The latest figures from Europe have been getting better. Let’s hope it lasts. Nonetheless, the debate continues over whether the European Central Bank (ECB) has done “too little too late” in terms of its trillion-euro QE program to avoid “Japanese-style” deflation. It is a debate that has raged ever since the US Federal Reserve embarked on its own massive bond-buying program six years ago, with Japan’s deflation regularly cited as the reason for enacting such extraordinary monetary measures.
However, deflation in Japan was not caused by a lack of loose monetary policy. It was caused by supply-side issues. Nor is QE a cure for deflation. It is a temporary painkiller that should be used in the short term while otherwise difficult structural reforms are carried out. The fact that “short term” has become six years and counting in the US and UK’s fight against deflation underlines QE’s shortcomings as a treatment on its own.
The biggest reason for Japan’s current turmoil is its demographics. In fact, the make-up of a country’s population is one of the most important top down factors in deciding whether it can have long-term, anti-cyclical growth. Investors should invest in companies, not countries, but either way, a booming national economy cannot hurt.
The Japanese have compounded their demographic problems over the last few decades with their surprising commitment to long-standing positions on immigration, labour reform and women in the workplace. In 2013, men earned 132 per cent more than women in Japan. In the US and UK, that figure was still disappointing at just over 50 per cent – but much better than in Japan. The country’s fertility rate has dropped from 1.8 children per woman in 1980-85 to 1.4 in 2010-2015. Readings from France, the UK and the US were all higher in the first period, and have risen since then. Japan also has the highest life expectancy at birth in the G6. Combine that with declining fertility and it’s a pretty big headwind if you don’t welcome workers from abroad.
Much of the developed world faces similar but less pronounced problems to Japan. But compare Japan’s approach to the issue to Germany’s. Berlin embraces positive immigration better than probably any nation in the world – the European project centres on it. In order to remain competitive since the advent of the euro, Germans have endured many years of stagnant or falling real wages. Conversely, Japan’s workers are protected by various labour policies that make redundancies and wage cuts rare.
If Europe gets out of its current issues, it will be because of supply-side reform. Because of structural factors, not QE. If the current bounce in growth genuinely lasts, some will try to claim that QE was the magical cure. That would be misleading. But ECB president Mario Draghi – aka Super Mario, a fitting name in my opinion – has engineered (another) opportunity for many European nations to carry out much-needed supply-side reforms. France, Italy and Greece in particular must take it more meaningfully this time. Japan’s outlook is desperate. Europe’s is still just shy of that.
Demographics are about the workers who make up a country’s economy and the consumers who consume the bulk of it. Policy needs to address how the actions, behaviours and tastes of workers and consumers are changing. Monetary policy can never shape demographics, but fiscal policy can. Over the last close to seven years, we’ve seen an obsession with the former and a lack of long-term focus on the latter. Furthermore, the traditional way in which monetary policy does take effect on an economy works less well on older people, who are not going to change their habits unless their circumstances change drastically. There is also plenty of evidence to suggest that demographics are changing faster and in a more pronounced fashion than ever before, requiring more targeted supply-side policies to address it.
Plenty of other factors have contributed to Japan’s demise, of course. But demographics, and the failure to address the issue, is the most significant. One of the other factors has been over-investment. I mention it purely because, paired with quickly deteriorating demographics, China is looking worryingly like Japan did in the 1980s. And the level of debt as a proportion of GDP in China has already surged and is still rising. A country needs financial flexibility as its population ages – not to be forced to deleverage.
What about the flipside? Countries like the Philippines, India, Israel and Peru have some of the most attractive demographics in the world, with their working age populations set to grow strongly over the next 25 years. The long-term investor should have a look at some strong domestic businesses there. Happy hunting.
City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.