Sunday, February 05, 2006
As Time Goes By
A paper on how the three components of demand - private consumption, government spending and investment – may impact the value of real estate capital assets as Baby Boomers head for retirement.
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Time – a very ephemeral and yet very real concept. As time goes by economic variables shift as the dawn of one generation approaches and the next generation is ready to spring forward.
In just five years' time, 77-million "Baby Boomers" will start collecting Social Security benefits in the United States. In eight years they will start collecting Medicare benefits. By the time they are all retired in 2030, the US will have doubled the size of its elderly population but increased by only 18 percent the number of workers able to pay for seniors’ benefits. Economists regard the commitment to pay pension and medical benefits to the elderly now and in the future as part of the government's "implicit" liabilities. And the size of these government’s liabilities is such as to render the US Government in effect bankrupt. The scale of this implicit insolvency was exposed recently by the Federal Reserve Bank by comparing the present value of all the revenues the government can expect to collect in the future with the present value of all its future expenditure commitments, including debt service. The shortfall was a staggering $44,000 billions. In comparison the federal debt - $6,500 billion - is small change. Canada fares slightly better – but not very much.
In today’s ‘globalized’ world there are two types of economic imbalances. The first relates to the way savings and investments are being distributed across countries in an increasingly uneven way. The second is the possibility that, over the next couple of decades, the global economy might face a protracted period in which savings exceed planned investment, partly because of demographic trends. The United States face a large and growing current account deficit, which reflects an excess of investment spending relative to domestic savings. This is matched by growing current account surpluses in Asia, in oil-exporting nations, and in some other economies around the world.
Geographical imbalances are not necessarily a bad thing, nor are the large capital flows that they generate. Indeed, there should be a process that works through world financial markets to allow savers in one country to lend to borrowers in another. Such a process leads to higher global growth, since countries with surplus savings can invest in countries that do not generate enough savings internally. However, when imbalances grow at an unsustainable pace, as it appears to be the case at present, some form of correction must take place. The optimal correction will require greater net national savings in the United States. Investment in the U.S. economy will need more financing from domestic sources—be it from the household, business, or government sectors—and less from foreign sources. This implies an increase in net U.S. exports and a decrease in net exports elsewhere in the world, as well as an increase in domestic demand in other countries for American goods.
As it relates to the second type imbalance, that is the possibility that over the next couple of decades the global economy might face a protracted period in which savings exceed planned investment, if countries do not have the appropriate structural policies in place there is a risk of a prolonged deficiency in global demand in the future. There are in the making right now two trends that will be important over the next decade or two. First, we can expect that Asia's share of the world economy will continue to grow. For various reasons, Asian nations traditionally have had a higher rate of savings than other economies. And so, all other things being equal, we can expect that global savings will rise. The second trend that we can expect is higher savings in most economies of the Organization for Economic Co-operation and Development (OECD) as the Baby-Boom generation prepares for retirement. Taken together, these two trends can certainly be expected to lead to a higher level of savings worldwide. Therefore it is going to be critical for policy-makers to act now, so that there can be an increase in demand and investment – and thus consumption - to compensate for the increase in savings.
How policy-makers handle the events of the next ten to twenty years will be critical in preparing the global economy for the period from roughly 2020 on, when the proportion of the working-age population will start to decline in many countries. While demographic trends in the United States will likely be challenging, in many OECD countries as well the old-age dependency ratio is poised to rise sharply. According to a study by the European Commission, by 2025 the European Union will go from a ratio of roughly four working-age persons for every senior citizen to a ratio of 3 to 1. Indeed, without radical changes in fertility rates, life expectancies, or migration patterns, populations in many parts of the world will start declining, even as the world's total population continues to climb. According to the United Nations, the population of the EU could start to decline by 2025, with China expected to follow by 2050. Just last year Japan reported a drop in its male population, and the number of deaths in that country began to exceed the number of births.
For most OECD countries, the era of declining labor force and corresponding population drop is still at least a couple of decades away. Before we get there, we will first go through a period when savings are likely to rise. Workers in many countries can be expected to try to increase their savings for retirement through rising prices of assets, such as houses. However, real capital appreciation per se is not enough to sustain growth in the long run To spur consumption, increase demand and then again generate production and capital growth there must be present a component of liquidity that can only be obtained with a corresponding increase in saving from income on the part of the productive and working section of the population.
In just five years' time, 77-million "Baby Boomers" will start collecting Social Security benefits in the United States. In eight years they will start collecting Medicare benefits. By the time they are all retired in 2030, the US will have doubled the size of its elderly population but increased by only 18 percent the number of workers able to pay for seniors’ benefits. Economists regard the commitment to pay pension and medical benefits to the elderly now and in the future as part of the government's "implicit" liabilities. And the size of these government’s liabilities is such as to render the US Government in effect bankrupt. The scale of this implicit insolvency was exposed recently by the Federal Reserve Bank by comparing the present value of all the revenues the government can expect to collect in the future with the present value of all its future expenditure commitments, including debt service. The shortfall was a staggering $44,000 billions. In comparison the federal debt - $6,500 billion - is small change. Canada fares slightly better – but not very much.
In today’s ‘globalized’ world there are two types of economic imbalances. The first relates to the way savings and investments are being distributed across countries in an increasingly uneven way. The second is the possibility that, over the next couple of decades, the global economy might face a protracted period in which savings exceed planned investment, partly because of demographic trends. The United States face a large and growing current account deficit, which reflects an excess of investment spending relative to domestic savings. This is matched by growing current account surpluses in Asia, in oil-exporting nations, and in some other economies around the world.
Geographical imbalances are not necessarily a bad thing, nor are the large capital flows that they generate. Indeed, there should be a process that works through world financial markets to allow savers in one country to lend to borrowers in another. Such a process leads to higher global growth, since countries with surplus savings can invest in countries that do not generate enough savings internally. However, when imbalances grow at an unsustainable pace, as it appears to be the case at present, some form of correction must take place. The optimal correction will require greater net national savings in the United States. Investment in the U.S. economy will need more financing from domestic sources—be it from the household, business, or government sectors—and less from foreign sources. This implies an increase in net U.S. exports and a decrease in net exports elsewhere in the world, as well as an increase in domestic demand in other countries for American goods.
As it relates to the second type imbalance, that is the possibility that over the next couple of decades the global economy might face a protracted period in which savings exceed planned investment, if countries do not have the appropriate structural policies in place there is a risk of a prolonged deficiency in global demand in the future. There are in the making right now two trends that will be important over the next decade or two. First, we can expect that Asia's share of the world economy will continue to grow. For various reasons, Asian nations traditionally have had a higher rate of savings than other economies. And so, all other things being equal, we can expect that global savings will rise. The second trend that we can expect is higher savings in most economies of the Organization for Economic Co-operation and Development (OECD) as the Baby-Boom generation prepares for retirement. Taken together, these two trends can certainly be expected to lead to a higher level of savings worldwide. Therefore it is going to be critical for policy-makers to act now, so that there can be an increase in demand and investment – and thus consumption - to compensate for the increase in savings.
How policy-makers handle the events of the next ten to twenty years will be critical in preparing the global economy for the period from roughly 2020 on, when the proportion of the working-age population will start to decline in many countries. While demographic trends in the United States will likely be challenging, in many OECD countries as well the old-age dependency ratio is poised to rise sharply. According to a study by the European Commission, by 2025 the European Union will go from a ratio of roughly four working-age persons for every senior citizen to a ratio of 3 to 1. Indeed, without radical changes in fertility rates, life expectancies, or migration patterns, populations in many parts of the world will start declining, even as the world's total population continues to climb. According to the United Nations, the population of the EU could start to decline by 2025, with China expected to follow by 2050. Just last year Japan reported a drop in its male population, and the number of deaths in that country began to exceed the number of births.
For most OECD countries, the era of declining labor force and corresponding population drop is still at least a couple of decades away. Before we get there, we will first go through a period when savings are likely to rise. Workers in many countries can be expected to try to increase their savings for retirement through rising prices of assets, such as houses. However, real capital appreciation per se is not enough to sustain growth in the long run To spur consumption, increase demand and then again generate production and capital growth there must be present a component of liquidity that can only be obtained with a corresponding increase in saving from income on the part of the productive and working section of the population.
In conclusion, it will be wise for policy-makers especially in North America to encourage maximum economic flexibility so as to generate domestic investment and growth, and not to rely too much on foreign capitals particular in light of the forthcoming demographic changes here and elsewhere.
Luigi Frascati
Real Estate Chronicle
