Monday, September 24, 2007

Morgan Stanley's Stephen Jen and the Importance of Demographics

In keeping with the tone set in Edward's recent post you might ask what the h'll we are doing commenting on something coming from one of the biggest investment bank's chief currency strategist. I mean, have we gone completely mad? Well, not exactly and as we progress I am sure you will concede that this is worthwhile. What are we talking about then?

In so many words we are quite simply taking about the impact of demographics on financial markets and more specifically the way demographics are affecting (and will affect in the future) cross-country capital flows and global liquidity conditions. This is of course a topic which, contrary to many other issues dealing with demographics, has been widely debated in the literature and amongst financial practitioners and economists. As far as our own contributions go within the DM team I have authored two notes on the subject; Ageing and Financial Markets - Going for Yield? and Ageing and Financial Markets ... a revisit. As you will see by visiting these notes I have already been somewhat tuned in to Stephen Jen's work and in that light the headline above shouldn't come as a complete surprise. My immediate impetus for this post is consequently Stephen Jen's recent note over at Morgan Stanley's Global Economics Forum entitled: Demographic Trends and the Financial Markets. So, what does Jen has to say and do I agree with him? Well, I would like to begin with the simple point that Jen really does seem to be poking the right places and in fact if we include MS GEF's Robert Alan Feldman we can clearly see that the Morgan Stanley analyst team is pretty well cued up on the fact that demographic trends actually do exert a strong influence on global economic and financial markets. In this light alone I have been very impressed in general with MS GEF team's analysis on the topic. However, I still (of course) have a few and important quibbles.

First off we have the notion of dissaving which leads Jen to the following argument in the context of Japan;

The permanent income hypothesis suggests that very ‘young’ and very ‘old’ countries tend to dis-save, while those with low dependency ratios should be saving. The constellations of the C/A imbalances in the world are not consistent with this pattern. What this may imply is that, as Japan ages, its savings rate should decline, as retirees start to draw down their savings. This may very well start to happen. With such a high C/A surplus position (4% of GDP), this prospective trend should not pose a problem for Japan.

There are a lot of important points here but let us start with the first one which is of a theoretical nature. In the context of the theoretical framework as such there is no doubt that the general point is 'true' whether you take Friedman's permanent income hypothesis or Modigliani's life cycle theory of consumption and saving. Yet, we need to understand two things here I think. Firstly, there is an important distinction between the micro- and macrolevel here. In this way and while I have no problems with the argument from the point of view of the individual household viewed as a black-box I think we need to attach some qualifiers once we venture towards the macroeconomic level. Secondly, we need to realize I think that whatever characteristics we apply to the process of (rapid) dissaving we are essentially talking about a hypothetical endpoint in time which is not, at this point, possible to identify. Moreover, we also must remember the utter unattractiveness of such a process from the macroeconomic point of view since if such a process were to occur in the context of lingering lowest-low fertility we would effectively be talking about a rapid hollowing-out of whole societies which is not exactly feasible and desirable; I hope! This then brings us to those qualifiers mentioned above and in the context of Japan (and potentially other ageing societies). They can be summarised in three main points of which Stephen Jen in fact himself has inspired me to one.

A change in the consumption/saving schedule which is likely to emerge in the context of the relatively smaller working cohorts in the sense that they will be prone to save more of their disposable income in order to compensate for the rising dependency ratio as well as to secure an adequate level of life in retirement, particularly given the rising life expectancy. This will have as an important side-effect the tendency to further depress domestic consumption/demand.

2) This relates to the Japanese export surplus which Jen narrates as a 'buffer' from which to dissave. In the context of the general argument of dissaving I can understand this point but once again I think it is important to point out that the Japanese external surplus is a little more than a buffer at this point. In fact, as Edward argued recently over at Japan Economy Watch Japanese growth is deeply and structurally dependant on external demand. This once again serves to substantiate my point on dissaving in the sense that a country such as a Japan will most likely fight long and hard to avoid bringing itself into a situation of (rapid) dissaving since this essentially would mean 'game over'; I mean, how on earth would Japan for example be able to finance an external deficit?

3) This point is actually taken from Stephen Jen's own work and analyses and relates to the decline in home bias of Japanese investors. As he puts it in the note in question;

Fixed retirement age, coupled with ever improving life expectancy, has created a ‘longevity risk’, whereby retirees can no longer be confident of their ability to defend their lifestyle if they end up living much longer than they expect at the time of their retirement. In the case of Japan, this has led to more risk-taking, not less, as retirees try to enhance their expected investment returns by diversifying away from assets with low credit risk. In contrast to the first hypothesis, this alternative hypothesis suggests that retirees should have a bigger appetite for equities.

Please note that I am in no ways trying to catch Jen off guard here but, at least to me, the rising risk appetite of Japanese retail investors (don't forget those housewives) and the subsequent decline in home bias indicate yet another level through which dissaving can be (is being) postponed since in stead of actually 'dissaving' as such we are witnessing the attempt to earn a return on those massive poolings of savings.

The second and final niggle I have concerns Jen's perception of 'ageing' and essentially his conceptualization of what constitutes an old society/economy. This might seem as a trivial question of calibration since in the end we are all ageing but as we will see, an initial calibration mistake/difference can end up making the whole argument scoot off towards quite differing conclusions. In short, I am at odds with Jen's pooling of e.g. Japan and the US in the same bracket as 'ageing'/old economies. There is no way around this one I feel and quite simply this is not 'possible' given the different age structures of these two countries. In order to substantiate my point I think that we should take a look at the two graphs below which demonstrate the difference between two countries in terms of ageing; the countries in question are the US and Germany where the latter is as useful proxy for Japan as any in connection to age structure (at this point I have not yet completed my median age calculations on Japan).

As we know ageing occurs as a result of a joint process of falling fertility and rising life expectancy where migration of course provides an important potential factor in smoothing out what otherwise seems to be a pretty linear process of ageing. Regarding life expectancy and when we speak of the biggest OECD economies we can safely say I think that the divergence in ageing does not decisively come from differing degrees of longevity. Rather we need to look at fertility and to some extent also migration where the latter's effect of course tend to work with almost no lag relative to changes in fertility which tend to take longer time in showing their effect but also then demand a much longer backdrop of action in order to swing the situation back into some kind of 'balance'. If we look at the US and Germany above and the evolution of fertility and median age we can, quite unsurprisingly, see a very strong correlation between the two. There are two things to note in particular regarding the evolution of fertility. The first is that both countries seem to have entered a decisive stage of the demographic transition which began in the beginning of the 1970s (we don't know whether this in fact is also the final stage). Now, the interesting thing here is that the US and Germany started off from different starting points (taking 1970 as year '0') with the US 'starting' the transition from a TFR at about 2.5 and Germany from about 2. This had the obvious effect that while both countries' TFR rate went below replacement level the German TFR stayed persistently lower (at about 1.5) than is the case in the US (at about 1.7). If we then factor out the difference in starting points we can see that during the 1980s the relative decline in TFR was no greater in Germany than it was in the US. However, from the 1990s (1987 in the US) and onwards a striking difference emerges by which the US TFR begins to climb towards replacement level (a bit below) whereas Germany's TFR falls below the dreaded mark of 1.5 where it has lingered ever since (the fertility trap?). Now, both the absolute as well as relative difference in evolution of TFR rates quite dramatically translate into the median age where we can see above that Germany is substantially older than the US. In fact, the time series above tend to underestimate the difference a bit since the REAL impact on German median age (and Japan's, Italy's, etc) is going to come in the decades to come. So, the US is younger than Germany (and thus Japan); that much is pretty certain I think. But how can we extrapolate this to my general point in terms of calibration? This brings me to my second point on fertility.

As such, we can see that for both Germany and the US, the evolution of median age seems to exhibit a very strong linear trend over the course of the last half of the 20th century and into the 21st century. This is most likely due to a steady upward movement in life expectancy as well as of course a steady downward path of fertility, especially once we get into the 1970s and beyond. However, and here comes the important point, we need to realize I think that although ageing occurs with a steady linearity (migration flows can distort this though) the effects of ageing exhibit notable non-linearities; this at least is our hypothesis. In short, there seems to be a median age range (let us say <40 years) years where conventional economic theory seem to cope 'pretty well' with understanding the processes taking place; i.e. developed economies in this range seem to respond strongly to low real interest rates/credit expansion, are able to sustain asset price booms, can run large external deficits, have a solid domestic demand component, etc. Yet once we transist into the 40s regarding median age there seems to be a change in all of this as we have tried so many times to point out here at DM in the context of e.g. Japan, Germany, and Italy(who IS running an external deficit mind you). Now, in terms of Jen's remark this all shores up at his point on how demographics will have a tendency to be tantamount to Dollar weakness and thus a misconception in my view regarding the point where the US would 'hypothetically' start to dissave.

In Summary

In order to sum up why don't we have a look at the way Jen summarizes his main points;

Demographic trends have important economic and financial implications. Without remedial action, global ageing in the developed world tends to raise the level of real interest rates, flatten the yield curves, benefit equities at the expense of bonds, and lower the value of the dollar.

By the reading the note above you could be tempted to believe that I disagree quite strongly with Stephen Jen. This would be a mistake. However, I do want to emphasise the two points noted above . Firstly, it does not serve us well for analytical purposes to narrate ageing in the context of dissaving since this takes us away from what happens in the transition towards this situation which we after all might not want to reach. Secondly, I think that we need to be rather careful with which economies we denote as 'old'. Of course all OECD economies are ageing but they are doing so in different tempi and moreover as I have argued above the real effects of ageing seem to materialize with notable non-linearities relative to the process of ageing itself which is fairly linear. Finishing of with Stephen Jen's work in general much of my own work on ageing and financial markets has transpired from Jen's continuous digging on the topic in the context of MS' GEF. Especially, his hypothesis on a decline in home bias in the context of Japan is a very important contribution to the big picture. Also, I am very sympathetic to the way Stephen Jen has been working his way towards this. Basically, he started digging on Sovereign Wealth Funds went on to Sovereign Pension Funds and then ended up with this important contribution to the debate which I am sure will be modified and refined as we go along. And all this over the course of a year in the context of MS' GEF; who the h'eck ever said that blogging couldn't add value?

Saturday, September 22, 2007

Why Demography Matters, The Romanian Case

Well, the argument on this blog is about to start developing, since events are now (as Claus and I have been trying to suggest since the early summer), moving quite fast. At least in the East European context they are. The day when all the outstanding checks are called due to see if the books balance is getting nearer, and we have all seen only too recently what happens to banks when you need the liquidity to close your accounting for the day and you simply can't find it. Who would ever have thought that this could happen to countries and their stock of people? Well, as we have been saying, the numbers simply don't add up, and in the same way you can't make your bank solvent by "robbing Peter to pay Paul" and frantically shifting money from one account to another, you can't make your continent "population solvent" by massively shifting people around (600,000 from Poland to the UK, 500,000 from Romania to Spain) if there is an underlying deficit (and there is, remember, our current economic growth models are tremendously "people intensive", that is our economies chew up people almost as fast as they burn oil, and with the same consequence, if the supply is constrained the price soars).

At the present point I am busying myself gathering data on Romania, since Romania, for a variety of different reasons, seems to have been singled out by destiny to be the country where all the roads cross, with everything from the global credit crunch emanating from the US sub-prime crisis, to the export dependence of the German economy, to the difficulties presented by tight currency pegs (read Latvia, Lithuania, Estonia and Bulgaria) to the massive migrations of working age population and long term low fertility all coming to a head at one and the same moment, to produce a huge crescendo of cacophony and disorder. And one that may turn out to be contagious, mind you.

People often say that they don't understand why fertility should be so important, or why the hell Edward is so obsessed with this issue. Demography doesn't matter to economics, now does it? The Economist among others have re-assured us on this point time and time again. Aha! Well just key your eyes on those TV screens in the coming months, since all of this is about to be tested, and bigtime I'm afraid. Hopefully I'm wrong.

Incidentally, and following Claus's example, my apologies for the sparse posting of late, but we have been, as you are about to see, somewhat busy.

First off, let's do something unusual for this blog, and start with a currency curve. The euro vs the Romanian leu last Thursday.

Well one thing to remember (since we are measuring the value of one euro in Romanian leu) is that in this peculiar world up actually means down, and hence the point we might like to notice - since the curve goes spiking up - is that the leu took a hell of a hammering on Thursday, that's what it did.

Indeed, since the start of the sub-prime crisis back mid-August the leu has been the worst-performing of the complete batch of 26 key emerging market currencies against the euro. Here's a one month chart as of the end of last week:

Migration the Key

OK, these are currency charts, so what?

Well the point is that in the coming downturn in the global economy (the US is headed slowly into recession, Germany, Italy and Japan already seem to be following suit, and we will see how long the Chinese export model can survive when all the customers are less able to buy) the Romanian economy is going to be particularly exposed, and the reason it is going to be particularly exposed is its fragile demography. Yes, ladies and gentlemen, I kid you not. This IS the situation.

Now the relevant demography here is long term fertility (ie the number of live births since the late 1980s) and the recent huge hemorrhage in out-migration. On fertility we do have reasonably accurate data (more below), but on migration we are scandalously in the dark, despite the fact that one of the key topics we (the "we here" being not the royal one, but "we the economists") need to know about in order to try to get to grips with forecasts and things like that is the level of potential "capacity" in Romania, ie the level of the available labour force. You simply cannot measure potential output if you don't have an accurate measure of how many people you have available. So, to take one 'trivial' example, a central bank cannot carry out a monetary policy analysis, since to facilitate growth, and set and interest rate, you need to know how fast an economy can grow without producing wage inflation and to do this you need an accurate measure of potential labour force growth.

So if we are to make any sort of informed assessment of the future path of the Romanian economy the level of out-migration which has taken place in recent years is a key data point.This I think has to be obvious to anyone with an ounce of economic preparation. And Romania has certainly its full share of out-migration. In this sense the situation is very similar to the Polish one, with the exception that the Polish situation has had a lot more media coverage.

Well.... in order to try and get some data to put online I took the trouble to go and have a look at what Eurostat actually had (the English language version of the Romanian statistical office site, being, unfortunately, a hopeless mess). So here is a chart showing the migration information the Romanian statistical authorities have found themselves able - to date - to provide to Eurostat.

Well, nothing out of the normal here you might think. Romania is simply a country with a very low level of migrant flows. The data is, of course, for net movement, so there could be larger numbers of people coming and going, but still, the order of magnitude difference cannot be that large, or can it?

Now lets take a look at the data provided by the Spanish national statistics office (the INE) for Romanians resident in Spain over the last few years, and compare this data with the official Romanian numbers.

Wow! Well there certainly does seem to be something happening after all. And we should remember that not all the Romanians who have out-migrated since the end of the 1990s have gone to Spain (there are for example a significant number in Italy), although I dare say a fair proportion of them have. The important thing is that we simply don't know. What we do know - and know since the Romanians in Spain (whether they are working legally or not) have an interest (like access to the health system and future amnesties) in registering with the authorities, and indeed the Spanish authorities have (for their own reasons) an interest in maintaining the data in a very up-to-date condition - is that according to the Spanish Padron Municipal electronic-data there were 524,995 Romanians with active and valid id cards for the Spanish health care system as of 1 Jan 2007. These are not just Romanians who are simply passing through, or just might be around somewhere. The municipal registration which lies behind the data is renewable regularly for those without resident permits, and renewing them is how you get the right to have residence later, so this data is VERY accurate.

But we don't know how many Romanians are currently living and working outside Romania in total (or how many Moldovans are living and working in Romania, which is the other side of the issue) and we don't know because the Romanian national statistics office and the Romanian government don't see the issue as important enough to take the trouble to give this the same sort of priority the Spanish government do, despite the fact that Romania is now a member of the EU, and despite the fact that it is considered normal (even by the IMF apparently, reading the staff reports) that Romanian wages should rise rapidly towards European levels. European levels means European levels in every sense of the word.

Of course Romanian wages should steadily rise to the West European level, but the question is how you do it, and the keyword would be "steadily". If you simply increase them by fiat, or because you have no relevant labour supply this won't work. It is not sustainable, and in this way you cannot maintain an internationally competitive economy. You need to raise wages by becoming more productive - per capita - that this the only sustainable way.

Unfortunately the Romanian authorities will live to regret this failing. They will regret it since, as my analysis in this blog post will attempt to demonstrate, in the coming economic crisis in Romania, the outflow of people, and the reverse inflow of money in the form of remittances, when these are coupled with the subsequent distortions in the kinds of economic activity undertaken as a consequence will, unfortunately, prove to have been a very important factor.

(Incidentally, please, will anyone who may be out there with any reasonably accurate data to offer on the migration situation please get in touch.)

Construction, Did Someone Mention Construction?

Coincidentally with all of this Eurostat has just just published its monthly construction production index for all the EU countries. For our present purposes here I reproduce what is perhaps the most significant extract:

Annual comparison

Among those Member States for which data are available for July 2007, construction output rose in seven and fell in seven. The highest increases were recorded in Romania (+26.3%), Slovenia (+17.9%) and Poland (+17.0%). The largest decreases were recorded in Hungary (-14.6%), the United Kingdom (-6.6%) and Belgium (-4.9%).

So construction in Romania is booming. What a surprise! And not only is it booming, it is booming more than anywhere else in the European Union (at least, better put, it was booming while the banks - globally speaking - were still lending money to low-quality creditors for construction purposes, quite how much this activity will now continue as we move forward is exactly the point I am try to make here).

To get a better overall view of the position here's the construction output index for Romania since July 2006:

What we can see is that even though the rate of expansion has slowed noticeably over the last three months, the general expansion in Romanian construction has been significant. Here's the quarterly index for Romanian construction index going back to 2002 which makes the general evolution even clearer:

Now the result of all this frantic construction activity on an economy with tightly constrained labour force capacity (but which is not, please note, inward-capital-flow constrained) was, of course, not long in coming and it was the one which wascompletely to be expected: the price of construction new construction began to strongly surges upwards (readers in the US, does all of this remind you anything, some recent event or other in your country?).

The effect on wages and salaries should also not surprise us too much either, and here I present the index of construction salaries which only serves to confirm our worst suspicions:

Now as we have already noted, and despite the inability of the Romanian government to face up to the implications, there are currently around half a million Romanians working in Spain, and logically these Romanians are not available to work in construction in Romania, so, when you come to think about it, it is hardly surprising that we should find that wage inflation in construction has been enormous. The quarterly year on year chart makes this even plainer. The rate of salary increase in the first quarter of this year, for example, exceeded the astonishing level of a 50% annual rate.

The immigration data is only, of course, on part of the picture here. The other part of the story is the money which the migrants send home, much of which is then diverted into construction. Data on remittance transfers is available from the Romanian national bank, and as can be seen remittance flows have been rising steadily in the last few years, and are currently running at a rate of more than 500 million (or half a billion) euros a month.

This steady upward rise in the volume of inward remittances can also be seen in the following annual chart:

Now one of the central points I want to make here is that this flow in remittances also encourages an increase in the expansion of domestic credit (since the new income can be used to fund the repayments), and this can be seen from in the chart below.

Private credit in Romania is not at preoccupying levels (in terms of % shares of GDP), but it is important to note the steady increase in the quantity of these loans and in the quantity which are foreign currency denominated (normally in euros). In fact foreign denominated loans have been running neck-and-neck with domestic ones in as a share of total credit. This trend of course adds significantly to the vulnerability of the Romanian economy to any currency correction like the one we are beginning to observe in the charts which I presented at the start of this post. And it isn't only the private sector, since foreign currency loan indebtedness is more or less equally distributed between the private and the corporate sector.

General Wage Rises

So OK, wages and costs are going up in construction, but again: so what? Romania is a poor country, wages can rise, they can stand this, can't they? Well unfortunately, they can't, since among other problems the sudden surge in internal demand that all this construction related activity has been producing has created a big hole in Romania's international trade position, and the current account deficit is ballooning, and with this the dependency on international capital glows (and hence on global risk appetite) . Romania is no longer an independent actor here, it depends on the "whims" of its creditors.

But lets look a bit more at some of the general implications of the construction boom. The problem is that the spike in construction wages has not been confined to construction. Here we have the quarterly index for Romanian wages and salaries since 2000. The trend is pretty clear I think. General wage inflation is now an important phenomenon in the Romanian economy.

If we look at the annual rates of increase we will see that from 2001 to the end of 2005 a strict monetary policy from the Romanian central bank was steadily bringing a bad situation under control. But since the start of 2006 this position has once more started to turn round, and has been gradually getting out of control.


So my big argument is that all of this is, in part, driven by a very structurally distorted underlying demography. Let's now take a closer look at this, and to get the ball rolling let's start off with the fertility situation:

Despite the fact that we have a gap in the data during the late 1980s we can see that after falling steadily to replacement level during the 1960s and 1970s, the Romanian fertility rate dropped well below replacement in the 1980s and has been hovering round the 1.2/1.3 "lowest-low" TFR since the start of this century. This is a level in which the population cohort size nearly halves with each generation, so it is no laughing matter.

Now if we look at the drivers of short term fertility, as most of the regular readers of this blog will be aware, they key indicator here is the birth postponement process, and this process revolves around the rising rate of age at first birth of the mothers who have children. In the Romanian case we do not have specific data for this age, but (again thanks to Eurostat) we do have data for mean age on childbirth, and since most Romanian mothers now have only one child this is not a bad indicator.

As we can see, the median age at childbirth has been rising slowly but steadily, and this process is, in part, behind the very low fertility readings which have been registered in Romania in recent years. But at the current level of 27 (and this is an average for ALL births and not just first births, so the first birth median age will be somewhat lower) it is still significantly below the Western European norm, which is around the 30 mark. So more years of very low fertility are to be anticipated as postponement continues, and if Romania hits a major economic crisis in the meantime (which is, I am afraid, a very distinct possibility) then we may get stuck in exactly the kind of low fertility trap which Wolfgang Lutz has so ably identified.

If we now move onto the natural evolution of the Romanian population, I think it is worth starting by taking a look at the live births' chart, because there is, at first sight, a rather strange phenomenon to observe there. This phenomenon is the sudden jump in births in 1969:

Now this jump is undoubtedly the result of one of those rather notorious incidents in Romanian history, the Ceaucescu pro-natality campaign. Perhaps it isn't necessary to say this (it shouldn't be!), but those of us here on this blog who advocate pro-natalist policies along the Swedish or French pattern would obviously wish to completely dissociate ourselves from the type of coercive pro-natalism advocated by Ceausescu and his ilk. What we ARE arguing for is a collective effort on the part of the whole of society (organized collectively and via the state) to transfer resources to those women who would like to have children (Adam Smiths "hidden hand" seems to have gone "missing" at just this point, societies and economies guaranteeing their own reproduction). This is a policy to support choice, but based on the secure knowledge that our collective interest as societies lies in the direction of doing this, and of reproducing ourselves on a stable trajectory. It lies in this direction since otherwise.... well, unfortunately we are just about to find out what the otherwise alternative is in the present Romanian case.

Another import point which comes out of this analysis is the sharp drop in the number of births which took place around the end of the 1980s. To put this in some perspective we might point out that in 1988 some 380,000 children were born, while in 1991 this number was down to 275,000. This is a drop of over 100,000 children a year in just 3 years (and of course the annual rate has subsequently only dropped further). So in 2009 there will be 100,000 young people of 18 years of age LESS than might otherwise have been the case, and the Romanian labour market is BOUND to notice this sharp adjustment, out-migration or no out-migration.

But if we now come to look at the balance of births and deaths, and especially for those which took place in the late 1960s, we will again notice something strange, since we should be able to see that the number of registered deaths rose quite sharply in 1967 and it is plain from the way in which the birth and death curves track one another here that the pro-natalism policy which lies behind the rise in births does seem to have been somehow linked to the dramatic rise in the number of deaths.

Perhaps in comparison with the huge spike in live births the increase in deaths does not seem too significant, but if we look at the chart for deaths a bit closer up, the increase is readily apparent. Deaths in 1967 were up 21,000 on 1966, in 1968 they were up 31,000 and in 1969 they were up by 43,000 over the 1967 figure.

So we have a phenomenon - yet one more time in the Romanian case - which is different from the typical one, in that the numbers of births fell below replacement very early on, and then this fall was followed by a subsequent huge spike which distorted the whole age structure, and then finally the annual number of live births dropped below the number of annual deaths in the early 1990s, and since that time the Romanian population - even ignoring the net loss from migration - has been falling. And if we look at the theoretical population position we will see this confirmed:

Turning to life expectancy at birth, we will see, despite a decline in the early 1990s (which may have been associated with high infant mortality) the headline number is now rising, but it is still low in comparison with Western Europe, and this is going to have important economic implications, not least because it places severe limitations on one of the favourite economic recipes for getting out of the kind of problems Romania is getting into, namely raising participation rates in the over 55 age group. Looking at all this data it may well be that the health of the older Romanian population is just not up to taking this kind of strain. I suspect we are going to hear a lot more of this kind of issue in the East European context in the months and years to come.

Finally, to complete our demographic round up, we could look at the median age of the Romanian population. This age is - at a current level of 36.9 - very young by modern standards, but it is hard to know what interpretation to put on this, since Romania is hardly a "young" population in the sense that Iceland or Ireland are, since the whole structural configuration of the demographic panorama is so uniquely skewed and distorted, and in part the comparatively young median age is a reflection of the comparatively low level of life expectancy.

Now I appreciate that most of you reading this blog are not economists, and hence even if you can see that there is something preoccupying and even deeply disturbing about the demographic profile I have outlined, you can't necessarily see why this is economically important. Maybe you can even see that all this construction activity, and wage push inflation isn't especially positive (and even less so in the wake of the US sub-prime blow-out) but still, why should things be about to go so wrong? Well you need to think about Romania's external position, and the ability of Romania to export its way out of trouble at the same time as the huge wage push inflation means it is experiencing a major loss in international cost competitiveness. Simply put, it is much harder to sell Romanian products abroad. As evidence what I am talking about, here is the chart showing Romania's growing trade deficit:

And here's another one showing the Current Account deficit.

Now this point about the rise of foreign indebtedness brings us directly back to the issue of remittances and construction, and in particular to the high proportion of current mortgages which are being taken out in foreign currency (87% of the total of Romanian mortgages were in foreign currency in July 2007 according to data supplied by the Romanian central bank). This exposure not only to external interest rates, but to the relative values of currencies) makes the individual Romanian household (not to mention their corporate peers) especially vulnerable to any sudden change in the value of the Romanian currency, as the cost of the associated loan repayments would obviously rise significantly. Here's another charts, this time showing the inexorable rise of foreign currency mortgages in Romania.

The point is of course that not only will the repayment on these loans become unbearable for Romanian households if the leu continues its downward decline, the external banks who have these households as clients in their portfolios will also become increasingly exposed (which is why I keep mentioning sub-prime here, it isn't just for the fun of it). Indeed the problem is even worse, since given that these loans are regulated by interest rates established by external banks, the Central Bank in Romania will effectively have little control over monetary policy in the event of a severe downturn. So, simply put, things look bad on all fronts.

And unfortunately - I'm afraid history is just like that, it comes and hits you smack in the face just when you least expect it - just right now we seem to be entering a significant downturn in the global economy whose depth and extent is yet to be determined. And during such downturns the chains normally crack first at their weakest links. Unfortunately for the citizens of Romania their country seems to currently be the weakest link in that 26 key emerging market chain which is chafing at the bit waiting to see who will be the first to fold. So it is to Romania I would be looking if you want to watch that first, initial, blow-out. And the reason why the blow-out will come here, why, "it's the demography, stupid!".

Thursday, September 13, 2007

Non/Delayed Marriage and Fertility in Asia Pacific

We have done it again and we know it. Apart from Randy's excellent follow-up below on an earlier post on the imbalances between Canadian states as a result of differing demographic fundamentals the DM team has found itself sidetracked by other matters. Regular readers will be customed to this but still I feel the need to dish up the mandatory apology.

Now, we have on several occasions been discussing the underlying dynamics regarding the demographic transition and the subsequent drop in fertility rates. First of all and as an immediate qualifier we need to realize that this is far from a uniform process but rather one which occurs with different speed, characteristics and thus effects from country to country. As a basic framework it is fruitful to look at the overall drop in fertility as a two-mechanism process. These two mechanisms are often coined as the quantum and tempo effect of fertility where the former denotes how women choose to have fewer children overall whereas the latter describes the wellknown process of birth postponement which again is believed to have notable derivative effects on the quantum effect (i.e. this is just to say there are feedback mechanisms all over the place). At this point, this whole issue might seem very simple but as we move further it becomes clear that the issue is one of notable complexity. In this entry, I will refer a paper which uses the overall framework of life-course theory (e.g. time of marriage if at all) to explain why fertility has reached alarmingly low levels in pacific Asia. The paper (full text is firewalled!) is written by Gavin W. Jones and will appear in volume 33 issue 3 of the journal Population and Development Review. Below, I reproduce the abstract ...

The general decline in fertility levels in Pacific Asia has in its vanguard countries where fertility rates are among the lowest in the world. A related trend is toward delayed marriage and nonmarriage. When prevalence of cohabitation in European countries is allowed for, levels of "effective singlehood" in many countries of Pacific Asia have run ahead of those in northern and western Europe. This raises questions about the extent to which delayed marriage has been implicated in fertility declines, and whether the same factors are leading both to delayed marriage and to lowered fertility within marriage. The article argues that involuntary nonmarriage is likely to be more common in Pacific Asia than in Western countries, and that resultant involuntary childlessness plays a substantial role in the low fertility rates currently observed.

Before I leave you I want to emphasise the perspective taken by paper through life-course theory to explain the sustained drop in fertility. In this way, this is what we need to be aware of in the sense that both economic theory and the more soft social sciences (e.g. life course theory) both offer valuable contributions to explain why fertility is falling. As a very crude approximation we can say that economic theory customarily has been used to account for the quantum effect through the well known Becker-Barro fertility theory whereas the tempo effect seems to be more vested in life-course theory where e.g. Robert Sobotka's dissertation is a hallmark study. Regarding the immediate topic in question the framework used is not new. In this way, the correlation between delayed marriage/non-marriage and fertility levels has also been entertained in Japan as well as many other countries.