Pyramid LeveragePosted: March 30, 2015
It is commonly accepted that “true” economic growth is the growth driven by technological innovation, and it is roughly approximated by a country’s GDP per capita growth. However, as I argued in an earlier post, short-term economic growth numbers could be distorted by monetary and fiscal policy choices. For example, a government may boost short-term GDP numbers by borrowing money through the sale of its long-term debt (say, twenty year bonds). By doing so, it employs the fundamental “time machine” feature of finance, which allows for the exchange of an uncertain future payoff for a certain payoff today. Ultimately, the repayment of the long-term government debt would be driven by the overall economy twenty years from now, i.e. people working, producing, consuming, and paying taxes then. Some of these people may not even be born today – how can we know for sure the number of workers and how productive they will be twenty years from now?
Who are those guys?
The answers to these questions depend on two assumptions: on the “true” long-term economic growth rate, and on demographic trends. Yes, ultimately it is the actions of other people who come after us that will drive the economy and government debt repayments! Doesn’t it sound familiar to the basic concept of a pyramid scheme of paying earlier investors with the money brought in by the later ones? Notice that a younger population yields higher GDP per capita compared to an older one: as young workers enter the labor market, GDP per capita increases even if the productivity in the economy stays the same. On the other hand, as the percentage of older retired people increases, the GDP per capita goes down even for highly productive economies. This is the population pyramid property: it is great to belong to a smaller generation followed by a bigger one – your retirement payoff is truly secure then!
In a broader sense, the ability to increase the economic growth numbers through either government borrowing or demographic properties can be viewed as “pyramid leverage” in the economy. Pyramid leverage essentially allows borrowing from future generations in order to improve current economic numbers, even with no increase in the economy’s productive capacity! In this sense, the “true” baseline economic growth numbers would be representative of the economy with no additional borrowing and with homogeneous and stable demographics.
This means that the potential long-term economic impact of government fiscal policies and the overall dynamic of the GDP per capita should be considered with the “true” future economic growth and also demographic trends in mind. Furthermore, is there a relationship between the overall economic growth and demographic growth? I don’t know the answer to this question, but it seems that periods of economic optimism have higher birth rates than periods of economic pessimism…
US vs. Japan
Applying the above logic of “pyramid leverage” to developed economies doesn’t yield a pretty picture, as all developed countries have been throwing their pyramid leverage at the most recent global recession. It is still up for a debate whether these massive stimuli did result in increased productive capacity, however, it is likely that the pyramid leverage that existed prior to the global meltdown of 2008-2009 has now been largely exhausted. Relatively low birth rates among developed countries definitely don’t help, severely limiting the ability to lever further. If significant increases in productive capacity don’t follow, the recent extensive use of pyramid leverage will end up putting a big drag on economic growth numbers in the future. In fact, the pyramid leverage can become negative if further government borrowing is limited and the population starts shrinking. From this perspective, the United States and Japan occupy opposite sides of the spectrum of possible alternatives.
The United States has perhaps the best pyramid leverage among the developed countries. While its Debt-to-GDP ratio is pretty high, the US still has potential for moderately positive pyramid leverage, driven primarily by its relatively younger demographics. There is also a potential for an increase in pyramid leverage through the immigration of younger workers, that is, if the government finally works out a sensible immigration reform. However, given that the government has already used up most of what was available by heavily borrowing throughout the great recession, any further use of pyramid leverage would be limited.
On the other hand, Japan’s pyramid leverage is highly negative, as it has the highest government debt burden combined with very low birth rates. In fact, it is the worst among developed countries. Japan’s cultural resistance to immigration doesn’t make things any better. Unfortunately, Abenomics seems to be failing in bringing up birth rates, while adding to the total debt, hence pushing Japan’s pyramid leverage further into the red, further hampering its economic growth in the long-term. Tokyo-based social commentator Roland Kelts reflected on the general mood in Japan:
If you compare China or Vietnam, most of those kids on scooters going to nightclubs, and dancing their heart away and perhaps having sex – they know it’s getting better, they know they are probably going to rock their parents’ income … No-one in Japan feels that way.
Perhaps, Japan could be better off directly incentivizing higher birth rates instead of a general economic stimulus…
Governments should be seriously considering demographic effects in conjunction with monetary and fiscal policies. Increasing the Debt-to-GDP ratio not backed by sufficiently youthful demographic might have very negative consequences down the road. Perhaps, additional economic incentives for having children should be a part of any sound fiscal stimulus package…