In our previous edition of Global Economy Watch, which included our predictions for the world economy in 2019, we suggested that around 40 countries would see their labour forces shrink this year, owing to a combination of low birth rates and ageing populations. Interestingly, the country most closely associated with unfavourable demographics– Japan–was not among them. At present, the Japanese labour market is pulling off a neat trick. Although both the whole population and the working-age population are declining every year, the number of Japanese in the workforce is growing, and expanding at a rate that outperforms many other younger and more vibrant advanced economies. We explain how this is happening and assess whether it is sustainable in our feature article.
We also consider what the weakening global economy means for the central banks of the three largest advanced economies. Barring a major, immediate adjustment to monetary policy, the Federal Reserve’s shrinking of its balance sheet, combined with the end of quantitative easing by the European Central Bank, means that these central banks will begin to drain liquidity from the global economy for the first time since the global financial crisis by the middle of this year. The combination of de facto monetary policy tightening at the same time as global growth continues to slow could generate some volatility in financial markets during 2019. We note that the Fed is still determining the level of assets it wishes to hold and expect it to end the process with a significantly larger balance sheet than it held before the financial crisis.
Finally, we continue to watch the effects of the trade conflict between the US and China. Not for the first time, hopes have been raised at the time of writing that a deal is imminent that would prevent another escalating round of tariffs. That would be propitious. The effects of the trade war have not been especially clear in the data so far, with some initial stockpiling inflating volumes. However, this temporary boost has now passed and the tariffs could begin to impede trade growth in early 2019. Unless that is, the world’s two largest economies can agree that trade barriers are not in their interest.
Senior Economist Mike Jakeman describes how Japan's labour market is growing despite the country's difficult demographics | Duration: 1.58
Japan has some of the world’s most challenging demographics. Since the country’s population peaked at 128 million in 2010, it has shrunk by 1.3 million people. Data for 2018 suggested that natural decline alone–the number of deaths minus the number of births, ignoring migration– reached 448,000, suggesting this decline is accelerating. The government has warned that the population could fall as low as 88 million by 2065. Furthermore, the population is old: 28% is over 65, compared with 18% in the UK and 15% in the US. This trend, too, will accelerate in the coming years.
An ageing and shrinking population has important implications for the economy. Fewer workers mean that productivity has to rise every year just to prevent the economy from shrinking. Meanwhile, a higher proportion of pensioners in society means more people using public services, such as healthcare and transport, without contributing to government revenue through taxation. In this respect, Japan is a test case for other economies facing demographic challenges.
But in Japan something curious is happening. In 2018, the number of people aged 15 and over fell by 0.1%, but the number of people working rose by 1.7%. This growth was not enabled by a reduction in high unemployment; joblessness has been low and falling for years. Instead, an already strong labour market found a way to strengthen further. Figure 2 shows that in 2012 Japan had an employment rate that was about average among advanced economies. But by 2018, its participation rate had risen to among the highest in the world. Growth in employment also picked up.
Figure 3 gives an indication of where some of this growth has come from. Japan’s female employment rate has historically been quite low, relative to its peers. Various reasons have been suggested as explanations, including a culture of long office hours, entrenched gender roles and a lack of flexibility in the labour market. But these characteristics of the job market are changing. As recently as 2002, there was a ten-percentage-point gap between the female employment rates in the US and Japan. But as the US rate plateaued, the Japanese rate rose, and it is now comfortably ahead of the US rate.
Another famous characteristic of the Japanese labour market–the ‘m’-shaped distribution of women in work by age–is also shifting. A higher proportion of women are now returning to work sooner after having children. The shallower decline in participation among women in their 30s means the graph increasingly looks less like an ‘m’ and more like an ‘n’.
Government policy has something to do with this. It has increased the number of nursery places and will make provision for all 3-5 year olds free by 2021. (Care for younger children will be provided for those on lower incomes.) A law passed in 2015 demands that larger firms set targets for hiring and promoting women. (There are no penalties for non-compliance.) Other legislation caps overtime at 100 hours a month, a move designed to both prevent over-work and generate new roles where demand clearly exists.
Figure 4 shows another area of underutilised labour supply: older workers. (This group are not captured in the data shown on Figure 2.) During Japan’s period of rapid economic development the proportion of over 65s in work fell steadily, eventually reaching a low of around 18% in the early 2000s. But as life expectancy has continued to grow, retiring at 60 has become less appealing.
The government is also nudging would-be pensioners in the direction of remaining in work. It wishes to push up the retirement age for state workers from 60 to 65 and boost the public pension for those that opt to defer drawing from it.
Already, Japan is leading the world by retaining so many older workers; its rate of around 25% is higher than that in the US (18%) and the UK (10%).
Efforts to increase female and older workers’ employment is partly because of cultural preference for these measures over higher immigration. Nonetheless, in late 2018 parliament approved the creation of two new visa categories, one that is time limited and another that offers the opportunity of eventual residency rights. It has branded these a stop-gap solution until it can get yet more Japanese in the workforce.
How long can these trends continue? If the decline in the unemployment rate continued at the (very steady) average rate of the past eight years since the population peaked, the economy would hit zero unemployment in 2027. It is possible that this date could be deferred if the labour force continued to grow, but the eventual impediment to this will be the shrinking population. Figure 2 suggests that Japan has a little further to go to emulate the employment rates of some European countries, but here too, there will be a limit. Eventually, the remarkable performance of its labour market will require more births and more immigrants to be sustained.
For much of 2018 the US-China trade dispute seemed to be more phony war than actual conflict. Despite exchanging tariffs on goods worth hundreds of billions of dollars, China’s exports to the US continued to grow and hit an all-time high in September 2018. However, some of this strong performance is likely to represent stockpiling, with firms and consumers opting to bring forward purchases as a hedge against tariffs being applied to more goods and at higher rates. Warnings from leading businesses about soft trading conditions in China suggest that this phase has ended.
Chinese exports to the US fell by 3.5% year on year in December, while imports plunged at a much faster rate.
Such is the size of the US and Chinese economies that weaker trade between them will become visible in global data. Figures from the CPB World Trade Monitor show that a bumper period of growth in merchandise trade is coming to an end. Trade volume growth was the weakest in November for more than two years. With global economic growth slowing in China and the G7, global trade growth is unlikely to bounce back strongly in 2019.
Central banks in the world’s three largest advanced economies all responded to the global financial crisis of 2008-09 in the same way: by cutting interest rates and stimulating borrowing through quantitative easing (‘QE’). These programmes added assets worth trillions of dollars to the balance sheets of the Federal Reserve (‘Fed’), the European Central Bank (‘ECB’) and the Bank of Japan (‘BoJ’).
A decade on from the worst of the crisis, the central banks are seeking to ‘normalise’ monetary policy, or return interest rates to close to their pre-crisis averages. The Fed has made the most progress. It ended its third QE programme in 2014, raised its policy interest rate for the first time in 2015 and began to allow some of the assets bought under QE to expire in 2017. The ECB, by contrast, only ended its QE programme in 2018 and is still contemplating whether to stop repurchases of assets, while the BoJ continues to buy government bonds and private-sector assets each month.
The end of the ECB’s bond-buying, combined with an increase in the rate at which the Fed is allowing bonds and securities to expire, means that an important threshold may be crossed in the first half of 2019. For the first time since the crisis, these three central banks together could be withdrawing funds from the global economy (see Figure 6). At the peak of the stimulus, in 2009 and again in late 2016, the value of the liquidity they were pumping into the global economy was growing at a rate equivalent to 2.5% of global GDP.
Such an injection at a time of rock bottom interest rates pushed up prices for a variety of assets as flush investors searched for a good return. This phenomenon is best observed in the housing markets of cosmopolitan cities, such as London, Sydney and New York, but it also extended to equities, art and bonds.
However, the combination of the Fed raising interest rates and reducing its balance-sheet has coincided with slower global economic growth and greater financial market volatility.
This shakier environment complicates central banks’ future planning. Where the Fed faced a benign outlook when it began to raise interest rates in 2015, the path looks trickier for the ECB. Economic growth in the Euro zone has slowed significantly. The Fed said in January that global economic conditions necessitated that US interest rates remain at current levels. In China the government has again been distracted from its long-term goal of improving the economy’s debt profile by the short-term need to ensure acceptable levels of economic growth.
It is possible that the ECB and the BoJ could change course. Neither has committed to tightening monetary policy. The BoJ has reduced the value of its monthly bond purchases, but has not set a lower target. The ECB is at the beginning of a wait-and-see phase of unknown duration. It is not clear to what level the Fed wants to reduce its holdings. Prior to the crisis, it held assets of around $900bn, a slightly larger amount than the value of cash in the economy. (Cash is a liability for a central bank.) With the value of US dollars in circulation now at $1.5trn, it would take until early 2023 for the balance sheet to return to this level, assuming the maximum $50bn of assets were allowed to roll off each month.
But the Fed is likely to change course before then. It sees its balance sheet as a technical matter that enables it to control interest rates, rather than a policy issue. But if the economy slowed, it would struggle to persuade financial markets that it should continue to shed assets at the same time as cutting interest rates. Consequently, the Fed’s balance sheet is likely to remain larger than it was pre-crisis, with its reduction halted by a shift in interest rate policy to support the economy when it next slows.
Returning central banks’ accounts to more familiar territory will be a long process that poses risk to global economic growth and will prove more challenging to policymakers than initially expected. It is also likely to be interrupted, or delayed, if there is another global economic shock.
Senior Economist, PwC United Kingdom
Tel: +44 (0)7715 1562331