The latest figures out Europe have been getting better. Let’s hope it continues.
Nonetheless, the debate continues whether the European Central Bank (ECB) has done “too little too late” in terms of its trillion-euro quantitative easing program (QE) to avoid “Japanese-style” deflation. It is a debate that has raged ever since the U.S. Federal Reserve embarked on its own massive bond-buying program six years ago. Ever since, Japan’s deflation has been cited as the reason to enact such extraordinary monetary measures.
However, deflation in Japan was not caused by lack of loose monetary policy. It was caused by various 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 for deciding whether a country can have a 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 this issue over the last few decades due to their surprising commitment to long standing positions on immigration, labour reform and women in the work place. In 2013 men earned 132 percent more than women in Japan. In the US and UK that figure was still disappointing at just over 50 percent — but much better than in Japan. The country’s fertility rate has dropped from 1.8 children per women from 1980-85 to 1.4 from 2010-2015. France’s, the UK’s and the USA’s readings were all higher in the first period, and have risen since then. Japan also has the biggest life expectancy at birth of the G-6, combine that with declining fertility and it’s a pretty big headwind if you don’t welcome workers from abroad. Take a look at the chart below – all of the G-6 have their work cut out – but none more so than Japan.
Much of the developed world faces similar but less pronounced problems than Japan. But compare Japan’s to Germany’s approach to the problem. Berlin embraces positive immigration better than probably any nation in the world – the European project centres on that. In order to remain competitive since the advent of the euro German’s 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 because of QE. Though if the current bounce in growth genuinely lasts, some will try and 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 workers who make up a country’s economy and consumers who consume the bulk of it. Policy needs to address how actions, behaviours and tastes of workers and consumers are changing. Monetary policy can never shape demographics. Fiscal policy can. The last close to seven years has seen an obsession with the former and lack of long term focus with 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 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 policy to address it.
There are plenty of other factors of course that have contributed to Japan’s demise. But demographics, and the lack of addressing the issue, is the most significant. One of the other factors was 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 gross domestic product has ALREADY surged and is still rising. A country needs financial flexibility as a 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 with working age population 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.
The full story is available from www.cnbc.com. To find out more click here.