Morningstar Advisor - June/July 2013 - (Page 53)

theoretical argument among economists about how long this will last. But if we look at not only Southern Europe but also Eastern Europe—these are all countries that are about to enter this important aging period, and they’ve got strong negative external investment positions. This is a great concern. How are they going to manage the aging process? They haven’t got the external savings to draw down, and they have external debts to pay. people were not moving from one country to another. Or even within countries. Take the example of Spain; even when the economy was growing at 4% a year and 750,000 migrants were entering the country every year, there was double-digit unemployment in the southern parts of Spain. There was no movement from these areas towards richer regions like Madrid, Valencia, or Barcelona, where the economies were booming, and there was plenty of opportunity for work. they owe money to the external sector. Hugh: Every month, just to cover the current outflows on the equities and on the debt obligations these countries have, they have to do an extra dose of exporting to be able to earn the money to pay it down. That exporting doesn’t help compensate for deficient internal demand. So, it’s going to become an increasing headache. Labor Mobility Torralba: I’d like to discuss the relationship between migration and fiscal policy. Spain is quite a nice microcosm of the problems that the euro area has as a whole. If this mobility wasn’t evident, or wasn’t evident in Italy from the south to the north in the first decade of this century, how much less wasn’t it there in the euro area as a whole. I mean, there was a migration from Eastern Europe into the euro area, but not from one eurozone country to another, except at the most highly qualified level. What we are seeing now is something new, and something that in principle is very welcome—people are moving from countries which are stuck in deep recession to areas where there is economic growth, where there is demand for labor. In an economic area like the eurozone, where in theory you have a free labor market— people are free to work and live wherever they choose—you have the possibility that people will move from the least-productive, lowest-wage parts of the eurozone to the most-productive, highest-wage areas. That leaves behind retirees, or people with very low earnings, who make small fiscal contributions to the state. What does the free labor market in the eurozone imply for fiscal solidarity in the eurozone? Hugh: This is a very important point. The euro was set up with major institutional deficiencies. Some of these had to do with the fiscal coordination and product market integration, services integration, or whatever. One of the deficiencies was the absence of widespread labor mobility. For some reason or another, Torralba: From a political point of view, it’s going to be extremely complicated. It creates tensions between regions, and it creates resentment. In Spain, people in Catalonia Torralba: Exactly. Not only do they have current account deficits, but on top of that, the sharing of the benefits of this migration? Because if it isn’t, then what you are left with is what the old East Germany would be like, if it wasn’t part of the Federal Republic, a country with a very large number of old people, quite a high unemployment rate, and insufficient growth to support the basic welfare system. But, as you’re suggesting, this basically good news also presents us with a problem, as it highlights yet another institutional deficiency in the design of the euro area. Basically, those who are moving have been brought up, educated, and prepared for life by one society but they then go and work in another one. Instead of paying contributions through the pay-go system of their own country, they contribute to the pay-go system of another one, and there’s no evident mechanism whereby any of this money gets recycled back to meet the old-age needs of the parents who raised them. The issue then is, is the euro area going to set up some kind of equivalent arrangement to the one that’s been set up in the Federal Republic of Germany, or the autonomous communities of Spain, and make some kind of allowance for think they’re paying too much to Madrid. How is that going to work in Europe when Germany is told that they’re going to have to send checks every month to pay for the Spanish retirees? I don’t see that going down very well. Hugh: No, and I don’t think that’s going to happen, either. Japan has these problems, not at the regional level, but the problem simply of sustaining the health and pension system, given the lackluster nature of the economy and now the declining workforce and problems of productivity that they’re having, associated with its aging. How Japan is handling this is just by boosting debt. Japan’s gross sovereign debt last year was around 235% of GDP, and they were running a fiscal deficit of around 10%. The prime minister, Shinzo Abe, is talking about doing even more of the same this year, so we can imagine they could go up through the 250% of GDP and onwards to upwards to more than 300% over the next few years. These are unheard of proportions in any modern society. We don’t know where this leads. But I would suggest that the most likely tendency that we can see in Europe at the moment is a tendency for some kind of mechanism to be devised, yet to be specified, which allows these countries to continue spending without all the weight of this falling on Germany. Torralba: We’ve been talking about the implications of demographics for fiscal solidarity. Another implication that we read about is that having a single financial system eventually leads to some sort of MorningstarAdvisor.com 53 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2013

Morningstar Advisor - June/July 2013
Contents
Contributors
Letter From the Editor
Not Your Values
How Do You Use Alternatives for Clients?
Working to Build a Niche
How to Put Buffett’s Investing Philosophy into Practice
Sophisticated Strategies for the Masses
Investments á la Carte
Investment Briefs
The Percentile Trap
Defense Firms Will Stay Aloft
Beware the Lure of Diversification
Using Alternatives in Practice
Managed Futures and Cash Rates
The World Is Getting Grayer
Waiting to Pull Up Anchor
The Price of Managing Volatility
Let’s Get Back to Basics
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Mutual Fund Urban Myths

Morningstar Advisor - June/July 2013