The return of the old normal

A demographics thesis has shed light on why much of the western world is experiencing little or no growth in income or yield – and warns of more pain to come, writes Anthony Hilton

For the past decade, the vast majority of people in the UK have seen no growth in their real incomes. It is the same story across Europe and, surprisingly, even in middle-class America. You have to go back to the Great Depression of the 1930s and beyond to find anything like it. Not since the Victorian era has so little been earned by so many for so long.

Incomes are not aloneIt is not just incomes; investors and savers are suffering too. Andrew Haldane, Chief Economist at the Bank of England (BoE), made a speech a few months ago in which he pointed out that official interest rates today are lower than they have been at any time since the BoE’s formation over 300 years ago. Indeed he went on to suggest – admittedly tongue in cheek – that our rates today are probably the lowest they have been for 10,000 years.

Low interest rates on savings feeds directly into low returns on almost every other investment too. The search for yield has become the defining mantra of our times.

At the same time, global growth has all but disappeared. Since 2008, the Chinese locomotive has been the only game in town. Now that it is slowing, what will pull the world along? There is growth elsewhere, of course, but not the vigorous variety to which we became accustomed in happier times. Not enough to act as a locomotive.

Understanding the economic weatherThis is a totally different economic world from that which existed from 1945 to the millennium. But we know that. What we don’t know is: why? What is lacking is an explanation as to how this has happened. We are living through the biggest shift in the economic weather any of us have seen in a lifetime and yet, other than assuming it is an unfortunate consequence of the global financial crisis, no one knows where it has come from.

At least, not until economist Charles Goodhart and a team at Morgan Stanley came along recently. They say it is all about demographics.

Their thesis is that since around 1970 when the baby boomers – those born in the surge just after the war – entered the labour force for the first time, there has been a massive and sustained increase in the number of workers in the industrially connected world. It began with the boomers. Then it received a further boost in the 1990s with the collapse of communism and the subsequent integration of Eastern Europe and Russia into the world economy. Then it received an even bigger boost when China arrived on the scene. These three factors together virtually doubled the globalised labour pool.

Now, when the supply of something doubles, the price drops, and that is what happened. Wages around the world fell or at best stagnated. But it did not stop there. Because labour was so cheap, other prices had to adjust too. It made sense to employ extra people rather than to buy labour saving machinery. Companies preferred to outsource to Asia rather than build a new factory in the West. The result was that investment fell around the world.

But that then left us with too much saving – huge pools of money built up because they were no longer needed to finance investment. And because there was a savings glut, the price of money also fell – hence the low interest rates. All the key economic variables in the world have had to adjust to the sudden fall in the price of labour. And this is what we now call the new normal. Get used to it.

Reverting to typeOr perhaps not. The most fascinating part of the analysis is still to come. The population of the developed world is rapidly ageing, and because birth rates have been falling for years, labour is about to become scarce again. The pendulum is about to swing back because the numbers of young people coming into work are insufficient to replace the numbers retiring.

This is already happening in Japan and, as it gathers pace elsewhere, including China, wages will have to rise. That will increase spending power, push up demand and encourage companies to invest. More investment means an increased demand for savings, which will in turn push up the cost of money. Higher interest rates will lead to higher investment returns across the piste. Gradually, over the next decade, higher real incomes will feed through into everything else, the processes of the last 30 years will reverse and the world will come once again to resemble the world we used to know. 

So there you have it. Just as we have got used to the new normal, the old normal is going to come back to bite us.

Anthony Hilton is the award-winning former City Editor of The Times and the London Evening Standard.

The original version of this article was published in the December 2015 print edition of the S&IR.
Published: 24 Dec 2015
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