

As can be seen, this has been - barring the boom years of the mid 1990s - steadily declining in its ability to drive German growth, and it would be rather foolish to expect this to suddenly change now.

Lastly export growth and GDP growth:

As can be seen, since the mid ninetees, every time the German export performance flags GDP tanks. Claus and I haven't gotten round to doing the correlation coefficients yet (but we will do). But the relationship is pretty clear, so if the markets in the US and Eastern Europe slow noticeably this winter, just you watch what happens to German GDP.

So, as they say:

Quod Erat Demonstrandum

Or, if you prefer, "game, set, and bloody match". Anyone got some glasses handy, it's time to cork out the champagne I think. Or no, since this is Catalonia, a nice glass of Cava will do me fine. Have a nice day everyone. I will.