Some Random Observations Regarding the Global Demographic Outlook (2024)

The world is in undergoing extensive demographic change, leading to slowing economic growth and increasing public debt in many advanced economies and potentially increasing political and economic instability in developing economies. Differential demographic developments are giving rise to varying economic and political challenges. Advanced economies have been characterized by very slow population growth, stagnating population levels or even outright population decline. This has led to a significant increase in the share of the elderly population and, in some cases, to decline of the work-age population in absolute terms. Upper middle income countries are undergoing very similar demographic changes, although with a time lag. However, in many instances, their demographic transition has been more rapid, largely due to rapid decline in fertility rate. By contrast, low income and many lower middle income (developing) economies continue to be characterized by rapid population growth and rapid increase in the number of people of working age. 

· The world’s population increased from 2.4 billion in 1950 to more than 8 billion last year. In its medium-variant scenario, the UN projects population to peak at 10.3 billion in roughly 2080 and remain at above 10 billion for the remainder of the decade.

· Decades of below replacement fertility rates have begun to translate into stagnating population levels or outright population decline, particularly in countries characterized by low inward and large outward migration. The bulk of the countries experiencing population decline is located in Eastern Europe due to a combination of sharply lower fertility levels and net emigration, mainly to Western European countries.

· Other countries experiencing population decline do so due to economic crisis, civil war or external armed conflict, such as Syria (until recently) and Venezuela. Ukraine, already demographically challenged before the full-scale Russian invasion in 2022, lost 6-7 million people due to Ukrainians fleeing the war. Ukraine’s population has fallen by a third since 1990. It pre-2022 population was 38 million, compared to 52 million in 1990.

Global demographic balances will continue to shift dramatically with advanced and emerging economies aging rapidly in the context of slowly growing, stagnating and declining populations, and developing economies experiencing rapid population growth. The differences in terms of present demographic development between advanced, emerging and developing economies are stark. Virtually all advanced (high income) economies have fertility rates below replacement level, which absent substantial net immigration will lead, or has already led, to stagnating or declining work-age populations. Africa, including North Africa and West Asia will see significant population growth, including a sharp increase in the number of their working-age population. East Asia and parts of Europe will also see, or are already seeing declining working-age population, while North and Latin America will register modest increases over the next quarter of a century, according to UN projections.

· In low-income countries, the fertility rate is 4.6, in middle income countries 2.1 (ranging from 2.6 in lower middle income to 1.5 in upper middle income countries) and 1.5 in high income (advanced) countries. Geographically, the average fertility rate of African countries is above 4, ranging from 6.6 in Niger to 2.3 in South Africa. By contrast, fertility rates are below replacement in Asia (1.9), North America (1.8) and Europe (1.5). In Asia, the rate varies from 2.9 in Central Asia to 1.2 in East Asia. With the exception of Africa and West Asia (and South Asia, barely at 2.2), all regions of the world will experience declining population levels over the next two generations unless fertility rates recover substantially and sustainably, which historically speaking is unlikely.

· By 2050, sub-Saharan Africa’s population will be 2.1 billion (compared to 1.2 billion today), Latin America’s 730 million (660 million), North America 430 million (390 million), South Asia 2.5 billion (2.1 billion), Western Europe 112 million (125 million), Northern Africa 370 million (270 million) and East Asia 1.5 billion (1.7 billion).

· Long-term projections are only as good as the assumptions they are based on as well as the quality of historical data they take as a starting point. The number cited in this comment refer to the UN’s medium variant scenario. Quite likely, this scenario underestimates the speed with which fertility rates will decline in countries that are currently experiencing rapid population growth. Nonetheless, this will do little to alter the sharply diverging demographic trends in advanced versus developing economies.

· A methodological note: The total fertility rate in a specific year is defined as the total number of children that would be born to each woman if she were to live to the end of her child-bearing years and give birth to children in alignment with the prevailing age-specific fertility rates. It is calculated by totalling the age-specific fertility rates as defined over five-year intervals (OECD). In other words, the fertility rate is an unobserved variable.

Politically, aging societies see the emergence of “grey majorities”, which make it more difficult to implement economic reform that negatively affect “acquired rights” and increasingly costly and financially difficult-to-sustain social security regimes. While total population levels may not decline in advanced economies thanks to immigration, they are and will continue to age and see the share of the elderly population increase relative to the working-age population. This emerging “grey majority”, however diverse it may be politically, shares an interest in defending “acquired rights” and oppose cost-saving reform of the social security regime. This raises the medium- and long-term challenges to government finances and might jeopardize economic and financial stability in the context of slowing economic growth. Demographically rapidly expanding societies also face significant economic challenges in terms of integrating an expanding working-age population into the economy. As these countries are often very poor, governments find it difficult to provide education and infrastructure that would support strong, sustainable economic growth and facilitate the integration of young people into the economy. Relatedly, the so-called youth bulge then often makes countries more prone to domestic political violence and instability. Political violence in turn weigh on economic development as well as a country’s ability to attract foreign investment and integrate itself into international supply chains.

· All other things, the combination of demographic stagnation in advanced economies and rapidly expanding working-age population in Africa and the Middle East will translate into greater migration to Europe, including Russia. By comparison, North America will face less pressure given a demographically rapidly maturing Latin America. Migration pressure are not simply a function of demographic pressure, even though the latter play an important role. Political and economic condition in sender countries with large population increases matter, as do the immigration policies of the target countries.

Economically, rapidly aging societies are faced with significant economic challenges, such as slowing economic growth and intensifying distributional conflict. An increasing old-age dependency ratio, defined as “people younger than 16 and older than 65”/ “working-age population, will generally lead to declining savings and increased government pension and health expenditure, or at least political demand for increased expenditure. This in turn will tend to increase government spending and often government deficit as well as public debt, leading to a further intensification of distributional conflict. The dependency ratio can increase even though the population of working-age continues to increase in absolute terms. A relatively and absolutely declining working-age population means that if labor productivity fails to compensate for it, per capita incomes will fall. This does not mean though that demographically challenged countries are doomed economically. They have various options to offset demographic decline. First, liberal migration policies can help offset a shrinking workforce and help keep per capita income growth on an upward trajectory. Second, investment in innovation and technology can accelerate productivity growth. Third, where female labor participation rates are low, policies that help integrate women into the labor market can help. Fourth, policies that create incentives for older people to remain in the workforce for longer (or create disincentives for them leave the workforce) can help slow the impact of a declining working-age population. Fifth, pro-natalist policies may help slow population decline in the longer term, even though in the recent past their impact has been demographically negligible and financially costly. Politically, however, such reform will prove challenging, not least due to the existence of increasingly influential grey majorities. 

· The overall dependency ratios in sub-Saharan Africa and North Africa will decline between 2025 and 2050. In East Asia, North America and Europe, the ratio will increase, in some case sharply. In Japan, the overall dependency will reach 95 and the old-age dependence ratio 80, meaning that for every four people older than 65, there will only five people of working age. In China, the overall dependency ratio will reach 55, compared to 23 today. While much lower than in Japan, the speed with which China’s demographic profile will be deteriorating is much greater. By contrast, India’s old-age dependency ratio will rise from 10 to 20, and America’s from 28 to 38. (medium variant).

 

 

 

 

 

How Dramatic Will the Shift in U.S. Economic Policy Be (2024)?

The Republican sweep in U.S. elections will lead to a shift in U.S. economic policy, which will boost short-term economic growth, but could prove detrimental to the outlook for much of the rest of the world, especially if U.S. trade policy turns decisively and lastingly protectionist. On November 5, the Republican party won the presidential and congressional elections. The president-elect is widely seen to have won a decisive mandate for economic policy change, the electoral remains deeply divided and polarized. The Republican majorities in the House and the Senate are small, but will prove sufficient to push through wide-ranging changes, to the extent that this does not require overcoming a Democratic filibuster in the Senate. 

> Republican presidential candidate Donald Trump won the popular vote for the first time since the re-election of GW Bush in 2004 and won all swing states. Republicans also took over the Senate and to maintain their majority in the House, where they are projected to control 220 out of 435 seats. The Supreme Court remains dominated by Republican-appointed judges (six versus three).

Unified Republican government will have significant leeway to implement Republican economic policy preferences on fiscal policy, deregulation and trade. Unified government will allow the Republican party to push through wide-ranging changes to economic policy, including immigration policies. Moreover, the president will make significant use of executive power in terms of trade and deregulation. The president-elect has pledged to impose broad-based tariffs on U.S. imports, cut taxes, deregulate the economy, particularly the Biden administration’s green transition focused spending, crack down on immigration and take a less restrictive stance on anti-trust policies. The president-elect (or advisor close to him) has also suggested replacing income tax with tariffs, taxing foreign holdings of U.S. financial assets. The new administration will have the greatest latitude to bring about a shift in fiscal policy, which will translate into tax cuts, but at best limited spending cuts. On trade, the government faces statutory constraints in terms of imposing across-the-board tariffs. On regulation and anti-trust policy, the government can repeal existing legislation or make use of executive decrees to block parts of existing legislation, like the Inflation Reduction Act. On other policies, the Republicans will need to overcome Democratic opposition in the Senate.

> Trade policy during the first Trump administration used to protectionist threats and policy measures to renegotiate existing trade agreements (NAFTA, Korea, Japan) or agree to negotiate a trade agreement (European Union). But trade policy also led to the imposition of high, across-the-board tariffs on Chinese imports and sector-specific tariffs on steel and aluminum, and other goods. Given the new administration’s protectionist implications, trade tensions on other issues, such as digital taxes, will increase. In order to impose broad-based tariffs, the president needs to declare a national emergency. Existing trade legislation does not give the president the authority to impose across-the-board tariffs.

> The bulk of spending tied to the Biden administration’s Inflation Reduction Act benefits Republican states, which may lead the Trump administration to target selective provisions rather than all IRA-related spending. There is also significant corporate pushback to repealing the CHIPS and Science Act, which largely aligns with the pro-domestic manufacturing stance of the Trump administration. The Republicans do not have a filibuster-proof majority in the Senate, which will force them to negotiate legislation, outside of what can be passed through budget reconciliation.

If the Republican administration succeeds in implementing its preferred tax, immigration and trade policy, inflationary pressure will increase, leading to a stronger dollar and higher U.S. interest rates. An expansionary fiscal policy and a crackdown on immigration will put upward pressure on inflation, leading the Federal Reserve to slow down and perhaps reverse interest rates cuts. If the tax cuts prove extensive and spending cuts paltry, a wider deficit will put upward pressure on government debt and hence increase the risk premium on long-term government bonds. Tax cuts and deregulation have the potential to raise short- and medium-term economic growth, but large-scale tariffs (and foreign trade retaliation) and concomitant economic uncertainty may lead to a weakening of the economic outlook, at least in the medium term. Though unlikely given the legal-institutional autonomy of the Federal Reserve, a successful policy of putting pressure on the Federal Reserve to pursue a more dovish monetary policy could further undermine medium- and long-term financial and monetary stability. 

> U.S. fiscal deficits will increase further leading to a more rapid increase in federal government debt, particularly once economic growth converges to its medium-term potential of 2%. The administration is all but certain to make the 2017 tax cuts permanent and may cut other taxes, while at implementing only limited cuts to federal spending. an is in the White House. Federal spending only account for ¼ of federal spending, meaning that significant changes would be required to offset the fiscal effects of making the 2017 tax cuts permanent.

> The macroeconomic policy mix, particularly if combined with protectionist trade and hawkish immigration policies will be negative for fixed-income markets, given the potential for upward pressure on long-term interest rates. Provided protectionist policies do not prove too detrimental to economic confidence, an expansionary fiscal policy, highish interest rates and deregulation should provide a short-term boost to economic growth in the context of higher-than-anticipated inflation, which should benefit equities, broadly speaking. Moreover, deregulation, corporate tax cuts and a less hawkish anti-trust policy should benefit selected sectors, such as banks, fossil fuels, among others, while the repeal of ESG-related rules and legislation will be negative for ESG-related sector and equities.

A stronger dollar, higher (relative to baseline) U.S. interest rates and higher U.S. tariffs will have a negative effect much of the rest of the world, and particularly countries with large dollar-denominated debts. A stronger dollar will put greater strain on economies with larger dollar-denominated debt given the higher cost of servicing their debts and the strain a stronger dollar puts on their balance sheet position/ net worth. A stronger dollar also typically leads to a fall in commodity prices further hurting emerging and especially developing economies relying on commodity exports. While a stronger dollar and stronger U.S. dollar could help offset some of the increased financial distress, higher tariffs on U.S. imports would sharply limit the offset. Countries with net dollar obligations would take hit on both their capital account (lower financial inflows) and their current account (lower exports). This would be greatly magnified if the Trump administration were to impose exorbitant tariffs on imports from China, as this would slow Chinese growth. As China is the dominant trade partners of more than 120 countries around the world, emerging and developing economies would suffer due to reduced Chinese demand. Much will therefore depend on how extensive and how permanent U.S. tariffs will prove. Both the EU and China, the world’s second- and third-largest economies, are currently in a weak and vulnerable position and a trade war would likely push the EU into recession and could reduce already weakening Chinese economic growth by as much as half.

> Although recently, the relationship between U.S. valuation and commodity prices exhibited an unusual pattern, with dollar strengthen coinciding with higher commodity prices, this pattern is unlikely to hold in the future, outside the energy complex.

> China is the dominant trading partner of more than 120 countries. A significant slowdown in China due to U.S. tariffs would have a negative knock-on effect on the rest of the world. While most emerging markets will be able to ride the negative effect of U.S. economic policies due to their manageable foreign debt position and generally flexible exchange rates, many developing countries could face renewed financial distress, including emerging economies currently undergoing IMF reform, such as Argentina, Pakistan and many African countries

> The IMF projects euro area growth to recover from 0.8% in 2024 to 1.2% in 2025. A trade war or even just uncertainty about U.S. trade policy and the prospect of a transatlantic trade war makes this forecast look optimistic. The IMF also forecast Chinese real GDP growth to slow from 4.8% this year to 4.5% in 2025. However, thus far limited appetite for additional stimulus means that significant U.S.-China trade tensions, and particularly a 60% tariff on U.S. imports from China, could reduce Chinese economic growth by more than 200 basis points.

Why ASEAN Will Fail to Emulate the EU (2024)

Although ASEAN’s economic diversity and less than fully aligned security interests will hamper further significant progress towards regional economic and political integration, individually and collectively, the outlook for economic growth in the region ranges is fair-to-excellent, only Myanmar and Thailand excepted. ASEAN (Association of South-East Asian Nations) is an economic and political grouping consisting of ten South-East Asian countries. While the members share many interests, their economic diversity hampers the outlook for significantly greater economic integration and their differing geopolitical orientation will make it difficult to make further progress towards political integration, particularly in light of Sino-US geopolitical competition. Countries very significantly in terms of demographics, economic development and domestic-political regimes, ranging from liberal laissez-faire economies like Singapore to less non-market economies like Vietnam. Geopolitically, some countries are semi-aligned with China (Cambodia, Laos), while others are treaty allies of the United States (Philippines, Thailand). Compared to the most successful example of economic and political integration, the European Union, the region is economically more heterogenous, it is less aligned in terms of security, and it lacks important intra-regional leadership to drive regional integration. 

· ASEAN has ten members: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam. ASEAN was founded in 1967 and its charter commits member to accelerate economic growth, social progress and cultural development as well as promote regional peace and stability.

· The population of ASEAN countries is almost 700 million. In purchasing power parity terms, ASEAN economies account for around 7% of the global economy. At markets exchange rates, however, ASEAN economies account for a far smaller share of global economic output, roughly equivalent to Japan or Germany.

· Several ASEAN countries are among the fastest-growing economies in the world. Economic growth is higher than in Latin America, Eastern Europe and the Middle East. The IMF projects Cambodia and Indonesia to grow more than 5% in 2024-29 and the Philippines and Vietnam to average growth of more than 6%. The ASEAN laggards, Brunei, Myanmar and Thailand will average real GDP growth of 2-3%. Unweighted average real GDP growth (ex-Singapore) is projected to be 4.4%.

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ASEAN is a large free-trade area and it has various free-trade agreements with other countries, but both the ASEAN FTA and FTAs with third parties are largely limited to tariff-free market access for goods. All ASEAN members are part of ASEAN’s Free-Trade Area (AFTA). AFTA establishes a common effective preferential tariff of 0-0.5% among its members, meaning that ASEAN members largely trade goods duty-free amongst each other. But as an FTA, individual members continue to impose tariffs on trade with extra-ASEAN countries based on their national schedules. ASEAN also free-trade agreements with third countries, such as Australia, China, India, Japan, Korea and New Zealand. In 2020, ASEAN signed up to Regional Comprehensive Economic Partnership (RCEP), which also includes all the countries ASEAN has FTAs with, except India. Most ASEAN members are also members of Belt and Road Initiative in view of building connectivity, some countries are more wary of Chinese influence (Philippines, Vietnam) than others (Laos, Cambodia). Some ASEAN members are also parties to other, separate free-trade agreements. Brunei, Malaysia, Singapore, Vietnam, for example, are members of high-quality Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which goes way beyond lowering tariffs, compromises eleven Asian and Latin American economies and whose original purpose was to tie the United States more closely to East and South-East Asia, until Washington backed out of negotiations in 2017.

· ASEAN FTA (or AFTA) was established in 1992. However, Vietnam, Laos, Myanmar and Cambodia have not fully implemented internal preferential tariffs yet. In 1995, ASEAN adopted a Framework Agreement on Trade in Services and Mutual Recognition Agreements (MRAs) in order to make progress on liberalization of trade in services. But progress has been limited, leading to the liberalization and mutual recognition of a small number of selected professions.

· ASEAN has several FTAs with other countries, including ASEAN bilateral FTAs with Australia and New Zealand, China, India, Japan, Korea. In 2020, ASEAN signed on to RCEP, which foresees the liberalization of 90% of tariffs within the next two decades and is mainly focused on tariff reduction and common rules, but fails to tackle ever more important non-tariff barriers and other trade-related issues. As such, its economic benefits will be limited, except for allowing for greater goods supply chain integration across the region.

· ASEAN is not to be confused with Asia-Pacific Economic Cooperation (APEC), which 21 members, including the United States and China as well as ASEAN members, such as Brunei, Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam. APEC is committed to voluntary liberalization and open regionalism, meaning that trade and economic concessions are extended to all countries, including non-APEC members. APEC has made limited progress in terms of trade liberalization. 

Further progress on intra-regional economic integration will prove challenging given the high degree of economic and political diversity, including geopolitical outlook. In 2007, ASEAN member states signed a declaration pledging to establish an “EU-style community”. In 2015, ASEAN also launched the ASEAN Economic Community (AEC) with the aim of creating a common market, including further trade liberalization and regulatory harmonization as well as the establishment of the four freedoms, namely the goods, services, capital and labor. EU-style community can mean many things, but appears to be primarily focused on establishing an EU-style single market, guaranteeing the so-called “four freedoms,” namely the free flow of goods, services, capital and labor across borders. It may also imply the establishment of a customs unions rather than a more basic free-trade area, increasing alignment of currency and macroeconomic policies, and banking and capital market integration. Less ambitiously, ASEAN set a goal of establishing a single market (four freedoms) by 2015. This goal has been pushed back to 2025, but looks highly unlikely to be realized next year. 

· ASEAN economies are very diverse in terms of their level of development. Per capita income in purchasing power parity terms varies widely, from $132,000 in Singapore to $5,200 in Myanmar. This makes economic integration more difficult, particularly the free movement of labor.

· Although ASEAN is a free-trade area, intra-regional trade is limited, and members trade far more with countries outside the region, pointing to the importance of the region’s role in multi-national supply chains that supply goods to the United States, European and, increasingly, China.

· Not a single ASEAN member has more than one other ASEAN members as its top export market: Brunei (Singapore is 4th largest export market), Cambodia (none), Indonesia (none), Laos (Indonesia 3rd), Malaysia (Singapore 2nd), Myanmar (Thailand 1st), Philippines (none), Singapore (Malaysia 3rd), Thailand (Vietnam 5th), Vietnam (none). The United States, the EU, China, Japan and Hong Kong dominate the ranking of ASEAN members top-five export markets.

· Progress on monetary cooperation is in its infancy. Due to its low level of intra-regional trade, ASEAN is far from being an optimal currency area. Stable foreign-exchange rates require a broader alignment of macroeconomic policies, which is economically and politically difficult to achieve, given economic diversity, different economic structures and an eagerness to preserve macroeconomic policy autonomy.

Greater political cooperation and integration will also be hampered by the less than fully aligned security interests of ASEAN members, especially in light of intensifying US-China competition. As in the case of Europe’s greater economic homogeneity, at least in the early stages of integration from 1949/ 51/ 57 (NATO/ European Coal and Steel Community/ Treaty of Rome) to 1995 (Austria, Finland, Sweden join EU), ASEAN is much less aligned in terms of security. ASEAN predecessor organization, the Association of South-East Asia (ASA) established in 1961 by Thailand, Malaya and the Philippines, was partly driven by similar interests in terms of the Cold War, the right against Communism, including Communist insurgencies in Malaya and the Philippines. Today, however, ASEAN, unlike Europe, misses many of the features that facilitated European political (and economic) integration. ASEAN also lacks the equivalent of Franco-German leadership, a major engine of European integration. Europe also benefitted from the presence of an external security guarantor (United States, NATO). SEATO was never as cohesive and encompassing a security alliance as NATO and was ultimately dissolved in 1977. By contrast, ASEAN members are much less aligned in terms of security policies. Cambodia and Laos lean towards China, while the Philippines and Vietnam are effectively engaged in security competition with China, while the Philippines and Thailand are US treaty allies. This will make it difficult to find intra-ASEAN consensus in terms of internal political integration in view of diverging international security (and economic) interests. 

· ASEAN is broadly committed to upholding the status quo and object to China’s nine-dash line that claims most of the South China Sea. But the degree of security conflict with China in the South China Sea varies. The Philippines and Vietnam’s dispute are far more intense than those of Indonesia, Malaysia or Brunei. The Philippines and Thailand are US treaty allies. All of this makes substantial progress on political integration difficult, as ASEAN members will object to giving up autonomy, domestically or internationally.

China - Bar For Large Consumption-Focused Fiscal Stimulus Remains High (2024)

Chinese policymakers have thus far largely relied on targeted, limited and incremental policies to support economic rebalancing away from real estate sector focussed growth, and it would require a significant worsening of the growth outlook, greater deflation and an increasing risk of a debt-deflation spiral for the authorities to opt for a large, largely consumption-focused fiscal stimulus. In an attempt to tackle macroeconomic imbalances (overinvestment in the real estate sector) and reduce related financial vulnerabilities (over-indebted real estate developers and impact on banks’ balance sheets), the Chinese authorities in 2022 introduced measures to rebalance the economic away from real estate sector investment with the goal of redirecting investment toward other, higher-productivity economic sectors. The rebalancing process, which is not yet complete, led to weakening real estate prices and led to, or at least coincided, with softening domestic consumption and declining economic confidence. Economic growth has decelerated from 6-7% during the years leading up to the COVID-19 pandemic in 2020 to around 5% in 2023-24. The deceleration in economic growth can also in part be attributed to a structural decline in productivity growth, less favorable demographics, increasing government intervention in the economy and increasing regulatory uncertainty and, more recently, geopolitical tensions and declining foreign direct investment inflows. Nonetheless, China did exceed its five-percent growth target in 2023 and is set to meet its 2024 target of “around 5%”, even if the final full-year print comes in slightly below 5%. Concerns about the growth outlook in the context of seeming deflationary pressure have increased over the course of 2024. In response, the authorities have taken a gradual, incremental and largely targeted approach to support rebalancing through selective measures targeting the housing market and limited macroeconomic stimulus. Policymakers have also remained committed to promoting so-called “new productive forces” aimed at supporting productivity growth, largely through manufacturing-focused industrial policies and government-supported investment, rather than through a large-scale macroeconomic, including consumption-focused fiscal measures.

> China’s economy grew 5.2% in 2023 and 5% during the first half of 2024. Chinese policymakers seem to view the measures they have taken thus far as sufficient to meet the 2024 growth target. They have also stated to be willing to take a more “proactive” fiscal stance in 2025 depending on economic developments.
Fiscal support for the real estate sector has been targeted to affordable housing and completing pre-sold, yet uncompleted housing projects. The government also issued a special bond worth RMB 1 trillion to finance projects and help support investment as well as help local governments finance real estate purchases to clear the market. 

> Despite some very limited measures encouraging consumption, additional spending has been focused on investment rather than consumption. Most recently, the government announced its intention to bring forward the issuance of RMB 200 bn worth of bond issuance from 2025 (or less than $ 30 billion), which amounts to less than 0.2% of GDP and may not even constitute additional spending if it ends up being subtracted from next year’s spending. Fiscal measures directly targeting consumption rather than investment, housing-related objectives or support for financially distressed local governments have been quite limited. In general, fiscal and quasi-fiscal policy remains strongly focused on technology investment and manufacturing development in the context of the Made in China 2025 strategy. Policymakers view public investment rather than private consumption as the key driver of economic growth.

 
> The PBoC has provided some macroeconomic support, most recently on September 24 in the guise of simultaneous and larger than usual reserve requirement and policy rate cuts, but the central bank has been careful not to ease up too much for fear of weakening the RMB in the context of the large China-US interest rate differential and possible out of concern for banking sector profitability in the context of increased real-estate-sector-related credit risk. The PBoc also lowered the mortgage rate to support the housing market and it has introduced policy tools to support the equity market. None of these measures are game-changers and fail to address more directly the immediate problem of limited domestic demand, especially household consumption. The relative efficacy of an easier monetary policy and supportive credit policy will be much more limited than fiscal measures targeting public or household consumption. 

> The PBoC has repeatedly intervened in the foreign-exchange market, not just through its daily fixing but also in offshore markets to prevent RMB weakness. The limited monetary stimulus is reflected in the fact that real interest rates remain high and financial conditions are tight. The PBoC has also provided support through so-called structural credit policy measures targeting the housing market. Overall, macroeconomic support through monetary policy has been modest.

While economic growth has held up so far, deflation has persisted and the outlook for economic growth may be weakening, which has led the government to announce a fiscal stimulus” flanked by other supporting measures in late September. Since then, the government has failed to offer a detailed plan as to the kind and size of fiscal stimulus. There is likely a lively debate taking place in the Chinese government over the size and type of fiscal stimulus that is required. But the September 24 announcement strongly suggests that policymakers’ worries about the outlook for economic growth and continued deflation is increasing. A sufficiently strong fiscal stimulus would help reduce the risk of deflation, stimulate the economy and revive consumer confidence, and thus help put a floor under economic growth while economic rebalancing is proceeding and while deflation continues to points to continued spare capacity, itself partly a consequence of strong manufacturing investment, but also of weaker commodity prices and relatively subdued domestic consumption. A permanent drift into deflation raises the risk of an adverse feedback loop between falling prices, including asset and property prices, and an emerging debt overhang, raising fears of a Japan-style economic deflation and depression. But policymakers likely remain fairly strongly wedded to investment-focused industrial policies and remain somewhat reluctant to increase government spending to support “unproductive”, non-productivity-enhancing consumption, consumption not being investment. A large fiscal stimulus is likely seen as costly in the context of high general (augmented) government debt, which limits the appetite for a large-scale, consumption-oriented fiscal stimulus among parts of the government. The bar for a large, consumption-oriented stimulus remains high, but not(?) insurmountably so.

> The IMF has highlighted the risk of significant property market downturn, deflation and negative feedback loop of high debt level and deflation, making debt less sustainable. A combination of falling prices, declining consumer confidence and lower economic growth risk denting the economic outlook. However, price decline in major urban centers has been relatively limited, so it is far from clear that marginally weaker home prices are the major factor explaining less rapidly growing consumption. Deflation has also been affected by lower good and commodity prices. In line with the authorities commitment to “new productive forces”, public sector investment has increased, while private investment has been relatively stagnant, although it has increased in manufacturing while declining in the real estate sector. 

> Total non-financial debt exceeds 300% of GDP, which is very high even though it is underpinned by a very high national savings ratio. Corporate debt exceeds 130% of GDP. While general government debt amounts to a seemingly manageable 60% of GDP, augmented debt (incl. LGFVs) is approaching 130% of GDP. Meanwhile, the augmented fiscal deficit remains very high in the context of sharply lower nominal GDP growth, which leads to a continuous increase in government debt, absent major fiscal reform. This is likely one reason why parts of the government are reluctant to support large fiscal stimulus, particularly if it does not look necessarily urgent given that China has been able to meet its growth targets.

China will remain wedded to an incremental approach to supporting growth rather than opt for a major fiscal stimulus, unless the economic growth were at risk of slowing down significantly and deflation risks accelerating further. For a start, an incremental approach is more likely because the economic outlook, unlike in 2008-09, will deteriorate gradually rather than suddenly. However, if full-year growth projections were to fall below 4% in the near term and deflation to reach 1% on a year-on-year basis for more than a quarter, the cost-benefit calculus would change in favor of a larger fiscal stimulus, including one with a significant consumption-oriented component.This is our best guidance in an increasingly opaque policy environment. We define a large fiscal stimulus as additional full-year fiscal spending measures, at least half of which needs to target household consumption, exceeding 5% of GDP. Such a scenario would not prevent policymakers from continuing to introduce targeted measures aimed at stabilizing real estate prices, as well as provide further monetary stimulus, particularly in the context of declining U.S. interest rates, thus creating more supportive domestic financial conditions. 

> The IMF projects real GDP growth of 5%, 4.5% and 4.1% in 2024-26. Officialunemployment remains low at just over 5%. The IMF also projects real GDP growth to slow from currently 5% to 3.3% by 2029 due to slowing productivity growth and adverse demographics as well as increasing international economic fragmentation. 

> China’s producer price index has been in negative territory for almost two years, pointing to both weak demand and continued significant (over) investment. The last time China’s consumer price inflation was negative on a year-on-year basis was in January. More recently, it has been helped by higher food prices. The last time core consumer price inflation was negative was in January 2021 at the beginning of COVID-19, but in August core inflation fell to 0.3%, or less than half than a year earlier. 

> The 2008-09 fiscal and quasi-fiscal (credit policy driven) stimulus in response to the global financial crisis was predominantly focused on investment, such as public infrastructure investment, rural development and industrial upgrading and reconstruction (in the wake of the Sichuan earthquake) and a relatively small share going towards social spending. It exceeded 10% of China’s 2009 GDP. It raised concerns about mal-investment, financial write-downs and unbalanced economic growth, which continues to shape policymakers’ attitudes towards another large-scale stimulus in a context where such a measure does not necessarily appear necessary. 

>Private-sector economists put the total stimulus required to reflate the economy at Rmb5-10tn (Macquarie, HSBC). Morgan Stanley estimates puts the number at Rmb10tn over 24 months to reflate and return to stable growth. This is roughly equivalent to 7-8% of GDP annually and would lead to a massive widening of the fiscal deficit.

If a large consumption-oriented fiscal were stimulus were implemented, it would help reduce the risk of a debt-deflation spiral and might help put China on a path toward more sustainable economic growth. However, longer-lasting sustainability would require structural fiscal reform (e.g. health, pension and social expenditure) to support domestic consumption rather than a one-off, potentially time-limited fiscal stimulus. A successful stimulus would not necessarily raise China’s medium-term economic growth substantially. This would require wide-ranging structural economic reform, including reducing the role of the government in the economy, reducing regulatory uncertainty and providing for a more market-directed allocation of savings and investment. China’s focus on national security and increased government involvement and the more prominent role played by SOEs compared to more efficient private companies, the economy will continue to weigh on the medium- to long-term growth outlook. Stronger consumption-driven economic growth would help reduce China’s trade surpluses and provide a demand stimulus to the global economy and especially countries relying on exports to China. But a smaller Chinese trade surplus would only marginally reduce trade tensions with the US, the EU and RoW. As long as China continues to rely on industrial policy, including public investment in strategic industries, the outlook for international trade tension would improve and will be limited. If China manages to move toward a more consumption-oriented economic model, the risk of a broader systemic crisis or broader economic stagnation would diminish. But this world requires broader structural economic and fiscal reform that provides sufficient incentives to households to reduce their savings rate.

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How a “Defense Tax” Can Finance Europe’s Higher Defense Expenditure (2024)

See also: https://ip-quarterly.com/en/how-defense-tax-can-finance-europes-higher-defense-expenditure

Highly indebted European NATO countries should levy a “defense tax” to make their long-term commitment to higher defense spending politically credible and financially sustainable.

This year, 23 out of 32 NATO members are expected to meet the 2 percent of gross domestic product (GDP) defense spending target that the allies agreed to in 2014. While this is an improvement, the failure of nearly one third of NATO members to meet the relatively modest two-percent spending target speaks for itself. To strengthen its political-strategic and deterrence effect, defense spending needs to be made politically credible and financially sustainable. A long-term commitment to higher defense spending would also incentivize Europe’s private sector to make the investments necessary to rebuild Europe’s indigenous defense-industrial base.

European NATO countries have a sufficiently large economic resource base to balance Russia militarily. In terms of economic size, measured in purchasing power parity (PPP) terms to adjust for differences in prices, NATO GDP exceeds Russian GDP by a factor of 12, European NATO GDP exceeds Russia’s by a factor of six, and the combined GDP of Germany, the United Kingdom, and France exceed Russia’s by a factor of two and half. (Measured at market exchange rates, European NATO member GDP is more than 20 times larger than Russia’s.) 

The challenge European governments face is how to mobilize the necessary resources in the face of domestic distributional conflict. To the extent that greater resources are allocated to defense, fewer resources will be available for private consumption or non-defense investment (or both), unless they are borrowed from abroad. If the increase in defense spending comes primarily at the expense of private consumption, the population will be economically worse off. If it comes primarily at the expense of non-defense investment, longer-term growth will suffer. Allocating greater resources to defense implies economic tradeoffs and gives rise to domestic distributional conflict.

High Government Debt Constrains Larger European NATO Members

The five economically largest Western European NATO members (Germany, the United Kingdom, France, Italy, and Spain) account for 60 percent of European NATO GDP. Their ability to mobilize resources will have an outsized impact on European defense capabilities. But with the exception of Germany, government debt in these countries exceeds 100 percent of GDP and the International Monetary Fund (IMF) projects debt ratios to continue to exceed this level by the end of the decade. Financing substantial increases in defense spending through larger fiscal deficits therefore would seem at best financially imprudent. (All the other 25 European NATO members have more manageable debt levels of 80 percent of GDP or less, except for Belgium, Greece, and Portugal.)

Admittedly, France and the United Kingdom already spend 2 percent of GDP or more on defense, compared to 1.5 percent of GDP in Italy and Spain as well as Germany (if one discounts the contribution from its €100 billion special defense fund). However, should it become necessary to raise defense spending to 3 percent of GDP, as recently suggested by Poland, they would be faced with financial challenges. All of them are already faced with significant spending pressures as a result of higher spending related to demographic change, climate change, and defense. The European Central Bank (ECB) estimates that eurozone governments would need to raise an additional 3 percent of GDP – and substantially more than that in France, Italy and Spain – to cope with these increasing spending pressures and stabilize their debt-to-GDP ratios at current levels. But this would, according to the ECB’s projection, only prevent debt levels from increasing from today’s already high levels. It would require an additional 2 percent of GDP to bring government debt levels to the eurozone target of 60 percent of GDP. 

How to Finance Increased Defense Expenditure

So how should they go about financing higher defense expenditure? First, governments can increase defense expenditure by simply running larger deficits and accumulating additional debt. Germany has some fiscal space to do so in the short- to medium term. The other large European NATO members, as suggested, do not have that option. At the very least, it would be financially imprudent to do so, as it might undermine financial sustainability and therefore also political credibility. In terms of distributional politics, however, it would be the least challenging option, as it largely sidesteps distributional conflict by pushing the costs into the future and leaving it uncertain who will end up having to pay for higher spending.

Second, governments can cut non-defense spending (or, if no major immediate increase is necessary, reduce its increase relative to economic growth over time), thus freeing up resources to be spent on defense. According to the OECD, public social spending, by far the largest single expenditure category in the five countries, exceeds 30 percent of GDP in France and Italy. It is also high in Germany and Spain. 

Economically, reducing non-defense spending would be the preferred option, as the concomitant reduction in transfers to households for consumption purposes would help finance higher defense expenditure without reducing national savings. But politically it would be the most challenging option, as reducing social welfare spending or “acquired rights” typically mobilizes significant opposition, not least because who will incur economic losses, even if the materialize in the future, will be far less uncertain than in the case of issuing additional debt. Governments can also reduce public investment or other types of expenditure, like subsidies. But the former is costly in terms of foregone future economic growth, and the latter can just easily lead to significant political opposition if it affects well-organized or highly mobilized interests, such as farmers.

Third, governments can increase revenues, primarily income taxes, social security contributions, and taxes on goods and services. Higher taxes are hardly politically popular, and they, too, can trigger distributional conflict, particularly if they are perceived to exempt or favor one group over another. And increasing social security contributions to finance defense expenditure would be a difficult sell, even if higher contributions simply helped plug existing social security deficits and thereby allow the government to redirect resources to defense. But unlike spending cuts, higher taxes, if properly designed, can help spread the costs more evenly and more widely, thus limiting domestic political opposition.

Economic Effects of Higher Defense Spending Will Vary 

The macroeconomic effects of increased defense spending will depend on how they are financed, but also on how the additional funds are spent. If financed by additional debt in the absence of binding financial constraints, higher defense spending would provide a demand stimulus, at least in the short term. In debt-constrained economies, however, higher debt would increase the level of interest to be repaid, thus offsetting some or even all of the fiscal stimulus. In a worst-case scenario, it might undermine economic confidence altogether and force the government into a strategically disastrous fiscal retrenchment.

If financed by higher taxes or lower non-defense expenditure, the impact on short-term economic growth would likely be limited. Much would depend on where higher defense expenditure is directed. Increased spending on personnel, maintenance, and infrastructure would support domestic demand, while spending on overseas operations and equipment, much of which is currently being bought from abroad, would lead to what economists call fiscal leakage. But with spending on equipment typically accounting for about one third of defense spending, the broader macroeconomic drag—all other things being equal—would be limited. Over time, the build-up of intra-EU defense production capacity would also lead equipment spending to be redirected to the EU economy and support domestic and growth in the future. 

However, without a complete offset from a reduction of domestic consumption, allocating greater resources to defense would weigh on longer-term economic growth, at least in savings-constrained economies. Here again, Germany’s very large current account surpluses, which reflect “excess savings,” would provide it with much greater leeway to increase defense spending without jeopardizing non-defense investment than France, Italy, Spain, and the United Kingdom, whose current account positions are far less favorable.

European Governments Should Consider a “Defense Tax” 

In view of the need to raise defense spending in a financially sustainable and politically credible manner, fiscally constrained EU governments should consider introducing a “defense tax” at the national level. The related recurrent revenues should be earmarked for defense spending and finance the gap between current defense spending levels and current (and future) expenditure goals. If properly designed, such a tax would spread the financial burden broadly across society. 

This should help make it politically more palatable, compared to the alternative of financing increased defense expenditure through cuts to welfare spending. After all, the defense of the realm is a public good. So, everybody should contribute to it. Naturally, such a tax would not help governments avoid tackling broader, politically painful budgetary reform to address current and future spending pressures related to demographic change and the green transition. But by earmarking the revenue raised with the new tax for defense, it would go quite some way toward credibly and sustainably committing European governments to higher long-term defense spending, thus bolstering its strategic and deterrence effect.