Demographics and Macroeconomics – Part 2 (Wonkish)
I don’t suspect anyone remember part 1 of this series. So if you want to refresh your memory, you can have a look here. In that note, I covered some of the more theoretical issues in the form of how demographics might affect long run growth as well as open economy dynamics. In particular, I discussed the broad tenets of the life cycle framework and how it relates to savings and investment behavior as a function of ageing. In particular, I discussed where I think there was room for improvement and further study.
So, in this one I would like to look at an all together more practical topic in the form of asset demand and prices as a function of demographics. Again, there is a substantial amount on this in finance and macroeconomic literature. So I will not give a detailed literature review here. Besides, if you want to move straight to investment and portfolio implications, this piece by Alicia Damley and this piece by Ed Dolan are really spot on in terms of what you need to think about. Basically, you want to buy the young guns and sell the old farts and the key to obtaining this insight is to remove the focus from population size to population structure (age structure). I have been harping on this since my own blog Alpha.Sources’ inception 5 years ago. I am doing a PhD about it! So it is with pleasure that I see the discourse hitting the pages of Seeking Alpha, which indicates that it is grabbing hold of other people not stuck in the university ivory tower.
In this sense, this is hardly a new story. Emerging markets represent the main investment story in a post Lehman context. Everyone wants to buy India, China (although she is quite different), and Brazil and as a result of a myriad of ETFs and other types of market trackers, you don’t need to know your way around the streets of Bangalore to gain exposure to the Indian growth story.
This is a turkey shoot then. And I largely agree with the main thrust of the argument.
The real maturing of the emerging world which began some 10-12 years ago and which will continue for the next decades is undeniably a force of good for savers and investors and the real question is whether it is too good, and thus whether there will end up being too much capital chasing too little yield. In order to understand this link, you would need the second part of the equation (see part 1) and understand how demographics affect capital flows and the transfer of savings between economies as a function of demographics.
In this note, I will talk about the idea of a life course but in the way that it is traditionally narrated. As such, the life course is a sociological theory which describes phases of life and in this sense it is more topical than the idea of a life cycle which only describes the flow of investment and savings. Indeed, in finance and economics you only hear about the life cycle even if scholars who investigate for example the dynamics of house prices as a function of demographics essentially are deploying a life course framework.
What is the Life Course then?
Well, Wikipedia does a good job of explaining it for the layman and this small snippet also captures the essence quite well especially
In particular, it [Life Course Theory] directs attention to the powerful connection between individual lives and the historical and socioeconomic context in which these lives unfold. As a concept, a life course is defined as "a sequence of socially defined events and roles that the individual enacts over time" (Giele and Elder 1998, p. 22). These events and roles do not necessarily proceed in a given sequence, but rather constitute the sum total of the person’s actual experience. Thus the concept of life course implies age-differentiated social phenomena distinct from uniform life-cycle stages and the life span.
The only mental leap you need to perform here is to replace socially defined events with economically defined events and you have yourself a working model. Now, if the finance geeks out there think that I am turning soft and if the sociologists believe that I am reducing their complicated theory of human lives into numbers and equations, both groups have my sympathies.
Yet, this is a part of my master plan to elevate ageing and the change in age structure to the ultimate unit of analysis on a macroeconomic level. And in order to do this, we need more than merely the life cycle or the life course. We need them both. In fact, only by fusing the two will be able to develop a framework which is rich enough to deal with the complexities of ageing and macroeconomics. Indeed, I am betting a good deal of my academic oeuvre on this.
Consequently, if a socially defined event of interest to a sociologist or demographer might be the age of marriage, age of first child birth, age of first encounter with alcohol, age of sexual debut etc, then an economically defined event be something along the lines of age of maximum borrowing relative to asset value, age of purchase of first home, purchase of durables as a function of age as well as of course, the main topic in the financial literature as it currently stands – portfolio choice as a function of age (stocks and bonds basically, but you can vary the portfolio here as much as you like, at least in principle).
So, this inclusion of life course into the general thinking of macroeconomics is crucial and even though economists always talk about the life cycle, they are often implicitly assuming a life course perspective.
In the end, I will keep it short here.
There are a myriad of sources on ageing and asset prices and demand in general. The main man in the world of economics and finance is James Poterba from MIT (just check list of papers) and I would emphasize in particular the strand of literature that deals with housing and demographics (I have a paper coming here).