The latest International Monetary Fund’s latest World Economic Outlook finally breaks half of the taboo that has stopped most economists from accepting this seemingly common sense conclusion. Its Summary argues as follows:
- “Potential output growth has declined since the global financial crisis
- Decline reflects impact of aging; lower capital and productivity growth
- Policy action required to boost productivity, foster capital growth, and offset the effects of aging”
Thus the impact of “aging” is highlighted twice in the Fund’s 35-word Summary. And the IMF then focuses on the adverse employment impact in the above 2 charts. These show a major decline underway in both the working age population (blue column) and labor force participation rates (red) in the Advanced and Emerging economies. In turn, this means the previously positive net effect (yellow line) on growth is now disappearing.
Of course, this is major progress, and must be welcomed with both arms. But as with the recent Bank for International Settlement paper, “Can demography affect inflation and monetary policy?”, the IMF still holds on to the other half of the taboo – that aging does not affect demand.
In many ways, this is not surprising. The world has never before had an aging population. Even as recently as 1950, most people in developed countries died fairly soon after retirement. And most people in emerging economies died before retirement. So there is no previous history for economists to model.
Equally important is that most have learnt to model demand as a multiple of GDP growth. In petrochemicals, for example, ethylene growth is typically assumed to be 1x GDP. So few have seen a need to separately model demand.
However, there is plenty of evidence to confirm that consumption is age-related. National consumption surveys consistently highlight this key feature, as I noted in the Financial Times last week for the UK economy:
“Consumption is around 60% of GDP. Thus the boomers created an economic supercycle as they moved into the 25-50 age group, when spending and incomes typically peak. But now the pendulum is swinging the other way. The ageing of the boomers means the majority of UK households have been headed by someone aged over 50 since 2002.
These older households already own most of what they need, and their incomes are declining as they head into retirement. At the same time, lower fertility rates mean there are fewer households in the highest-spending 30-49 age group. Thus average household expenditure has been in steady decline since 2006 in real terms”
The problem is that this data is not commonly tracked by economists, who have been taught by Friedman and others to focus only on the supply side of the economy. Thus as another economist, JM Keynes, wrote as long-ago as 1936:
“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.”
Demand is, however, the key determining factor in the New Normal. Companies and investors who recognise this will have an unbeatable competitive advantage for years to come. Others will simply have to wait for the world’s advisory bodies to wake up to the other side of this ‘New Reality’.