18/4/16: Demographics, Ageing & Inflation

In my Investment Theory & ESG Risk course, a week ago, we were looking at Asset Price Models extensions to incorporate inflation risks. One discussion we had was about the possible correlation between inflation and investor behaviour / choices, linked to behavioural anomalies.

A recent Bank of Finland working paper by Mikael Juselius and Elod Takats, titled “The Age-Structure – Inflation Puzzle” (2016, Bank of Finland Research Discussion Paper No. 4/2016: http://ssrn.com/abstract=2759780) sheds some light on this link via demographic side of investor / economic agent impact on inflationary expectations.

Specifically, the authors uncovered “a puzzling link between low-frequency inflation and the population age-structure”.

This link is pretty simple: due to asymmetric relationship between consumption, savings and investment across the life cycle, “the young and old (dependents) are inflationary whereas the working age population is disinflationary”.

In other words, risks of higher inflation are demographically tilted against markets / economies with either high young age dependencies, old age dependencies or both.

According to authors, “the relationship is not spurious and holds for different specifications and controls in data from 22 advanced economies from 1955 to 2014.”

And effects are large: “The age-structure effect is economically sizable, accounting e.g. for about 6.5 percentage points of U.S. disinflation from 1975 to today’s low inflation environment. It also accounts for much of inflation persistence, which challenges traditional narratives of trend inflation.”

Crucially, “the age-structure effect is forecastable” in so far as we can see pretty accurately long term demographic trends, “and will increase inflationary pressures over the coming decades”. In other words, deflationary environment today is expected to become inflationary environment tomorrow:

Hence, the rising demand for real assets and structural support for new levels of gold prices.

It’s all in the long run game.

14/1/16: Push or Pull: Entrepreneurship Among Older Households

Recently, I highlighted some of the potential problems relating to the less stable nature of the Gig Economy employment, including the longer-term pressures on life-cycle savings and pensions, as well as health care provision (you can see my discussion here: http://trueeconomics.blogspot.ie/2015/12/71215-cx-future-of-work-summit-dublin.html and my slides here: http://trueeconomics.blogspot.ie/2015/11/111115-gig-economy-challenge.html.

Mainstream economics has been lagging behind this trend, with little research on the long-term sustainability of the Gig Economy employment. Thus, it is quite heartening to see some related, albeit tangentially, research coming up.

One example is a very interesting study on entrepreneurship amongst the U.S. older households. Weller, Christian E. and Wenger, Jeffrey B. and Lichtenstein, Benyamin and Arcand, Carolyn, paper titled "Push or Pull: What Explains Growing Entrepreneurship Among Older Households?" (November 30, 2015: http://ssrn.com/abstract=2697091) does what it says: it looks at both push and pull factors for entrepreneurship and self-employment amongst older households.

Per authors (italics are mine): "Older households need to save more money for retirement, possibly by working longer. [Which is a pull factor for self-employment and  entrepreneurship]. But, the same labor market pressures that have made it harder for people to save, such as increasingly unstable labor markets, have also made it more difficult for people to work longer as wage and salary employees. [Which is a push factor toward self-employment and entrepreneurship].

Self-employment hence may have become an increasingly attractive alternative option for older households.

Entrepreneurship among older households has indeed grown faster than wage and salary employment, especially since the late 1990s.

But, this growth, rather than reflecting rising economic pressures, may have been the result of growing financial strengths – fewer financial constraints and more access to income diversification through capital income from rising wealth. Our empirical analysis finds little support for the hypothesis that growing economic pressures have contributed to increasing entrepreneurship. Instead, our results suggest that the growth of older entrepreneurship is coincident with increasing access to income diversification, especially from dividend and interest income. We also find some tentative evidence that access to Social Security and other annuity benefits increasingly correlate with self-employment. Greater access to interest and dividend income follows in part from more wealth and improved access to Social Security may reflect relatively strong labor market experience in the past."

This is an interesting result, because it is based on older households' access to:

1. Income from savings and wealth, including assets wealth; and
2. Income from retirement.

In the Gig Economy, both are likely to be compressed due to higher income volatility (and thus rising precautionary savings), tax incidences that impose liability with a lag (inducing higher income uncertainty), and lower earnings (due to lack of paid vacations, maternity/paternity and sick leave). In some cases, e.g. countries like Ireland, there is also an explicit income tax penalty for the self-employed (via both lower standard deductions and higher tax rates, such as those under the USC). All of which implies reduced access to income from retirement in the future, lower savings and wealth (including through inheritance). 

Subsequently, the current cohort of older entrepreneurs and self-employed may exhibit exactly the opposite drivers for their post-retirement employment choices than today's younger cohorts. And that matters because entrepreneurship and self-employment that start with push factors (e.g. necessity of life and constraints of the labour markets) is less successful than entrepreneurship and self-employment that start with pull factors.

27/11/15: The Welfare State Going Broke, and You Know It...

Bruegel’s  Pa Huttl and Guntram Wolff have recently posted on Capx.co results of their study, under a handy title “Lack of confidence in the welfare state in the year 2050” (link here).

One chart sums up key evidence:

Thus, across eight European countries,

• Majority of those polled felt that by 2050 public welfare systems will provide inadequate supports for pensions (59.5% of those polled) and for the unemployed (52.4%). 
• Roughly half of those polled thought that care for the elderly (49.5%) will be inadequately supplied by the public welfare systems, and 
• Over 45% thought that healthcare supply will fall short of their expected standards (45.4%). 

Darn scary numbers these are, even though, in my opinion, these are still too optimistic. The levels of implied state debt relating to what we call 'unfunded obligations' - contractually specified future commitments across pensions and healthcare benefits (excluding statutory, but non-contractual obligations) implies much lower probabilities of the modern welfare states being able to sustain current levels of funding.

Good example is the U.S. where current official debt stands at around USD18.5 trillion, whilst unfunded civilian and military pensions, plus Social Security and Medicare, inclusive of other contractually set Federal commitments and contingencies add another USD46-47 trillion to that (you can read more on this here)

4/6/15: Trend-spotting Out in 3 Key Charts

If you want to understand the German (and the Euro area) economy key trend, here are three charts:

Source for all: http://www.pewsocialtrends.org/2015/05/21/family-support-in-graying-societies/#

Combined, these imply one thing and one thing only: Domestic Demand (Investment + Consumption + Government Spending) can be sustained [in theory] over the next decades by just one thing: "Government Spending". In practice, the bad news is: such spending is neither hugely productive, nor feasible in current levels of indebtedness worldwide. Worse [from economic perspective] news: much of this spending will be swallowed by health & end-of-life services that will not be increasing the productive capacity of our societies.

In the mean time, logic of the above two charts implies:

1. Increased build up of external imbalances (current account surpluses in more extremely ageing countries);
2. Increased savings not suitable (due to risk profiles) for private investment (hence higher retail & long-term demand for highly rated bonds and equity, as opposed to higher growth bonds and equity); 
3. Reduced domestic consumption;
4. Heating up tax competition on the side of capturing revenues (as opposed to incentivising higher growth);
5. Growing reliance on 'hidden' taxes (e.g. currency devaluations and indirect taxation) to amplify (1) and (4);
6. Current 'peak productivity' generation (chart 3 above) is screwed on the double, and productivity growth curve going forward is downward-sloping, most likely even if we control for technological innovation.

All six points currently are at play. Draw your own conclusions.