Thursday, 15 December 2011

Global Capital Demographics

Yesterday I wrote about how in the Eurozone, where there is by definition little room for competitive flexibility in labour markets, and none in currency rates, one of the few remaining keys to comparative advantage is in the relative age of a country's capital stock. Thus, now that Germany has quietly been renewing and modernising its capital stock over the last couple of years whilst France and the Netherlands (as competitors) have been letting theirs quietly age, its comparative advantage within the Eurozone is only likely to widen.

But what's happening in the rest of the world: how do the demographic trends in capital stock work out in the US and NE Asia, as well as the Eurozone? Can we learn anything about the shifts of global comparative advantage from this, with all the potential for adjustments for pricing adjustments in labour and currency markets that implies? (I am, incidentally, absolutely aware that this is a long way from the last word on this issue – a complete analysis would also have to take in growth of capital stock, labour productivity, terms of trade and currency fluctuations. I am concentrating on this issue of the demography of capital because it's usually tends not to surface on economists screens.)

Let's start with NE Asia, where we can see very different trends emerging throughout the last 20 years, which we can interpret.
Starting with Japan, we can see that the implosion of the bubble economy in 1990 led to a long period where Japan hung back on re-investment and let its capital stock age. This period lasted for a full decade, so that by 2000, the average age of capital stock had risen to 4.16 year, from a low of 3.41 years in 1991. That was about as old as Japan's capital stock got, but it was not until around 2005 that corporate Japan began quietly to reinvest and renew – a modest trend which was halted in its tracks, and reversed, by the global financial crisis in 2008/09. Right now, Japan's capital stock is once again about 4.1 years old on average – the oldest in NE Asia.

The contrast with China is, of course no accident: rather, that contrast represents the impact of Japanese industry relocating and expanding out of Japan and into China. The investment cycles generated by China's financial system prior to Zhu Rongji's reforms were wild affairs, as the swings in the average age of its capital suggests. However, the last ten years has seen a combination of enormous and sustained investment, which has left China with the fastest growing, but also youngest capital stock in NE Asia. The capital demographics of South Korea and Taiwan bear the imprints of, respectively the 1997/98 financial crises for Korea, and the post-2001 political/diplomatic deterioration for Taiwan. South Korea's aggressive currency depreciation in 2008/09 bought the room for, among other things, an attempt to rejuvenate its capital stock.

Over time, as economic weight in NE Asia has shifted dramatically to China, so it is China's investment spending which has gradually come to be the swing factor in the demographics of NE Asia's capital. I have weighted these demographics by a moving three-year average nominal GDPs to generate a demographic for NE Asia as a whole. This shows that the age of the region's capital stock has remained roughly stable at around 3.6 years since 2008. Here's how it compares with what's happened in the US and the Eurozone.
This is a really dramatic demonstration of how comparative advantage is likely to have shifted over the last decade. In 2000, the US had by far the youngest capital stock, whilst NE Asia was still aged by the combination of Japan's irrecoverable bubble economy, and the 1997/98 financial crises. We can infer that Europe's capital stock was older than that of the US, but younger than NE Asia's. In 2011, the situation has reversed very dramatically: now NE Asia's capital stock is by far the youngest; the US's is by far the eldest (and older than it has ever experienced), whilst Europe's capital stock, too, is old and still aging at an unprecedented pace.

Grounds for NE Asian triumphalism? Perhaps. But take another look at the second chart. Doesn't the current US/NE Asian situation look rather like the beginning of the 1990s – the last time that America was generally considered down and out?   

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