Asia the saver

Neelkanth Mishra | Last Updated at January 9, 2023 22:55 IST

This appeared in the Business Standard on 10 January 2023 (link).

In Tessellatum, over the last two months we have discussed two of the major implications of Asia’s ageing: That the demographic shift in 10 major Asian economies (the A-10: China, India, Indonesia, Japan, the Philippines, Vietnam, Thailand, Korea, Malaysia, and Taiwan) is faster than the economic transition, and that workforce quality is likely to trump quantity. Here we discuss the third: Will Asia continue to provide capital to the world?

There is disparity among the A-10 on the current account balance (India and Indonesia run deficits, whereas north Asian economies run persistent surpluses), but collectively they accumulated a surplus of nearly $5 trillion last decade. That is, they produced $5 trillion more than they consumed. These savings are then invested in global assets: The A-10 now holds net international assets of $15 trillion. These economies have thus funded the consumption boom in the developed world and the investments in some developing markets.

As populations age, many fear a drop in A-10 savings. The argument is simple: If there are fewer workers (as the workforce is shrinking), production would fall, but same or more consumers (as lifespans lengthen) mean consumption may keep rising. Demographers call the number of consumers per worker the dependency ratio. Over the past three decades this ratio has declined for the A-10 (except in Japan, where it troughed in 1995), but is now set to rise. A higher ratio could turn current account balances from surpluses to deficits.

This concern, however, is somewhat premature and too simplistic on several counts. In the next decade, only Korea, Thailand and Taiwan will see sharp increases in the dependency ratio; sharper and more worrying increases are expected in larger economies like China in the subsequent decade: 2030 to 2040. More importantly, though, demographics impact current account balances in several different ways.

First, the aggregate demand driving current account balances includes not just domestic consumption but also investment. Investment needs of all three parts of the economy — households, corporations and the government — fall as population growth slows first and then turns negative. There is less need for new investment in real-estate (slowing growth in the number of households), manufacturing capacity for domestic needs, and infrastructure (like roads, bridges, and railway lines). In older but richer countries, as labour becomes expensive, capital investment becomes more attractive, but most such supply chains tend to be global, and the need to invest is driven by global demand-supply balances and not necessarily just local ones.

Second, even household savings depend on sufficiency of pensions; if these are not adequate, a fall in incomes with age triggers a drop in consumption instead of a depletion of savings. People who live till 80 years of age earn for less than half of their lives; they are dependent on their parents for at least the first quarter and then must have access to a source of income to sustain their consumption post-retirement. While for much of human history, having capable children was the only feasible retirement plan, with growing financial sophistication, workers can now save during work years. Either the individual or the state, or both, need to save for the future. The state, cognisant of the future needs of its citizens, encourages savings in defined contribution pension schemes, which in several countries can only be accessed post-retirement.

But how much corpus is sufficient? The standard deduction from formal employees’ compensation is hard to calibrate and studies show that these are far lower than necessary in most A-10 economies. That some state governments in India are promising defined benefit pensions to government employees, redirecting taxpayer money to protect retired lives of a chosen few, underscores this problem. Further, a large proportion of the workforce is informally employed and not a part of government-run provident fund programmes. Given a steady increase in life expectancy, it is also prudent for the retiree to err on the side of caution when deciding the pace at which to deplete savings. Interestingly, consumption drops with old-age in the US, which does not have a large state-funded old-age medical insurance scheme, whereas in the UK it does not, courtesy the state-funded National Health Service.

Thus, in the absence of good public healthcare and a large public pension plan, older adults may curtail their consumption to maintain savings, sometimes many years before retirement. While Japan and South Korea have large pension assets, other A-10 economies need to still build them, necessitating higher savings. The Japanese fund GPIF has $1.5 trillion in assets, nearly 10 per cent of all Japanese wealth, with half of it deployed in foreign financial assets. In fact, accumulated foreign assets of Japan (across corporations, households, and government) are so large that the income from them exceeds 4 per cent of gross domestic product, helping Japan’s current account stay in surplus despite a shrinking workforce.

Hence, either through personal savings or government-mandated savings (like in the younger economies of India, Indonesia, and the Philippines), we expect financial savings in Asia to continue to expand (unless terms of trade change meaningfully, like, say, for energy). Our proprietary survey also found that due to insufficient pensions and public healthcare, households save for emergencies and retirement.

The nature of savings also matters. Early in an economy’s modernisation, most wealth is physical in the form of land, real-estate, and gold. Historically, this was the wealth that would be passed on through generations as, until a few generations back, agriculture was the dominant form of productive work in most of Asia. These cultural preferences change over time, but more importantly, research shows that rising dependency ratios mean weak real house prices. Near-term volatility aside, using consensus forecasts for economic growth, we find that real-estate prices in China, Japan and South Korea may be the most at risk over the next decade.

Thus, not only are savings likely to continue growing, but financial assets may grow faster. These assets are also more amenable to cross-border movement, particularly as geographical diversification becomes important once the size becomes large enough. This suggests that the position of the A-10 economies as providers of capital to the world may remain intact in the coming decade. They may also continue to boost the demand for safe assets, continuing the “savings glut” that former US Fed Chairman Ben Bernanke alluded to two decades ago. Geopolitical changes, though, are likely to change the definition of “safe assets”.