Emerging markets may soon become a source of global inflation rather than deflation. The main question is if this happens through the fire of trade barriers or the ice of demographics.
The integration of China, India and the former Soviet bloc into the global economy since the 1980s has provided a profound deflationary shock, effectively doubling the global labor pool. China’s integration into a complex web of global supply chains notably happened at the same time as tariffs were minimized or eliminated, allowing Western consumer goods to be manufactured using less-expensive Chinese and other Asian labor.
Yet China, its aging population the result of the now-rescinded one-child policy, is well past the point at which its supply of new labor exceeds demand, with new urban workers falling short of demand continuously since 2011. The movement of production out of China into less-expensive Asian and Indian locales has been widespread, but the impact of any price rises globally has perhaps been masked by falls in commodities costs in recent years.
“A shrinking labor force and population aging in China will bring inflationary pressures,” Christophe Donay, head of asset allocation and macro research at asset manager Pictet, wrote in a note to clients. “As labor costs continue to rise and commodity prices are lifted from their previously depressed levels, higher inflation will eventually come.”
A 2015 study by Mikael Juselius and Elod Takáts of the Bank for International Settlements found that having a larger working-age population in a given country tended to suppress inflation, while having more aged and young dependents tended to drive it higher.
Demographics alone may increase Chinese domestic headline inflation by 25 percent in 2025 compared with its average in the 2002-2015 period, according to Pictet estimates. Although Chinese inflation might be only 3 percent domestically in 2025, the impact on global inflation could be considerable and sustained, as there are few obvious pools of labor that could easily and cheaply be substituted to play the role China has over the past 25 years.
That’s not a bad thing for China itself, which needs to drive domestic wages higher to allow for the consumption share of its economy to grow and leave it less dependent on manufacturing and exports.
While demographics may well be destiny, and U.S. and global inflation thus destined to be pressured higher, the great thing about an aging population is that it happens slowly, giving policymakers and businesses time to adapt.
THE FIRE THIS TIME?
The more urgent and potentially destructive danger is not that emerging markets push prices higher slowly over time, but that a new trade war cuts them out partially from globally integrated supply chains, boosting prices rapidly.
Donald Trump won the presidency on a platform that accused China, and others, of manipulating the global trade system to its own advantage, hollowing out the U.S. economy and manufacturing employment.
Peter Navarro, his head of the White House National Trade Council – and the author of a book called “Death by China” – has evidently launched the administration’s trade campaign, taking aim this week at the “liberal trading order” under which we’ve lived since the end of World War Two. Focusing, to the distress of economists, on trade deficits, Navarro said the United States should aim to “reclaim all supply-chain and manufacturing capabilities that would otherwise exist if the playing field were leveled.”
At this point he is asking other countries to voluntarily buy American to drive that unlikely transformation. But if he and his president are actually serious about it, tariffs and trade barriers will be involved.
Remember, average world tariff rates were 30 percent in the early 1980s, spiking as high as 40 percent in the early 1990s and then steadily declining to roughly 6 percent by 2010, according to World Bank-derived data. Global inflation traced a similar path, from as high as 30 percent in the 1990s to about 3.3 percent today.
What happened slowly on the way down may reverse rapidly on the way back up, as the U.S. imposition of tariffs or a border tax or other barrier leads to a tit-for-tat response by trade partners. That could produce an inflation shock. Already analysts are forecasting that a border tax would add $2,000 to $2,500 to the average U.S. auto price, an increase of 6 percent to 7 percent.
The Federal Reserve might “look through” that kind of thing as a one-off increase in prices, but it is highly unlikely not to contribute to a wage spiral, prompting sharp increases in interest rates.
But investors, on the other hand, will be lucky if the ice of demographics-caused inflation is their worst problem.