The Group of 20’s stated goal is “strong, sustainable, balanced, and inclusive growth.” Amen to that. The quality-of-life triple threat of low productivity, unfavorable demographics, and stifling income inequality would all be licked if the G20 achieves that goal. The challenge of course is how to get there. Policy makers, economists, and the group itself all fall back on the tried-and-true prescription of “structural reforms.” That catch-all phrase is prominent in their publications, but one usually has to dig deep to uncover the specifics of what, really, these folks are recommending. For the US, infrastructure investment, tax reform, and regulatory reform—to the extent they rigorously address inefficiency, productivity, or inequality—would all count. Today, however, I want revisit in more detail a different proposal that I’ve discussed in the past, and expand on it with three key charts from the Organisation for Economic Co-operation and Development (OECD).
In short, a wholesale change in the US approach to childcare could have a profoundly positive impact on growth and quality of life. The idea is unusual, in that it is motivated by two factors which are often in conflict but here are aligned: first, a clinical focus on key macroeconomic outcomes, and second, deferential attention to small-scale outcomes for human individuals which improve the opportunities, incentives, and quality of life for families in the economy. The result could unlock significant gains in both productivity and hours worked, while at the same time counteract rising inequality—the three keys to sustainable and inclusive growth.
The United States government spends the second-least on preschool and childcare of the 32 individual countries plus the EU, measured as a whole, studied by the OECD:
When parents consider re-entering the workforce, childcare costs are a significant deterrent to doing so. For single parents, as well as the second earner in a two-parent household re-entering the workforce in the United States, the implicit tax rate is the fourth-worst in the OECD. It totals some 80%+ of gross pay just for taxes, childcare, and benefit reductions:
The result is an inefficient system, where primary caregivers are compelled to provide in-home childcare in lieu of participating in the wider economy. The impediments persist as children grow and their care needs are only partially met by primary school, with summer holidays and significant portions of the traditional workday hours still not covered. Parents are forced to accept jobs which can accommodate a certain schedule, rather than jobs which allow them to maximize their productivity, earnings, and participation in the economy.
If the United States treated childcare like public education, where every parent who wished could enroll their children in all-day, enriching childcare at little or no out-of-pocket cost, the economic benefits on both a macro and micro scale could be substantial:
Clearly any program like this, whether it’s done with physical structures, extensions of the public education system, or through vouchers and refundable tax credits would be costly. However, the realistic potential growth uplift outlined above allows “dynamic scoring” to be used with confidence for at least partial self-funding. Dynamic scoring uses future growth expectations, realized in the form of higher tax revenues, to fund current expenditures. The concept is frequently abused because growth forecasts are too optimistic, but in this case the pure economic effects are pretty simple. Near term funding through progressive taxation can provide a plausible bridge to a period of sustainably higher and more inclusive growth. Higher sustainable growth with less inequality allows a larger share of the economy to eventually make meaningful tax contributions. The ability of the economy to sustain less progressivity in the tax code ought to be a “win” for both political parties.
Any structural reform which can plausibly create jobs, increase labor force participation, increase productivity, and reduce inequality would produce meaningful progress toward “strong, sustainable, balanced, and inclusive growth.” Reforming the childcare system could potentially do all of this, while encouraging participation and engagement in the economy by all parents who wish to do so.
In 2002, China took the first steps to liberalize its capital account allowing investment onshore through the Qualified Foreign Institutional Investor (QFII) scheme. 2017 marks the fifteenth anniversary of such initiatives and Bond Connect is the latest addition to onshore investment channels.
On the surface Bond Connect’s benefits may not be obvious, but the move improved China bond accessibility and brought the asset class much closer to global standards. As a result, the chance for China to be included in the major bond indices has gone up significantly and we believe this will provide an investment opportunity that has yet to be embraced.
The hidden criterion for index providers
For those less familiar, China’s capital account is partially closed and bond access has historically come in the form of applying though one of the following schemes: QFII, RQFII (Renminbi Qualified Foreign Institutional Investor) and CIBM (China Interbank Bond Market). Bond Connect is the latest addition with key features below (Figure 1).
Interestingly, index providers don’t just look at sovereign rating, liquidity, GDP and other macro data to decide if a country is included in an index. Most providers measure ease of access, which is an assessment of the ability to get in and out of the markets on an infrastructure-adjusted basis. This has been one of the critical hurdles for China’s index inclusion.
Global bond settlement conventions are usually T+2 (trade +2 business days) however, China’s T+0/T+1 have been a challenge for global investors given infrastructure, over-draft and time-zone limitations. With Bond Connect, Chinese government bonds now settle on a T+2 basis for foreigners, bringing China on par with other G10 bonds (including no repatriation limits and global custodial connectivity). China will likely be included in bond indices within the next 12 months.
The asset with limited allocation
Although China onshore bonds have been quickly adopted by Asia (Bond Connect registered CNY 7bn of purchases on day 1), European and North American investors have been slower to on-board the asset class. Allocations are extremely low due to a mix of access restrictions, lesser familiarity and index representation.
In the medium term, we believe it is almost a given for index inclusion at some point and investors will likely try to get ahead of the announcements. In addition to that, investors should also consider the benefits of accessing the China Bond market:
Lesser known asset class flexibility
Unlike other bond markets, the RMB Bond market offers a healthy mix of instruments for investors with distinct features between them (Figure 5).
Throughout the past years (Figure 6), we have witnessed periods where CNH short-dated paper yielded 1.5% to 8% whilst synthetic CNH bonds yielded 2% to 12% vs. China onshore (USD bonds hedged back to CNH). Asset class returns have also been varied indicating potential benefits of diversification.
In short, the opportunity set allows for yield enhancement and diversified capital gains. Investors need to consider a holistic approach towards investing into China – not just purely onshore bonds.
To sum it up, we’ve gone a long way from 2007 to date in terms of liberalization measures and Bond Connect has brought global standards to onshore China bonds. The opportunity set is robust and underinvested, which warrants a place in asset allocations considering bond index inclusion pressures should pick-up over time.