Latvia's Agony Continues In The Second Quarter - With Little Relief In Sight

Latvia’s economy shrank a revised 18.7 percent in the second quarter of 2009 over a year earlier in what was the second-steepest drop in the entire European Union (worsted only by Lithuania) according to detailed data released by the statistics office yesterday. The contraction, which is now the largest since quarterly records began in 1995, was revised down from a preliminary estimate of a 19.6 percent annual drop. And Latvia's problem can easily be seen in the above charts which show the most recent movement in exports, and quarterly data for constant price imports and exports. The Latvian economy grew driven by domestic consumption and increased borrowing during 2006 and most of 2007, but then the country ran out of extra sources of cash, and so imports slumped, followed by exports as the global economy entered crisis. Now its time to pay back, which means the lines we see in 2006 and 2007 will now need to be repeated, only this time with exports on the top and imports below. Of course, really doing this will only be possible once the global economy recovers. But the key question is, will Latvian export capacity be ready when that critical moment comes, or will Latvia's agony continue, stuck in a horrid "L" shaped "non-recovery"? The most recent data on foreign trade, which saw exports fall and the trade deficit once more widen suggest that the latter danger is far from being a mere theoretical one.

And I am not the only one to be raising it, since according to the latest report out from Nordea Bank, Estonia, Latvia and Lithuania, may well suffer deeper economic contractions than previously estimated as government austerity measures simply serves to sap domestic demand while export growth remains muted.

So well done Nordea! But please permit me to say that this discovery does come as a bit rich from analysts who have persistently remained in denial that the key to Latvia's recovery was a substantial reduction in the price level in order to facilitate exports (on my view better achieved by formal devaluation, but by the express desire of the elected political leaders of the Latvian people now being carried out via a convoluted and painful process known as "internal devlauation").

Still, it is interesting to see mainstream analysts starting to question the current orthodoxy that fiscal prudency will (due to the impact on investor confidence) lead to recovery in Eastern Europe, while here in the West our leaders have just re-affirmed the need to maintain fiscal stimulus, given the fragility of even those earliest signs of recovery.

Indeed the analyst consensus is becoming more and more pessimistic. Danske Bank say the following in their latest Emerging Markets report:

"Worries over Latvia’s public finances continue. Despite aggressive cuts in public spending so far this year, total central government spending in August 2009 was, extraordinarily, exactly the same as in August 2008. This is partly due to spending cuts being offset by increased social spending, and partly to some ministries and agencies awarding their employees big pay increases in June this year before imposing cuts in July as part of the IMF/EU programme. It is still too early to say that everything is fine in the state of Latvia."

In the following monthly report I will examine just what evidence there is for the idea that Latvia's economy has actually bottomed out.

The Fall In GDP Continues


Latvia’s economy shrank an annual 18.7 percent last quarter, following a drop in gross domestic product of 18 percent in the first quarter. The charge downwards was lead by a decrease in private final consumption which fell an annual 23.21% (year on year - see chart). Government final consumption dropped bya mere 6.9%, but expenditure on gross capital formation (which includes the critical investment item) crashed by 38.1% - with construction (which forms part) down 29.5% (see chart below). Goods exports (63.6% of total exports) was down by 19.1% and the export of services by 15.7%. The slump in imports was, of course) even worse with the volume of goods imports (78.8% of total imports) down 39.4%, and the volume of services imports by 38.2%.





But Slows On A Quarterly Basis

Quarter on quarter, however, the rate of contraction did slow slowed substantially, from an 11% rate in the first quarter to a 1.6% rate in the second quarter. But even though the rate of contraction is now much, much slower, the economy is still contracting, so I think it is not quite accurate to say we have hit bottom yet. And hitting bottom is not the same as recovering, since there is unlikely to be any rapid bounce back, and any "recovery" is likely to have an "L" shape with a slight upward slope.

Meanwhile, and hardly surprisingly, during the month Latvia’s credit rating was lowered by Standard & Poor’s, with the long-term foreign currency rating being lowered to BB, two notches below investment grade, from BB+, with a negative outlook. According to S&P's:

“The rating action reflects our view of the political and economic challenges as a result of rapidly contracting nominal and real incomes and the associated pressures on public finances, as the country struggles to improve its growth prospects while maintaining a fixed exchange rate regime.....The outlook for growth beyond that remains highly uncertain, not least due to highly leveraged household balance sheets.”

S&P's estimate that Latvia’s general government debt, which stood at 19 percent of GDP last year, will grow to over 80 percent in 2011, an estime which is broadly in line with current EU Comission forecasts.

The International Monetary Fund also agreed on August 27 to disburse the second installment (of around 200 million euros) of the 1.7 billion-euro credit line approved last December. The decision followed a long period of uncretainty. Latvia’s government is trying to cut spending/or raise revenue by 500 million lati ($1 billion) a year between now and 2012, in a bid to get the budget deficit below 3 percent of GDP as part of an attempt to meet euro adoption criteria.

The IMF said in their statement that the program had been adjusted to reflect:

- a significant increase in the program’s fiscal deficit ceiling in 2009 (up to
13 percent of GDP, compared with 5 percent in the original program) to avoid
measures that would harm the most vulnerable, and

- an allowance of 1
percent of GDP in additional resources for social safety nets.

The statement which Moody's following the IMF decision asserting that Latvia’s Baa3 government bond rating - the lowest investment grade, - was being kept at stable was hardly surprising, although the justification they gave - that the bond issuance was supported by “significant, extraordinary fiscal assistance” from international lenders - surely was significant, and very much to the point. The EU Commission and the IMF are now guaranteeing and in order to do this have effectively assumed sovereign responsibility fo the country (see Appendix below).

Moody's were also a little more optimistic than S&Ps on government debt, since they estimated it would only rise to about 60 percent of gross domestic product in 2010 and fluctuate from about 60 percent to 65 percent over the medium term. I think this is too optimistic, basically for the sort of reasons S&Ps are giving. On the other hand they did also state that a currency devaluation, while not being their central scenario, "was a clear risk, along with additional problems in the banking sector".

Little Sign Of Any Recovery In Main Indicators

If we now come to the future, we have to note there is little hard evidence at this point for any real recovery - nor should we expect to see any. Industrial output is still falling, and was down 1.4 percent in July over June, and 17.7% year-on-year (over July 2008). This compared with a 18.5% annual fall in the previous month.



Latvia's industrial output started falling in February 2008, and has now fallen 22.4% from it peak.



Retail sales were down 1% in July over June, and 29.5% over July 2008.



Retail sales have now been falling since April 2008, and are now 31.18% below their peak.

The Trade Defict Widens in July As Exports Drop Back

Latvia's July trade deficit was 95.2 million Lati up from 67 million Lati in June. This was the first increase since December 2008. Latvian foreign trade turnover came in at 613.3 mln lats in July, down by 3.8% or 24.5 mln lats in current price terms than a month earlier and and down by 41.1% over July last year.

In the January – July 2009 period foreign trade turnover was 4517.6 mln lats – down by 36.1% or 2547.5 mln lats over the same period in 2008.



In July exports were down by 32.6% over July 2008 and imports down 46%. Over January to July exports were down by 27.2% or 705.4 mln lats, while imports were down by 41.2% or 1842.1 mln lats over the same period a year ago.

Unemployment Continues To Rise, And As It Does Bad Loans Pile Up In the Banking Sector

Latvia's unemployment rate hit 17.4% in July according to Eurostat data, and again this was the second highest level in the European Union (after Spain). Naturally with unemployment rising to such levels the number of distressed loans continues to rise and bad debt provisions in the banking sector wnet up again - to 6.6 percent of the total credit portfolio in July from 6.1 percent the month before, according to credit supervisor FKTK.

The FKTK also said in a statement that bank losses by the end of the first seven months had hit 400 million lats ($817.6 million), up from 346.8 million lats at the end of the first half.

Lending was again down, and the total credit portfolio fell by 0.7 percent in July. The level of debts with delayed payments of more than 90 days rose to 13 percent of the credit portfolio from 12 percent at the end of June.

What About The Internal Devaluation, Is It Working?

Well, prices have started falling, and the consumer price level was down in August by 1.0% compared to July. The average prices of goods fell by 1.3%, and of services by 0.4%. But if we compared to August 2008 we find that consumer prices (as measured on the Latvian national index) have incredibly still increased by 1.8% (down admitdely from the 2.5% rate of increase in July), which leads me to ask, given the pain that all of this is evidently causing, are prices still falling too little and too late to do any real good.

The central bank seems to think the process is working, since they point out on their website that the real effective exchange rate of the lat, which is one measure of the price competitiveness of Latvian goods versus those of the country's major trading partners, improved between April and July, marking the first four-month gain since the beginning of 2005. We need to remember howvere that the REER index showed prices developing far faster than trading partners all the way from 2006 through to April 2009 (see comparative chart with Finland below) so there really is a long long way back down to go. And if we look at the chart immmediately below, we will see that while the gap is closing Latvian prices are still in a worse position in August 2009 (as compared to other Eurozone countries) than they were in August 2008 - that is over the last year as a whole the position has even deteriorated.





A similar picture can be found in producer (factory gate) prices, which have only recently moved into negative territory on an annual basis. To get a comparison, German producer prices were down 7.8% year on year in July, while

In fact, while export prices are dropping substantially, import prices are also falling (see chart), and thus the real rate of price correction is still quite small.



I therefore contend that this weeks statement from Unicredit Group Chief Economist Marco Annunziata to the effect that, “For the region as a whole and for Latvia, we have gone through the worst,” is way too premature. Conditions are not improving, and as Moody's suggested pressures in the banking system are still building up. It is an open empirical question at this point whether we have the worst behind us. Even over a longer term horizon it is hard to see the grounds for optimism, since there are certainly no "green sprouts" to be seen on the new babies front, with year on year three month moving average being stuck around the 8% drop level. This depression is going to cast a long shadow over the future of the Latvian people, let's hope for everyone's sake that all those responsible (the government, the IMF, and the EU Commission) are fully aware of their hsitoric responsibilities here.




Appendix: IMF and EU Conditions from the respective Letters of Intent.



According to the letter of intent signed by the Latvian Government, The Central Bank and the IMF, a number of new reporting obligations were agreed to. These include:

* Consolidated central (basic and special budgets), local and general government operations based on the IMF fiscal template
* Detailed information on revenues from EU funds at the general government level, and EU-related spending by the central government, including transfers to local governments for EU-related spending
* Consolidated central and general government bank restructuring operations
* Privatization receipts received by the general government budget (in lats and foreign exchange, and payments in governments bonds)
* Information on debt stocks and flows, domestic and external (concessional and non concessional), by currency, and guarantees issued by the (i) consolidated central, local and general governments and (ii) public enterprises (including the Latvian guarantee agency and
the Rural guarantee fund), including amounts and beneficiaries
* Information on new contingent liabilities, domestic and external, of the consolidated central, local and general governments
* Data on general government arrears, including to suppliers
* Data on operations of extrabudgetary funds
* Data on the stock of the general government system external arrears
* Balance sheet of the BoL, including (at actual exchange rate) (i) data on components of program NIR; (ii) government balances at the BoL, broken into foreign exchange balances—distinguishing various program partner sub-accounts for program financing—and balances in lats.
* Balance sheet of the BoL (in program and actual exchange rates) (i) data on components of program NIR; (ii) government balances at the BoL, broken into foreign exchange balances—distinguishing various program partner sub-accounts for program financing—and balances in lats.
* Consolidated accounts of the commercial banks
* Monetary survey
* Currency operations, including government foreign receipts and payments and breakdown of interbank market operations by currencies (interventions)
* Aggregated data on free collateral—available, unpledged collateral held at the Bank of Latvia
* Daily data with banks’ current accounts, minimum reserve requirements, stock of repos and fx swaps
* Foreign exchange rate data
* Volume of foreign exchange lats trades
* Projections for external payments of the banking sector falling due in the next four quarters, interest and amortization (for medium and long-term loans)
* Projections for external payments of the corporate sector falling due in the next four quarters interest and amortization (for medium and long-term loans)
* The stock of external debt for both public and private sector

The Letter of Intent follows the earlier signing of a Supplementary Memorandum of Understanding between the Latvian government and the European Union. The terms of this understanding contained the following Monitoring and Reporting protocols.


Monitoring fiscal developments

• Monthly revenue and expenditure break-down of social budget, including data on social
benefits' hand-outs (unemployment, family, etc).
• Monthly state basic budget expenditure breakdown per type of expenditure for each
ministry or other relevant budget entity.
• Monthly revenue and expenditure break-down of local governments, including data on
GMI hand-outs and other benefits included in category "other social support".
• Monthly information on debt stocks and flows and guarantees given on new debt,
contracted by the (i) consolidated central, local and general governments and (ii) public
enterprises.
• Monthly data on new contingent liabilities of the consolidated central, local and general
governments.
• Monthly data on state budget loans and PPP projects.
• Monthly information on central government (i.e., ministries and agencies) and state
owned companies' staff and remuneration levels, institution-by-institution, showing last
months'/years' trends.
• Monthly data on general government arrears, including to suppliers.
• Bi-weekly Treasury cash-flow assessment of central government financing needs.


Monitoring financial developments

• Monthly statements of the operations on the special account.
• Monthly report on the amount of mortgage loans converted from EUR to LVL.
• Monthly report on outstanding loans split by currency and detailed to households
(housing, consumer, other) and non-financial corporations (by sector).
• Notify DG ECFIN whenever there is a consultation process with DG COMP related to
financial sector stabilization (i.e., Parex).
• Monthly report on banking sector stabilization measures.

Monitoring structural reforms

• Monthly data on budget allocations to and appropriations of line ministries for financing
of EU Structural funds and Cohesion fund projects (including which programming
period they are related to).
• Monthly data on the amounts disbursed to final beneficiaries for project
implementation, by ministry and by EU Structural funds and Cohesion fund projects
(including which programming period they are related to).
• Monthly data on the amounts spent by state budget financed entities as final
beneficiaries on EU Structural funds and Cohesion fund project implementation, by
ministry and by EU fund (including which programming period they are related to).
• Monthly financial reports on reaching the Structural Funds and Cohesion Fund
expenditure targets by the Managing Authority.
• Quarterly qualitative assessment reports on reaching the Structural Funds and Cohesion
Fund expenditure targets by the Managing Authority.
• Quarterly assessment of policy options taken by the government regarding poverty,
health and pensions.

From Original Sin To The Eternal Triangle - Lessons From Central Europe

The non-biblical concept of original sin, as Claus Vistesen notes in this post, when propounded in its standard Obstfeld & Krugman textbook version refers to the situation where many developing economies who are not able to borrow in their own currencies feel forced to denominate large parts of their sovereign and private sector debt in non-domestic currencies in order to attract capital from foreign investors - as evidenced most recently in the countries of Central and Eastern Europe. Well, piling insult upon injury, I'd like to take Claus's point a little further, and do so by drawing on another well tried and tested weapon from the Krugman armoury, the idea of the "eternal triangle".

As is evident, the reality which lies behind the current crisis in the EU10 is complex, and has its origin in a variety of causes. But one key factor has undoubtedly been the decisions the various countries took when thinking about their monetary policy and currency regimes. The case of the legendary euro "peggers" - the three Baltic countries and Bulgaria - has been receiving plenty of media attention on late, and two of the remaining six (Slovenia and Slovakia) are now members of the Eurozone, but what of the other four, Romania, Hungary, Poland and The Czech Republic? What can be learnt from the experience of these countries in the present crisis.

Well, one convenient way of thinking about what just happened could be to use Nobel Economist Paul Krugman’s Eternal Triangle” model (see his summary here), which postulates that when it comes to tensions within the strategic trio formed by exchange rate policy, monetary policy, and international liquidity flows, maintaining control over any one implies a loss of control in one of the other two.

In the case of the Central Europe "four", Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to "freefloat" and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.

The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.

A second problem which stems from this "initial decision" has been the tendency for households in the latter two countries to overload themselves with unhedged forex loans, a move which stems to some considerable extent from the currency decision, since in order to stabilise the currency, the central banks have had to maintain higher than desireable interest rates, which only reinforced the attractiveness of borrowing in forex, which in turn produced lock-in at the central bank, since it can no longer afford to let the currency slide due to the balance sheet impact on households. Significantly the forex borrowing problem is much less in Poland than it is in Hungary or Romania, and in the Czech Republic it is nearly non-existent.

The third consequence of the decision to loosen control on domestic monetary policy has been the need to tolerate higher than desireable inflation, a necessity which was also accompanied by a predisposition to do so (which had its origin in the erroneous belief that the lions share of the wage differential between West and Eastern Europe is an “unfair” reflection of the region’s earlier history, and essentially a market distortion). The result has been, since 2005, a steady increase in unit wage costs with an accompanying loss of competitiveness, and an increasing dependence on external borrowing to fuel domestic consumption.

So, if we look at the current state of economic play in the four countries, we find two of them (Hungary and Romania) undergoing very severe economic contractions - to such a degree that in both cases the IMF has had to be called in. At the same time both of them are still having to "grin and bear" higher than desireable inflation and interest rates. In the other two countries the contraction is milder, the financial instability less dramatic, and both inflation and domestic interest rates are much lower. Really, looked at in this light, I think there can be little doubt who made the best decision.


Appendix

Here for comparative purposes are charts illustrating the varying degrees of economic contraction, inflation, and interest rates. GDP contraction rates actually present a little problem at the moment, since one of the relevant countries - Poland - still has to report. However Michal Boni, chief adviser to the Prime Minister, told the newspaper Dziennik this week that the economy expanded at an annual rate of between 0.5% and 1% in Q1. So lets take the lower bound as good, it is still an expansion.

The economy in the Czech Republic contracted by an estimated 4.9% year on year in the second quarter.

The Hungarian economy contracted by an estimated 7.4% year on year in Q2.



While the Romanian economy contracted by an estimated 8.8% year on year.


Inflation Rates

Poland's CPI rose by an annual 4.2% in July.


The CPI in the Czech Republic rose by an annual 0.3% in July.



Romania's CPI rose by an annual 5.1% in July.


Polands CPI rose by an annual 5.1% in July.


Interest Rates

The benchmark central bank interest rate in Poland is currently 3.5%.

The benchmark central bank interest rate in the Czech Republic is currently 1.25%.


The benchmark central bank interest rate in Romania is currently 8.5%.



The benchmark central bank interest rate in Hungary is currently 8.5%.

"Advances in Development Reverse Fertility Declines" - Science or Hocus Pocus?

According to a once-upon-a-time post on the Economist's Certain Ideas of Europe Blog Edward Hugh “was very cross” about some of the journalism they were serving up over at that prestigious journal. Well, not to worry, since this time he is hopping mad. And the issue which lies behind his wrath is essentially the same one, how to interpret and understand the demographic processes which are currently so evidently affecting our societies. In what is simply the latest episode in a long and sorry saga (if you want documentation, please see the comments Claus Vistesen and I nailed to their "Wall" in the above linked post) this week's print issue contains a research review from their science and technology correspondent who is evidently not backward in coming forward with headline grabbing claims. According to the said corresponedent the demographic transition (a process which has been ongoing for over two hundred years now) has finally and definitively gone into reverse gear:

"One of the paradoxes of human biology is that the rich world has fewer children than the poor world. In most species, improved circumstances are expected to increase reproductive effort, not reduce it, yet as economic development gets going, country after country has experienced what is known as the demographic transition: fertility (defined as the number of children borne by a woman over her lifetime) drops from around eight to near one and a half. That number is so small that even with the reduced child mortality which usually accompanies development it cannot possibly sustain the population.

If Mikko Myrskyla of the University of Pennsylvania and his colleagues are correct, though, things might not be quite as bad as that. A study they have just published in Nature suggests that as development continues, the demographic transition goes into reverse."

Well quite a strong claim is being made here. The idea that a group of researchers have come up with a finding that shows the "rule....that people have fewer children as their countries get richer...no longer holds true" is certainly not one to be sniffed at. Such a strong claim needs some very heavy backing you would think, given all the research that has gone into the topic in recent years.

In fact, the research makes no such direct claim, since Myrskylä et al simply find statistically significant evidence for a reversal in the relationship between the human development index (HDI)
and the total fertility rate (Tfr) at HDI levels around 0.85–0.9. The rest is only interpretation. As we will see, to move from a simple statististical correlation to formulating a hypothesis you need an explanatory framework, and you need to be able to make falsifiable predictions. The Nature letter from Myrskylä et al is far from being at this stage of development. They have simply found an interesting correlation, and the rest is in the eye of the observer.

"Back in 1975, a graph plotting fertility rate against the Human Development Index fell as the Human Development Index rose. By 2005, though, the line had a kink in it. Above an HDI of 0.9 or so, it turned up, producing what is known in the jargon as a “J-shaped” curve (even though it is the mirror image of a letter J). As the chart shows, in many countries with really high levels of development (around 0.95) fertility rates are now approaching two children per woman. There are exceptions, notably Canada and Japan, but the trend is clear."

However, according to the Economist the trend is clear. But is it? Edward has been doing some digging.

In fact the problem goes beyond the Economist, since the source behind the article is a letter published in Nature. Below you can read that letter.

"During the twentieth century, the global population has gone through unprecedented increases in economic and social development that coincided with substantial declines in human fertility and population growth rates. The negative association of fertility with economic and social development has therefore become one of the most solidly established and generally accepted empirical regularities in the social sciences. As a result of this close connection between development and fertility decline, more than half of the global population now lives in regions with below-replacement fertility (less than 2.1 children per woman. In many highly developed countries, the trend towards low fertility has also been deemed irreversible. Rapid population ageing, and in some cases the prospect of significant population decline, have therefore become a central socioeconomic concern and policy challenge10. Here we show, using new cross-sectional and longitudinal analyses of the total fertility rate and the human development index (HDI), a fundamental change in the well-established negative relationship between fertility and development as the global population entered the twenty-first century. Although development continues to promote fertility decline at low and medium HDI levels, our analyses show that at advanced HDI levels, further development can reverse the declining trend in fertility. The previously negative development–fertility relationship has become J-shaped, with the HDI being positively associated with fertility among highly developed countries. This reversal of fertility decline as a result of continued economic and social development has the potential to slow the rates of population ageing, thereby ameliorating the social and economic problems that have been associated with the emergence and persistence of very low fertility."

Here is the chart (reproduce from Nature data) which the Economist presents to illustrate the 'J curve' relationship.



Nice, isn't it? Nature even go to the lengths of a putting up a special "event" podcast featuring an interview with Hans Peter Kohler (click here for link) as if to underline the importance of the "finding") But does any of this have any compelling validity?

Methinks not as much as the authors of the letter, or those who are covering it in the media, are trying to make out. There are many issues which are raised here, but I would just like to mention three.

The first is the decision of the research team to work with a period based fertility measure which is known to be very unreliable for "tempo" reasons (the Total Fertility Rate- Tfr) as the basis for a longitudinal study. And let us remember, the authors only really claim to have found a correlation between HDI levels in the 0.85–0.9 range and movements in the Tfr, and there could be many explanations for this. Indeed the authors themselves even offer one of them in their supplementary information - "countries at development levels near the critical level HDI = 0.86 might have a more rapid postponement of childbearing than more advanced countries.. " - a possibility which, in fairness to the authors, they try to test for.

And you don't have to rely on me for the suggestion that the Tfr is hardly the most desireable measure for what they want to do, since the authors themselves point this very fact out in the supplementary information (and the only thing which surprises me is that nobody else who has reviewed the research seems to have twigged the implications of this). So the very title of the Letter is totally misleading, they have not found that "Advances in Development Reverse Fertility Declines" -since in the first place the direction of causality is not adequately determined (it might be that reverses in fertility decline advance development, as I try to show in a piece referenced below) and in any event the research only shows movements in the HDI correlate with movements in the Tfr (and not with "fertility").

The recent literature on low fertility in developed countries has pointed to the important role of delayed childbearing, that is, the ongoing postponement of childbearing to increasingly later ages. In the context of this paper, delayed childbearing is potentially important because the postponement of childbearing can distort the total fertility rate as a measure of the quantum (or long-term level) of fertility. “Tempo effects”, or the reductions in the total fertility rate resulting from a postponement of childbearing, have been shown to partially explain the very low fertility rates observed in some European countries.

So this is the first issue. Due to the phenomenon of birth postponement, the Tfr is a hopelessly unreliable indicator, and what is often called "the birth recovery" is in fact a statistical issue produced by the fact that the Tfr first sinks to very low levels (the birth dearth) and then recovers as women reach the new (higher) childbearing age. Since all of this is simply so obvious, I am absolutely astounded that two such well known and highly respected demographers - Hans-Peter Kohler and Francesco Billari - have placed their name on a piece of research that could almost be described as a publicity stunt. I am even more astounded by the way Nature appear to have been hoodwinked.

Basically, I don't think that there can be any doubt that if they used a more comprehensive measure of fertility - say completed cohort fertility - they wouldn't get the correlation they claim to have found, since CFRs never fell so low, and have not bounced back in the same way. This is essentially because this indicator removes the temporal component found in the TFR (older first birth ages among women in developed societies) and only focuses on quantity. True, they did carry out a robustness test using an adjusted Tfr, but the results are much weaker, and the sample far from satisfactory (at least for the claims being made), and the authors well know this (see below).

In their longitudinal study the authors look at Tfrs for a number of countries over the period 1975 to 2005 and compare these to the lowest Tfr reading observed while a country's HDI was within the 0.85–0.9 window. For all countries considered, the HDI in 2005 was found to be higher than the HDI in the reference year. For 18 of the 26 countries that attained a HDI 0.9 by 2005, the Tfr in 2005 was found to be higher than the TFR in the reference year. As I say, this is hardly surprising, given the tempo impact on Tfrs. The "2005 18" are Norway, the Netherlands, the United States, Denmark, Germany, Spain, Belgium, Luxembourg, Finland, Israel, Italy, Sweden, France, Iceland, the United Kingdom, New Zealand, Greece and Ireland.

Perhaps it is more surprising (and interesting) to learn that they found six countries where the HDI was over 0.9 but where the Tfrs didn't pick up: Japan, Austria, Australia, Switzerland, Canada and South Korea. Clearly the absence of "rebound" in even the Tfrs is something of a cause for preoccupation in these countries, and examining the background to what is happening in these countries could at the end of the day turn this research into something quite interesting. That is to say, if for their level of development we might have expected the tempo effect to be more or less over, why do some countries continue to have very low fertility levels?

Basically, to shoot a hole straight through their hypothesis (falsify it that is, surely in science things should be falsifiable), I would say it is only necessary to find a significant number of countries in the first group where fertility as measured by a better indicator didn't rise. Unfortunately we don't have a really good time series for such an indicator, but Eurostat have published statistical estimates for Completed Cohort Fertility Rates (Cfrs) for EU countries up to the 1989 cohort. That is, estimates of what fertility is likely to be for women who were 30 in 2009. Looking at this data, the following countries would appear to offer no evidence whatever for a rebound in cohort fertility in what we know to dat: Norway, Netherlands, Denmark, Germany, Italy, Finland, Sweden, France, Iceland, the UK, Greece and Ireland. That is to say, as far as I am concerned, the whole hypothesis falls till at least subsequent data confirm it.

I haven't been able to check foir the US (but the Cfr is probably up) Israel (also) or New Zealand. Belgium has little available data. So the only two European countries which you could say with some degree of security actually could confirm the hypothesis would be Luxembourg and Spain - but if you just look at the increases in Spain - from 1.34 to 1.35 - and think about the fact that 5 million new migrants arrived (mainly in childbearing ages) between 2000 and 2009, then the result is hardly dramatic, and if you look what just happened to the economy, it is more than likely that GDP per capita is plummeting, and and household income (which has a weighting of more than one third in the HDI) with it. Which brings me to the second question, the reference year. But before I move on to that, as I say above, the authors are perfectly well aware of the issue with using Tfrs.

In particular, one could speculate that tempo effects might be—at least partially—responsible for the observed change in the development–fertility association. For example, countries at development levels near the critical level HDIcrit = 0.86 might have a more rapid postponement of childbearing than more advanced countries. If this were the case, tempo effects would reduce the TFR more strongly at intermediate than at advanced HDI levels, and the positive association between HDI and TFR in Figures 1–2 could be partially explained by differences in the pace of fertility postponement, rather than by variation in levels among advanced countries.

The authors therefore carry out a robustness test which effectively amounts to a cross-sectional study (cross-sectional note, not longitudinal) of the relationship between the total fertility rate with and without adjustment for tempo effects, and the human development index in 1975 and 2005. Tempo adjusted TFRs are not available over the period in question so they simply took data for 2005 (for those countries for which it is available from the ’European Demographic Data Sheet 2008’ (published by the Vienna Institute of Demography, Vienna, Austria) and from McDonald P, Kippen R. The Intrinsic Total Fertility Rate: A New Approach to the Measurement of Fertility (Population Association of America Annual Meeting 2007, New York, 2007). What they can then show is that the HDI–TFR relationship at persists at advanced development stages persists even after adjusting the total fertility rate for tempo effects. But, as I say, this is cross sectional, not longitudional. What does this jargon mean? It means there is no clear causal relationship, since equally it could be better HDIs which is driving better fertility, and hence you can use the HDI to explain differences between countries if you wish, but not the evolution of fertility in individual countries. The 2005 result is show as a black line in the chart below, where you can see that as HDI goes up, Tfr also seems to be higher.



Which is very much to the point, and brings me to my second issue, since in my blog post "Taking Solow Seriously - Does Neoclassical Steady State Growth Really Exist?" (which you can find here) - I demonstrate using a few simple charts that the evolution in GDP per capita (which accounts remember for one third of the HDI) may well be a function of underlying population dynamics, since three countries with stronger population growth and higher fertility (the US, the UK and France) evidently perform much better than three will low-to-negative population growth and very low fertility (Italy, Japan and Germany).

Also, it should be remembered, as I mention, we need to think about base years. 2005 was the mid point of a massive and unsustainable asset and construction boom. I think there is little doubt that if we took 2010 or 2011, the results would be rather different.

Finally, the piece in the Economist article that I personallyfind most interesting is the following:

"Dr Myrskyla’s data, however, suggest the ultimate outcome of development may not be a collapsing population at all but, rather, the environmentalist’s nirvana of uncoerced zero population growth."

I want to stress, I certainly think this stationary population idea is certainly one possibility in the more highly developed nations - but if we move to stationary populations, with higher and higher proportions of the population in the older age groups the result is - as we know - a rising median population age. It is the economic impact of the abrupt rise in median age that I personally am focused on, and how just this rise, and the resulting fall in living standards for many young people, might feedback in a negative way on fertility and thus produce ever more rising median ages. In recent days, some have been asking why people like myself are so focused on what is going on in Latvia, which is after all, a pretty small country. Well, I think here in the issues raised by the Nature letter we have just one more reason why that country is important, since in a sense it is conducting a "live" experiment.

Finally, I want to say, none of the above should be read as suggesting that there isn't a great deal of interest and material to talk about in the study the authors have carried out. Nor would I hold them entirely responsible for the way in which others have used and abused their work. I just the reserach doesn't demonstrate what they want it to demonstrate, and that the study doesn't deserve the kind of high media profile it has been receiving, since it is going to mislead the general public more than it will enlighten them, given the important methodological issue which are still to be clarified.

The heart of the problem is twofold. The excessive reliance on a rather problematic indicator (the Tfr) and the causality issue when it comes to GDP per capita and higher fertility (which way does the arrow point?). In fairness the authors do attempt to construct their own combined time series based on a mixture of tempo-adjusted Tfrs and Tfrs, a procedure which seems at the very least to be somewhat problematic if you want to reverse fifty years of academic consensus. And they do get the same sort of result, but the outcome is much weaker and is based on a much smaller sample of only 25 countries. But even this result is at the very least odd, since, as I argue above, cohort fertility hasn't really increased in most of thecountries concerned. So I think we really all need to see more details of how the authors actually constructed the time series to be able to form a better judgement.

But all this being said, and whatever the original intentions of the authors, serious scientific debate does seem to have been turned here into something of a media circus. Wasn't it blogs that were supposed to do that?

Appendix

Below I offer a series of charts showing estimated completed cohort fertility rates based on data compiled by Eurostat using the distribution of births by parity (first and second or higher order births) and mean age of mothers at respective parities to carry out the calculations. Evidently, the most recent data for hard data on completed cohort fertility comes for the 1960 - 1965 cohort. These charts should not be treated as hard data, but a rule-of-thumb type quick visual inspection suggests that it is hard to accept the case for a substantial fertility rebound in many European countries.