April 07, 2003

From the Land of the Pygmy Chimpanzees

Edward Hugh has a couple of very nice and thoughtful pieces on the current state of the European and world economies. In the firstBONOBO LAND piece he worries about differential regional inflation rates within Europe, the use and abuse of Harrod-Balassa-Samuelson, index number problems, and how it is "time to throw away the cucumber sandwiches and the fine lace and go to work to try to clutch Germany from the jaws of deflation before it's too late (assuming, that is, that it already isn't)." The second BONOBO LAND piece urges us all to email Morgan Stanley's Stephen Roach and tell him that we are listening to him--that we find his arguments that the world is on the edge of deflation crisis to be alarmingly powerful, and that he is not just spitting into the wind as far as his influence on the background intellectual climate in which economic policy is made is concerned.

Posted by DeLong at April 7, 2003 12:30 PM | TrackBack


Watch PBS reports of the economy and the focus is on the stable of American Enterprise "economists" who know there is already a boom in progress and are simply waiting for the passage of the Administration tax cut to confirm it. Loss of 2.4 million jobs in little more than 2 years? Not to worry. The unemployed can collect stock dividends till they get serious about finding a job. Why does American enterprise command such media access? Nuttiness abounds.

Posted by: lise on April 7, 2003 01:49 PM

So if demographics is the problem, what's the solution? And how should other countries handle it e.g. a big tax hike now in order to fund government consumption when demographic inflection hits? I don't think "immigration" is a good answer, because then what do India and China do a couple decades down the road? (and, perhaps more optimisitcally, what will Nigeria and Congo do a couple decades after that?)

Posted by: Amit Dubey on April 8, 2003 05:30 AM

"if demographics is the problem"

Inerestingly more and more people seem to be waking up to the fact that it might be at least part of the situation. Last month it was Alan Greenspan, now it is the deficit 'hawks' Volcker and company (See Brad post above).

"Looming at the end of the decade is a demographic transformation that threatens to swamp the budget and the economy with unfunded benefit promises, like Social Security and Medicare, of roughly $25 trillion in present value. Our children and grandchildren already face unthinkable payroll tax burdens that could go as high as 33 percent to pay for these promised benefits. It is neither fiscally nor morally responsible to give ourselves tax cuts and leave future generations with an even higher tax burden."

Remember: the 'pension reform' which is most the likely outcome, even in the US, is tantamount to a massive Enron-style default on previously contracted obligations, only this time the defaulting party is the national exchequer. This is bound to have an impact on saving, consumption and the output gap.

What's the solution. This is a fair question, and the honest answer is that I don't know.

The best answer I can come up with right now is that since an economy is a form of complex adaptive system, then there will be some automatic stabilisers. Maybe our expectations form part of the picture. Maybe we are assuming as inbuilt growth patterns which have only characterised the last two hundred years.

Taking three parameters - technology, population and per capta incomes - as key variables, we can see that for most of human history prior to the industrial revolution (outliers like the Greek and Roman empires being exceptions, and for interesting reasons) better technology meant more people and near stagnant living standards. This was Malthus' argument. Then came the industrial revolution, and both population and living standards increased rapidly with technological change. Now we have the information age, and technological change accelerates (possibly following a power law distribution?) population begins to decline, and we don't know what will happen to per capita incomes. Period: we don't know.

Posted by: Edward Hugh on April 11, 2003 02:28 AM

'what's the solution'

Apart from saying there is no insta-pundit solution on this one, there are obviously things we can do. Reduce our deficits in the good times for one. Carry out pension reforms and encourage private saving for two. Increase the retirement age for three. Individually have more children, for four. And most important of all change our attitudes to immigration.

Of course, none of these 'solve' the problem. But they may make things better rather than worse. If Britain scores rather favourably on the ageing vulnerability index, for example, it is because it has made important progress on pension reform, immigrant reception and multicultural identity when compared with its European neighbours. Is this unequivocally good? No. The pension reform comes at a price of increased poverty among old people. Is there much alternative? I don't think so.

The point about India and China is a good one: one day the planet will run out of immigrants. But what may be only a stop-gap solution does buy time, and that could be important as this is what we need to feel our way forward.

The point about Nigeria and Congo is also interesting. A demographer called Keyfitz once developed a thing called the population momentum equation. This is much more imporatnt than the name sounds, as it enables forward looking calculations on demography. Have you ever asked why the demographic problem has hit Japan first? Well Keyfitz goes a long way towards the answer. It's all about how quickly you make the first part of the demographic transition (the part which goes from 3-4 children per woman to below 2.1). Well if this occurs in less than one generation (simplifying greatly), then the population effectively becomes rapidly de-structured and enters a downward spiral. That is why Japan is first, and other countries like Italy, Spain , North Korea, Taiwan etc follow in quick succession. This could lead us to expect that in India, China and Brazil the situation could be still more dramatic, and so on till we reach Nigeria and the Congo. That is if HIV-AIDS doesn't get there first. Remember, things get faster, faster.

Posted by: Edward Hugh on April 11, 2003 02:53 AM

On analysis,in terms of more conventional economic analysis, this can be approached from both a macro and a micro angle. It's only when you come to lay the macro-horizon on its micro-foundations that, I feel, the extent of the problem becomes clear.

On the macro side standard growth theory can serves as well as any other base.

Solow suggested that Y= A f(K,L)

Well I would suggest(following Mokyr) that this characterises fairly well industrial society, but that in the information age (the age of human capital), a better formulation might be:

Y = A f(K, L1, L2,........Ln).

So obviously if the growth in value of each of the various components of human capital exceeds the reduction in quantity, you can still have growing GDP. This problem is extremely tricky to model, as Solow notices in his critique of endogenous growth theory. It is easy to build a model with exploding, knowledge driven growth, it is far more difficult to envisage this occuring in practice. In part this is for reasons associated with our understanding (or lack of understanding) of Total Factor Productivity (or TFP).

For the other part the actual values of the various human capital elements depend on the demand side equations, and it is here that consumption enters. I find Angus Deaton's notions of liquidity constraints enormously suggestive. Basically the collective constraint will be related to perceived rates of growth going forward, liklehoods of government debt (or pension) default, and the age structure and dependency ratios of the population.

This is as far as I have gone to date. Anyone willing and able to take this forward deserves a Nobel in my book. Any good suggestions or lines of investigation, please contact me.

Posted by: Edward Hugh on April 11, 2003 03:16 AM


Posted by: term life insurance on October 7, 2003 12:20 AM
Post a comment