CDF Dialogue with Charles Goodhart | The demographic reversal triggers an inflation crisis

CDF Dialogue focuses on topics such as the global political and economic situation, business values, international cooperation, and human development, with the purpose of "Dialogue with the world, seek common development", aiming to promote rational and equal communication between China and the world.

This episode, the guest is Charles Goodhart, Fellow of the British Academy and Emeritus Professor of the London School of Economics and Political Science.

In his book The Great Demographic Reversal, co-authored with Manoj Pradhan, Goodhart assesses the influence of the global labor structure changes on economic growth and details China's important role in globalization.

Goodhart believes that the low inflation and even deflation in the past three decades are mainly due to the world demographic dividend and globalization dividend. Now, the combination of aging population and deglobalization will reverse the previous trend and bring a series of changes.

In the future, will demography affect inflation? How will global inequality be affected?

In this dialogue, Professor Goodhart and Secretary General Fang Jin will explore the future we may face in terms of demographic reversals.

Fang: Professor Goodhart, you make a number of very interesting points worth exploring in The Great Demographic Reversal. For example, the mainstream view is that economic cycles are driven primarily by technological progress and capital accumulation and that labor supply is placed on a relatively periphery, and that most macroeconomic analysis focuses on cyclical and country-level changes.

However, you are more concerned with global-level changes and you believe that if we extend timeline, the influence of the global labor structure changes on economic growth will gradually emerge. What prompted you to write this book? Can you share with us the main conclusions of this book, especially the 'reversal' part?

Goodhart: Thank you very much. Our concern is not so much with shorter term cycles of 2,3,4 years but longer term trends, and the main point that we were making was that the disinflation that occurred in the west when inflation in the 70s and 80s and run at quite high rates, and it fell steadily from there, really, until the recent COVID crisis hit us all. It was due to the longer term trend of a massive increase in the availability of labor supply to employers in the western economy. During the three decades from 1990 to 2020, the effective labor supply in the western economies actually increased by more than 2 times. It practically tripled.

This was due to three factors, two mainly. A very beneficial demography and the decline in the birthrate had meant that there were fewer children for women to look after. With the availability of consumer durables, it meant that the proportion of women of working age who could participate in the workforce rose sharply. When I was young, the end of the 1940s and the end of the 1950s, probably only about 15 to 20 % of women of working age actually participated in the workforce. The rest were working at home.

And then whether those two factors: declining birthrate and consumer durables, the proportion rose from 15 to 20 % to about 65 or 70 %, and that was massive. So you are not only got a massive increase in the workforce overall, but half the workforce, the women increase their participation in the labor market just enormously.

And then again, the other main factor was liberalization. And here, the fall of the iron curtain in 1991, and the inclusion of China and some other parts of Asia, but particularly China in the world's trading system meant that employers in the west who could move their production of goods or even services to work within much lower wage economies, in particular, China, could increase their profits enormously.

And that also meant that in the west, the workforce shifted from being primarily largely manufacturing to being primarily in services, and it is much easier to organize labor, to try and undertake collective bargaining and to make threats of strikes if you are dealing with large factories where there are large numbers of workers working together who can be organized. Then in services where they're normally working in relatively small numbers are widely separated. So we saw the downwards trend in inflation during these 30 years as being due to the factors of globalization and a demography, particularly demography.

Now that demography has really shifted quite dramatically, and the trigger point for the change was about 2010. What was then happening was that the very large proportion of the population who had been born in the 40s and 50s and into the 60s before the birth rate started to decline so much. They came older and started becoming retired. That meant that the dependency ratio was rising very sharply. The ratio of those who consume, but do not produce and the young and the old started rising very sharply, because the life expectancy had been increasing with increasing prosperity. Better diets, better medicine, and so on and so on. And that means that there are now more old and still a number of young to look after for a declining working age population.

And the decline in the working age population is not quite sharp. It's not only China and Russia. It's Germany. It's most of continental Europe. It would also occur in the U.K and the United States and indeed in Canada, were it not for the inflow of immigrants into those countries, which is keeping their working population stable. You've now got a declining working age population and a larger number of old who need to be looked after and particularly when it is the state that has to look after the old, that means the fiscal position gets worse. Taxes have to rise to shift resources from workers to the aged. And that puts on a great deal of fiscal pressure, which we are going to see frequently.

Now when we wrote the book which was before COVID. In fact, I did an epilogue chapter after COVID struck in March 2020. The momentum of the availability of such a much larger workforce and its effect on keeping wage rates down, particularly to the unskilled, was still so great. Although we could see that the reversal of the factors of demography and to a degree of globalization would, in due course, shift the underlying trends from deflationary to inflationary, we didn't know when it would occur, to within plus or minus really 5 years.

And then COVID struck. And the effect of COVID has been, particularly in the west, I'm not quite sure quite how much in China, has been to reduce the available workforce. The old who are nearing retirement decided that they wouldn't go back to work. So their participation rates fell. And the effect of COVID has been more long-lasting. There is something called long-COVID. which means once you get it, the proportion of those with COVID, continually get weakness, illness, and incapacity, and cannot work or work fully, and so the available workforce, particularly in 2021, became much lower. Then central bankers and other policy makers had appreciated, and that led to a tight labor market in our countries, and that was one of the main factors bringing about faster inflation.

We think that the COVID has acted as a trigger to bring forward the time when we shift from a basically disinflationary trend to a basically inflationary trend. Thank you.

Fang: My next question is about the timing. In your book, which was published a few years ago, you did not give a clear answer to the question of when this deflation will change to inflation, but you think the global economy will experience long-term inflation. So today, like you said, global inflation pressures are increasing at an alarming rate, but many people believe that this inflation is due to the simultaneous oversupply of money in most economies and disruption of the supply chain caused by the pandemic and geopolitical factors. And that demographic changes do not play a dominant role. So how do you judge the outlook for the current episode? Will the combination for stimulus policies in many countries and global economic recovery bring us to what you call the 'tipping point' more quickly or we have already passed the tipping point?

Goodhart: I think we've already passed the tipping point. The impatience in the west has already become so entrenched. The labor market is so tight that interest rates will have to be moved up to levels that will be extremely uncomfortable for the fiscal position because given the highest public sector debt ratio that has now been reached in our countries, public sector debt ratio is about 100%.Most of our countries start raising interest rates. It means that the debt burden becomes a great deal higher, combined that with the generality and popularity of unemployment, And you will get increasing calls from politicians and others for central banks to stop raising interest rates before they have actually restored inflation back to their target level.

I think that the break on interest rates will occur at a point where inflation will go back. It will go back from the sort of 8,9,10 % that it is now running at in Europe, the United States and the U.K. It will go back to something like about 4 or 3.5 %. But I don't think it'll go back to 2%, because raising interest rates is always unpopular and raising interest rates when the debt burden is already so high means that the pressure on ministers of finance and chancellors becomes a great deal more severe, and they will respond, and ultimately the politicians will have the last word, and a pressure will get put on the Fed, the bank of England, and the ECB and not to raise interest rates anymore.

Fang: That is exactly the next question I'm going to ask you. The Federal Reserve and monetary authorities in many countries have raised interest rates significantly to dampen rising inflation. But if as you suggested, the current inflation is caused by long-term demographic factors and also deglobalization process, then will these short-term countercyclical policies be effective? And if not, what long-term structural measures can we take?

Goodhart: I'm afraid the answer is that they won't be effective. I should add here that I'm not the only... And my coauthor Manoj Pradhan. I'm not the only economist taking this view. There are a series of economists in the USA. John Cochrane at Stanford university. There was a paper produced by Bianchi and Melosi at this year's Jackson Hole Conference which have argued that as long as the deficits, public sector deficits and public sector debt ratio are as high as they are at the moment, and interest rate increases will not be effective in reducing inflation because of the adverse effect on the public sector finances, which sooner or later, will lead to cause as I've suggested, not to raise interest rates sufficiently or need to increase the money supply again in order to avoid collapses in the public sector debt market.

Of the kind which you saw very clearly in the aftermath of the latest British badly done mini budget, the problem there was that they tried to reduce taxes without saying how it was going to be paid for, and without giving any indication at all about what the sustainability of the public sector financial position would be in the long term. And raising interest rates does not improve the sustainability of the public sector fiscal position. And therefore, if you were going to a lower inflation for permanence at the moment, what you need is you need to have increases in tax rates of one kind or another or cutbacks in public sector spending. And both of these are extremely politically unpopular. And that, again, is a reason why we think that simply relying on the central bank to raise interest rates as a means of getting inflation back to target is not going to work.

Fang: Let me try to find a long term solution. India and Africa have much younger population and are eager to participate in a global supply chain. Do you think they will create a new demographic 'sweet spot' for the world today and new future? Like China did in the 1990s and early 2000s.

Goodhart: It's certainly possible, and it would be highly desirable if that was to occur. In the case of India, yes, India is growing fast. But again, the birth rate in India is now beginning to come down quite sharply. And I think there is a limit to what India can achieve,and I think it will achieve a lot. And it will be one of the growth spots in the world in coming decades. The African birth rate is still at very high levels among the highest in the world. And some of the figures are remarkable. I believe it to be the case that within about 10 years, the population of Nigeria will be bigger than the population of the United States. The population of Africa is increasing very sharply, but it's not just sufficient to have a very sharply rising population. If you have, as the Africans do, have a very sharply rising population,there are two ways of trying to use that available population to maintain world growth everywhere. One of those means would be migration of Africans, out of Africa, into Europe, into Asia, into America. The problem with that is that, it would, I think, be politically unacceptable. So much of, particularly right wing politics and so much of its success is, as for example, the Trump presidency and Brexit for Britain to leave exit from the European Union（EU） was driven by a dislike of inwards migration. And I think it virtually impossible, socially and politically, for there to be a massive migration of the young, working age people out of Africa into other countries. I dismiss that as a possibility.

The second alternative is to take manufacturing and maybe certain services that can be produced abroad to Africa. The problem there is that it's not just the availability of a working population, of a growing working population or a large available working population that you need. What you need is a stable, competent government,a good public sector administration, and you also need reasonably well educated population. The difficulty in Africa is that what my colleague calls the administrative capital, in which I call competent and effective government is not really in present, combined with the fact that there are something like about 40 odd different countries in Africa as compared to one single unified China, which with a competent government, a very competent government and a well-educated workforce, was able to have a quite staggering effective growth over the last 30 years. The Africans don't have that.

And let me just take one sort of, I think, sad example. Until about 2 or 3 years ago, Ethiopia was growing at a very fast and steady rate, and then it fell into a civil war, and that has all gone wrong. And if you look at the public sector that public capital administration, the effectiveness of government in Africa, it leaves something to be desired. If, and it's a big if, the Africans can get their political act together, and produce better education for the masses, then the availability of workforce in Africa could lead to Africa becoming the next China, and being the manufacturing hub of the world. But I think we got a long way to go before that. Actually, to comes to it, take into being.

Fang: Thank you, professor. Here's my last question for you. As you suggested, the increasing labor supply from developing countries played a significant role in widening income gap and backlash against globalization in Western economies. Then the demographic reversal, especially the coming shortage of labor, reduce income inequality, hence populist sentiment in the Western economies in the foreseeable future? Thank you.

Goodhart: And the short answer to that is yes. The last 30 years were the best ever for the capitalists in the Western world. Profits, then the share of profits increase really quite sharply. Asset prices, housing, financial capital, and also human capital. If you had managerial skills, if you were technical skills, if you knew your way around the new digital world, and program and computers and all that, then you did very well. If you had nothing to offer, but you're unskilled labor, particularly the muscular strength and nothing much else, then you really did fairly badly. So the capitalists, those with capital human or financial did brilliantly. Those were just human labor did really relatively poorly. In the US there has really been virtually no increase in the real wages of the lowest two quintiles of the workforce for the last sort of 30 or so years.

And inequality within countries has increased dramatically. Now we're going to get the reverse of that. The kind of problems of inflationary pressures leading to higher nominal and probably higher real interest rates are going to mean that asset prices are going to decline with greater shortages of labor and higher unit labor costs. Workers are going to do better. Capitalists and property owners are going to do relatively worse. So inequality within countries,I think, is going to decline, and decline actually quite sharply. More or less everywhere. And that is going to mean, I think that we're going to hear less of the right wing populists that had been so prominent in the west over the last decade or so. And with any luck, and we're going to go back to the more left wing socialist type approaches that we had in the 50s and 60s. At any rate in my country. I might add though that although inequality within countries as were some very sharply over the last 30 years or so, inequality between countries is actually lessened quite sharply. And that, again, is largely the result of the rise of China. And not only China, most of Asia countries like Indonesia and Thailand, for example, have grown remarkably sharply.

And the reversal that we talk about is likely to reduce inequality within countries, but may have the effect of increasing inequality between countries. We may find that there are countries, particularly those without competent political administrations, maybe Africa, maybe parts of south America will lag behind. And the countries in the North, in Asia and Europe, North America will go on growing, not as fast as they have been growing.

Because with the growth of the working age population, unless there's an unbelievable productivity miracle, the growth rate of your country, the growth rate in Europe, and the growth rate in America, will have to decline. We do actually think in our book that the productivity per worker is going to improve everywhere including China over future decades, because the shortage of labor will actually put incentives on management to increase productivity per head, an incentive which has actually been quite largely absent for the last 30 years or so. Because of the massive availability of labor which I talked about earlier.

Fang: Well, so, It seems the demographic reversal is a blessing in disguise of some sort. Thank you very much, professor.

Goodhart: Even though there are some advantages, I think productivity of worker will increase.

Inequality within our countries will decrease. But very undoubtedly difficulties I think in many ways. The main difficulty is the fiscal one, which leads me perhaps to my first question, which is, in the past in China, my understanding is that the old mostly been looked after within the family group.

Now, with it very sharp and continuing decline in the birth rate. And to take one extreme example. If the birth rate fell to a one per woman, in due course, there would be one grandchild to look after four grandparents. And of those grandparents, the problem with old age is not so much as you grow old. As you become incapacitated, you need people to look after you. And the diseases of the old dementia and Parkinson's are not yet at all being cured and not beginning to be cured.

So as the Chinese population ages, and there are many fewer young to look after them, what's going to happen? Thank you.

Fang: Professor, for your question, China has been preparing itself for the ageing society by building and improving a long-term care system, health service system and social security system for the old, especially incapacitated.

First, we would like to build a long-term care service system based on integrated care services with home-based，community based, fully developed institutions and an integrated care model.

In addition, medical and health services will be gradually integrated into the construction of home-based, elderly care services and elderly care institutions to improve their quality and efficiency. Secondly, we will continue to strengthen the family support system, probably care which is part of Chinese culture and has many advantages by providing tax incentives and paid vacations for family caregivers.

Thirdly, we will enhance disease prevention and health management to ensure our ageing population enjoys a longer period of healthy life.Firstly, we will continue to improve the economic security of the old by developing a multilevel social security system with pensions, occupational annuities, and commercial old-age insurance. In addition, we also plan to increase the labor force participation rate of the elderly to increase their labor income. But judging from the current fertility trend, it is difficult to raise the total fertility rate to a sustainable level.

China is actually improving the fertility support policy system and taking many measures to increase the total fertility rate. China has formulated and promulgated a number of policies improving childbearing and parenting services and reducing the relevant costs and has integrated demographic policy into related economic and social policies, such as housing, education, health care, employment, taxation, and social security.

Preference will be given to families that give birth to children and the mechanism for reasonable sharing of a chair bearing costs. Specifically, the following policies and measures have been taken. First, I gradually explore and improve the labor cost-sharing mechanism for maternity leave, which was jointly participated by the government, employers and individuals Second, accelerate the development of affordable rental housing and implement specific housing policies that cater to the needs of families with children. The third promotes the development of an inclusive childcare service system. In addition to the adjustment of fertility support, social policies for economic and social developments are also crucial to the recovery of fertility rates.

Generally speaking, international experience shows that the fertility rate bottoms out and rebounds, at least when the human development index, which is between 0.8 and 0.85.

Consider a very high human development level. So along with the general improvement in human development, we need to invest more in improving gender equality, health and education. China has already achieved significant progress in these areas, but there's still a huge potential for further improvement. So China is still at a very early stage of encouraging childbirth. We have many policy tools at our disposal, which if unleashed in full force. I think will have a skilled, intended effect. Thank you.

Goodhart: I thought your account was admirably cheerful. And I would hope that at some stage, I can get a written statement of that because I would like to have it. I'd be very grateful to have it.Goodhart: We've got a long way to go.

Fang: A long way to go, but I think we need to look at this situation, especially the declining labor force in a comprehensive and objective manner, although the size of the total working-age population in China is decreasing. Labor resources are still abundant according to the results of the 7th national census. Chinese population aged between 16 and 59 is 880 million with an average of 10.8 years of education and an average age of 38.8. So this is still a huge human resources pool, and that no country in the world can match.

Second, since the reform and opening up, China's rapid economic growth has been supported by the demographic dividend, especially in quantitative terms. The qualitative side of demographic dividend has not been fully tapped. So since the 18th party congress, the Chinese government has attached great importance to population issues and made major decisions to adjust, improve the fertility policy, and promote long-term balance population development, according to the changing situations of China's demographics and focus on balanced development. So the Chinese government has said his name, yes.

Goodhart: I wish you every luck in that. I would just point out that I think that the demographic future is perhaps the greatest problem that you in China face at the moment I need. And although you say the labor force is now abundant, I wouldn't disagree with that. The rate of change with the growth of the old and the falling, a fall of the increase of the young into the workforce. The rate of change is really fairly worrying. Right? If it goes on for too long in this way, you're going to be here in a horribly overly balanced aged society. Could I just turn to my final question? Immigration has played virtually no role whatsoever. I think in almost any Asian country. Do you think that the problem that any rate I foresee of a worsening dependency ratio with a growing ratio of old, the young? Do you think there's any likelihood in Asia of a change in attitudes towards immigration?

Fang: I don't know about other countries, but immigration has been one of the topics of concern in China. Not long ago, the Ministry of Public Security in China adjusted the scope of application for permanent residence, which caused widespread public discussion. But President Xi has repeatedly pointed out that China's development needs the participation of international talents. And China's growth will also provide opportunities for those international talents. So as China continue to open up to the world, China will implement a more active and open effective talent introduction policy, create an attractive internationally competitive talent system, and welcome national talent to participate in Chinese modernization in various ways. So thank you. That's all for me. Professor.

Goodhart: I think that's probably all for me, too. Could I add that I found this I discussed with you extremely useful and helpful? And I would be very grateful if someone could give me a written account of it.

Thank you very much for your great insight to learn a great deal. Thank you, professor. I hope we can see each other in person in another place in the future.

Goodhart: I think you'll have to come to England. I'm too old to fly and my wife is not well. So I can't leave her side.

Fang: So I'm hoping I’ll go next direction. Thank you. Take good care. Bye.