If current projections prove to be correct, the populations of most industrial countries will experience significant aging in the first few decades of the next century. Birthrates have already declined markedly from their high levels of the early postwar period, and are projected to decline further. Even though projections that far ahead are obviously subject to considerable uncertainty, a prospective increase in the average age of the population is to a large extent inevitable as the postwar “baby boom” generation moves through the age structure. Aging of the population can be expected to bring about major changes in the economy, associated with an increase in the number of dependents relative to those that are employed (the dependency ratio), and in some countries with very low birthrates, projected declines in the population. An especially large element of uncertainty attaches to birthrate projections and to changes in population due to migration, but in any case, dependency ratios will almost certainly rise in the next three decades; a substantial rise in birthrates would, if anything, increase dependency ratios over this time period.
With the aging of the population, it is plausible to expect a decline in saving rates to the extent that “life-cycle” motives for saving operate—that is, individuals save for retirement during the years in which they are employed and dissave subsequently.1 In addition, the demand for social services will change toward providing more medical services and pension benefits and away from spending on education. Finally, the presence of fewer individuals of working age will be associated with lower levels of employment and hence of output, other things being equal, than would otherwise be the case. What happens to per capita output will depend on the resulting capital stock per worker, as well as on the proportion of the population in the labor force.
The macroeconomic effects of these changes, which can be expected to be substantial, are the subject of this paper. Changes in saving propensities, government spending, and labor supply have implications for relative prices, real interest rates, and real exchange rates; these variables in turn feed back onto decisions to spend and produce. The paper is an attempt to gauge the global macroeconomic consequences of generalized aging of the population in industrial countries.
To understand these consequences requires a macroeconomic model. A multicountry context is also important because some of the effects—for example, on real exchange rates and on current account balances—depend crucially on the extent of aging in one country relative to that in other countries. In this paper, we use simulations of the International Monetary Fund’s multiregion econometric model (MULTIMOD) in order to gauge the effects of the demographic developments described above.
Aging of the population affects macroeconomic variables in the model through three channels.2 First, aggregate consumption relative to income is increased by a rise in the dependency ratio. Second, higher dependency ratios lower the labor force, which is associated with a decline in potential output. Third, an older population requires larger government expenditures on medical services and on pension benefits; however, these may be partially offset by a decline in education expenditures.
To date, a macroeconomic framework has not been used to capture the general equilibrium, multicountry effects of demographic projections. There are a number of relevant studies of various features of the issue, however. Heller and others (1986) considered the effect of aging on social expenditures in seven major industrial countries (the so-called Group of Seven), and we will use their estimates below as input to our simulations. Heller (1989) examined the impact of aging on private saving, using several estimated consumption models; he also discussed implications for government budgets. The Organization for Economic Cooperation and Development (OECD) has produced several studies of saving behavior, including effects of demographic factors (Dean and others (1989) and Herd (1989)), and has examined implications of aging for public finances (Hagemann and Nicoletti (1989)). In addition, Auerbach and others (1989) studied the dynamics of the effects of aging on the economies of four industrial countries using a general equilibrium, overlapping-generations model; however, that model considered each country in isolation rather than as part of a closed world system. Ritzen and van Dalen (1989) considered the optimal fiscal policy in the transition to an older population, using a single-country theoretical model. Lee and Lapkoff (1988) looked at intergenerational transfer issues in an overlapping-generations context, but did not treat multicountry issues. Home, Kremers, and Masson (1989) examined the long-run relationship between dependency ratios and net foreign asset positions for the United States, Japan, and the Federal Republic of Germany.
It is important to make clear at the outset the limitations of our study.3 We do not examine issues related to intergenerational transfers—namely, questions of equity—since this would require a more detailed model. Furthermore, policy questions—for instance, how should increases in government spending be financed, or whether incentives for private saving should be put in place today—are not treated here. We have not attempted to incorporate projections for aging in developing countries. Finally, we do not take into account effects of the age structure on labor force participation due to endogenous participation or retirement decisions,4 or to changes in the growth rate of the population.5
The plan of the paper is as follows. Section I discusses the OECD’s demographic projections and presents the projections of expenditures on government services given in Heller and others (1986). Section II details the model of private consumption that is embodied in MULTIMOD and compares its estimate of the effect of demographic factors to those found in other studies. Section III presents simulations of the effects of aging using MULTIMOD; the results are compared to the long-run effects that can be derived from a simple theoretical model that is the prototype for MULTIMOD. (Derivations are detailed in the Appendix.) Finally, Section IV provides some concluding remarks.
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)| false Auerbach, Alan, Kotlikoff Lawrence, Robert Hagemann, and Guiseppe Nico-letti, “The Economic Dynamics of an Ageing Population: the Case of Four OECD Economies,” OECD Department of Economics and Statistics Working Paper 62( Paris: Organization for Economic Cooperation and Development, January 1989).
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