ECOBATE 2014 – 1 Charles Goodhart and global trends

October 16, 2014

A single conference (2011) might be a one-off. The second (2013) a mere coincidence. But with number three (8 Oct) comes a strong hint that ECOBATE is now established in the sustainable economics and finance world. Prof Richard Werner (University of Southampton), again performed his conference double-act, providing a packed day for finance and economics people with dozens of academic papers and a keynote address from Prof Charles Goodhart; this was followed by an afternoon session to which the general public came too, addressed by eminent speakers such as John Kay, Lord Adair Turner, Sir John Gieve and Ralf Barkey. We are seven years from the near collapse of the financial world. Is the crisis over?  Or only just for now? What did ECOBATE 2014 add to the debate?

 Charles Goodhart told us (in his academic session Keynote speech 'Monetary Policy and Long Term Trends') that as a reaction to some of the colleagues he meets who - for the purposes of making money -  'have an attention span  of hours or days', he would give us an overview of decades past and future. He told us to be wary of the view: 'What has happened will happen', for this will be increasingly inappropriate for the next 10 years or longer.

For about the last 30 years the world's labour share of GDP has declined due to a massive increase in the the numbers of workers per head of population. Factors in this include: improved education, decline in the fertility rate, women's rising incomes, longevity increases and the decline in retirement age. The increased supply of labour exerts a downward pressure on real wages so that, e.g. in the US from 1980, wages have been virtually static. Additionally, if production has been able to relocate abroad for reasons of lower labour costs it has done so, again restraining wages back home. A consequence of this is the almost total disappearance of private sector trade unions. Prof Goodhart called the phenomenon a 'demographic sweet spot'. Inequalities between countries is falling but within countries is rising.

Labour-saving innovations also bear down on labour needs, and capital needs too are much lower for firms like Google, Apple and Amazon compared with the old technologies such as steel mills and oil refineries which needed 'massive great chunks of capital'.

Turning to policy implications of all this, weak consumer demand due to the relative lowering of poor consumers' wages helps reduce inflationary pressure. Rich consumers however - running out of the need for yet more consumer goods - pour their spare income into assets which is encouraged by the low interest rates of an easier monetary policy. This real estate wealth does not stimulate the real economy, as people don't spend the increase in their house price. Generally the trickle-down effect to the poor through making the rich richer via monetary policy is pretty limited, as is its effect on business investment. What easing monetary policy does in lowering interest rates, is to raise asset prices, particularly house and land prices - housing finance is most susceptible to it; and, except maybe in the US, house prices have gone up more than wages and incomes: 'shot up compared with the nominal compensation index'.


Unable to afford the credit needed, first time house buyers are left behind, especially if their parents aren't rich enough to help.  He said it was not just a 'London effect' but world-wide. First time buyers are in a dangerous position being only able to afford a relatively small deposit, with the rest as debt and if anything goes wrong, if prices collapse, they are 'really totally screwed'. He cited Mian and Sufi's book House of Debt who say that in those circumstances consumption collapses as people try and keep their households together. This comes from a combination of weak labour and first-time buyers in trouble, all flowing from the lax expansionary monetary policies.

The Bank of International Settlements (BIS) wants the loose monetary policy to end and to regain more normal house prices to incomes. Objections are that practical politics does not allow this through monetary policy means - so what else can you do? What fiscal policies might address the problem?  With pressures due to the increasing numbers of the elderly needing costly care and with high debt levels, possibilities are few - so what might be done?  'Structural reform' is mentioned and often these measures are little more than 'let's hope something turns up', but there are reforms that usually remove the wealth of those who have some monopoly position. As an example is the topical Uber smartphone app which puts potential passengers in touch with car hire drivers and thereby threatens the monopolies that officially registered taxi drivers enjoy which guarantees their income and wealth. He would like the use of a covered bonds system for backing the mortgage market as in Denmark .  Another solution from House of Debt (ch 12): shared responsibility so that borrower and lender would take equity and debt. He recommended that the government enter into such a system to require an equity share by the lender and to provide one. As an example he commented that the government's Help to Buy scheme had just such an equity share arrangement and he is a strong supporter of it an wants it to be continued and increased.

He thinks that the easier monetary scene and associated property problems will continue for a bit but demographic changes will lead to transformations ahead. The Support Ratio (workers per dependant, where the higher the ratio the greater the number of workers per dependent) will generally drop having peaked in about 2010 for most emerging countries. China will experience a reduction of workers and this will have inflationary results. For India however, the ratio will rise to 2030 as will Africa to 2050. Japan had a rising ratio to 1990 and is now falling. Economic growth (see Demographic Dividend) accompanies a rising ratio which occurs due to reductions in child mortality, leading to fewer births. Assuming good governance (as China with its competent administration, good infrastructure, hard working people and education) this enables the new workforce to participate fully - the demographic sweet spot. But there is a rapidly reversing demographic dividend in Japan, Germany and Italy, with a slower decline for the UK, US, Australia and Canada. The reason being that the number of workers is in decline and each worker is having to support elderly parents. Japan has been there for some time, US is projected to be relatively benign but Germany will experience a large drop - all this based on UN data and assumptions about immigration.

The structure of the international monetary system  whereby: 'China, Japan, Germany and the oil producers have been running massive current account surpluses and the US has been running massive great deficits. This isn't going to last that much longer because demography is going to change this dramatically'. During the demographic sweet spot when worker numbers increase rapidly, people save a lot and the savings ratio collapses when those demographics change, e.g. Japan (has done) e.g. China (will do). Current account surpluses will go down as the savings ratio declines. Additionally if the measures to achieve constraints on global warming are successful in bringing cheaper and more efficient renewables, the value of  hydrocarbons will drop, leading to the oil producers' current account surpluses disappearing too.  He predicted that from 5-15 years time there will be a swap whereby China, Germany and oil producers will move from surplus to deficit and the US, due to demography, 'is going to sweep from being the major deficit country to being the major surplus country'.

The demographic changes leading to a world savings decline will reduce investment, but residential housing investment (despite declining population) less so because the income elasticity of demand for housing is very high. Business investment is low because labour is cheap, but with fewer workers in the future labour will become more expensive and capital investment will increase to get more output from an expensive workforce. Tax rates on workers will go up. We can only consume what we produce and production each year depends on workers producing; if there is an increasing army of the old and if society believes that the consumption of the old to consume should be equal to that of the young, something has to be taken away from the workers to cover that. Thus we will have increasingly scarce labour subject to an increasing proportion of tax - all this within about 20 years. Real interest rates will rise as savings decline. We don't know what will happen to growth as productivity and innovation are unknowns. Robert Gordon (TED Talk) thinks the easy innovations are over. Output per worker will remain stable but rate of growth of output and consumption per head will decline.

'The world is going to change in the next 10 years - don't assume it's going to be the same as the last 10. It won't !'
In questions: Richard Werner asked if CG thought that as one of the influences on economic matters is credit should we be more careful in future to focus on productive credit rather than financial and asset credit? Designing the banking system in order to help reverse current problems would produce a more equal income distribution, among other things.

CG: 'We need to think very carefully about the structure of our financial system' . It was a great pity the building society system collapsed. If it hadn't happened we would all have been in a much better position. As to banking the old idea was that your assets should not be of a much greater duration than your liabilities - the old Real Bills Doctrine -  as a banker you invest in bills of exchange, lending for short term inventory and don't lend for long term capital purposes such as mortgages. Such traditional banking 'would mean that the banks would play a smaller role - not necessarily a bad thing' . The narrative of the great financial crisis was all wrong, being:  'bad banks, doing naughty things and bailed out by taxpayers'. However: 'the real narrative was that it was a failure of the housing finance nexus, how housing finance works, and we have done virtually nothing to reform that, so we are still in difficulties.'

To a questioner asking for his comments on the Islamic mortgage which involves the lender buying the property and the borrower taking a gradually reducing lease on it, Mr Goodhart said it is very similar to Mian and Sufi's ideas for shared responsibility mortgages.

Prof Goodhart's talk was a grand sweep across generations and national and world economies and was a valuable wide-angle lens view and should be useful to refer to ahead. I puzzled why, having identified the cause of the economic crisis as the working of housing finance, he only commented on solutions that just seem to make normal mortgages slightly safer. No problem with that of course, but what about: a)  land value tax, which would increase the supply of land and housing and reduce price and speculation - an Uber-like measure, see above; or  b) 'window guidance' on credit allocation?   OK, his bit about the Old Bills Doctrine, was a sort of 'subdued yes' to the credit allocation question, but without elaboration - although at that point he did have a flight to catch. So we were left a bit cheated as to his further insights into such solutions.


Reported by Charles Bazlinton from the ECOBATE 2014 in Winchester, UK on 8 October 2014. Charles is the author of The Free Lunch blog.