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The Global Macroeconomic Consequences of a Demographic Transition Warwick J McKibbin Centre for Applied Macroeconomic Analysis, RSPAS, ANU; Lowy Institute for International Policy, Sydney The Brookings Institution, Washington DC; Prepared for a seminar at the Harvard Program on the Global Demography of Aging. Cambridge Mass Thursday, February 23 1 Overview • Summary of Global Demographic trends • Macroeconomic issues • Alternative approaches • Consequence of global demographic change in 10 regions from 2004 to 2050 • Conclusions 2 Figure 1: Population Growth Rate 1950-2050 3.5 3.0 USA 2.5 2.0 Europe 1.5 ROECD Asia 1.0 Latin America 0.5 India China 0.0 FSU -0.5 DCs -1.0 19 50 19 -55 55 19 -60 60 19 -65 65 19 -70 70 19 -75 75 19 -80 80 19 -85 85 19 -90 90 19 -95 95 20 -00 00 20 -05 05 20 -10 10 20 -15 15 20 -20 20 20 -25 25 20 -30 30 20 -35 35 20 -40 40 20 -45 45 -5 0 percentage per year Japan Source: UN, World Population Prospects: The 2004 Revision (Medium Variant) Figure 2: Elderly Dependency Ratio 1950-2050 (ratio of adults 65+ to adults 15-65) 0.8 0.7 USA 0.6 Japan Europe 0.5 0.4 Asia Latin America 0.3 India China 0.2 FSU DCs 0.1 Source: UN, World Population Prospects: The 2004 Revision (Medium Variant) 2050 2045 2040 2035 2030 2025 2020 2015 2010 2005 2000 1995 1990 1985 1980 1975 1970 1965 1960 1955 0.0 1950 ratio ROECD Figure 3: Child Dependency Ratio 1950-2050 (ratio of children 0-14 to adults 15-65) 1.0 0.9 0.8 0.7 Japan 0.6 Europe ROECD 0.5 Asia 0.4 Latin America India 0.3 China FSU 0.2 DCs 0.1 Source: UN, World Population Prospects: The 2004 Revision (Medium Variant) 2050 2045 2040 2035 2030 2025 2020 2015 2010 2005 2000 1995 1990 1985 1980 1975 1970 1965 1960 1955 0.0 1950 ratio USA Main Macroeconomic Impacts • Aggregate saving, consumption, wealth – Composition of consumption bundles • Investment rates • aggregate • across sectors • Labor markets • Government budgets • => General equilibrium impacts on trade and financial flows and asset prices including real exchange rates 6 Macroeconomic Impacts • What happens to the current account on any country depends on the impact on savings relative to investment – A rise in savings relative to investment will tend to improve the current account – A fall in savings larger than a fall in investment will tend to worsen the current account 7 Alternative Approaches • Cross sectional/time series econometric estimation of aggregate saving and investment and growth equations or current accounts • Higgins (1998), Masson et al (1998), Helliwell (2004), IMF (2004) • Tend to find negative impact of dependency rates on investment, savings and the current account 8 Alternative Approaches • Vector Autoregression models with demographic and economic variables (Kim and Lee (2005) • Strong negative impact of dependency rates on saving • Strong negative impact of dependency rates on current account 9 Alternative Approaches • Calibrated OLG models of single economies and multiple economies – Brooks (2005), Ingenue (2004) • Calibrated CGE models of global economy – Tyers (2005) using GTAP 10 Alternative Approaches • Calibrated/estimated DIGE/DSGE models Bryant/Faraque/Laxton McKibbin/Nguyen/Callen/Battini 11 Theoretical Approach • Follows Yaari/Blanchard/Weil models as extended by Faruqee, Laxton, Bryant, McKibbin and others • Demographics from the “bottom up” – Approximate an OLG model using a probability of death and exogenous profiles of birth and death rates to generate cohort adjustment over time – The demographic change is taken as exogenous and cohort aggregation effects are calculated outside the core model 12 Minimum Requirements • Adults are distinguished from children so we can capture the importance of changes in the youth dependency ratio • Country specific models for the major countries/regions so we can capture the asymmetries 13 Children • • • • Are born to adults and stay children for 16 years Do not supply labour Do not hold financial wealth Receive transfers from adults (which grow at the rate of economy wide productivity growth) which they consume • Have a different birth rate (defined as the number of children as a percent of the adult population) than the adult maturity rate (defined as the number of new adults as a percent of the adult population) • Have a different mortality rate than adults 14 Adults/workers • Emerge at age 17 from the pool of children • The adult maturity rate is the rate of emergence of adults as a percent of the total adult population • Are born with the productivity of the cohort alive in time t and then acquire productivity based on the estimate age earnings profiles over time. • Die at a constant rate over time (major shortcoming but needed for aggregation). 15 Introduce empirical age earnings profiles • Labor income – rises with age and experience – reaches a peak in late middle age – then declines gradually for the rest of life • The shape of the age-earnings profile for individuals in the economy is assumed to be the same for all individuals and unchanged through time. 16 Introduce empirical age earnings profiles • But the demographic composition of the population can change over time. • Because aggregate labor income is obtained by aggregating over individuals that differ in age and experience, moreover, the bottom-up aggregation over individuals permits the demographic changes to influence both the aggregate level and the age distribution of labor income. 18 Introduce empirical age earnings profiles • The hump-shaped profile of earnings by age influences both the supply side and the demand side of the model economy's behavior. • Hence through these life-cycle effects, changes in demographics significantly influence macroeconomic outcomes. 19 Supply side effects • On the supply side, the earnings profile is an indicator of the changes in a cohort's relative productivity and its supply of labor over its lifetime. • The marginal product of capital will change and investment will respond 20 Demand Side • On the demand side, the anticipated path of labor income determines the saving plans of consumers over their lifetimes. • Changes in investment will change the demand the goods. 21 MSG-Cubed Model: Countries • • • • • • • • • • Japan USA Western Europe Rest of OECD Eastern Europe and the Former Soviet Union China India Other Asia Latin America Other Developing Countries 22 MSG-Cubed Model: Sectors • Energy • Non-Energy • Capital Producing sector 23 MSG-Cubed model • Estimated dynamic intertemporal model with Keynesian short-run rigidities – Adjustment costs in capital accumulation – Financial capital mobile given risk premia – Wages adjust slowly given labour market rigidities – Financial markets for equity, bonds, money – Mix of optimizing and rule of thumb decision rules 24 Question • We want to estimate the overall impacts of demographic change on the global economy from 2005 onwards 25 Approach • Develop a baseline projection of the global economy from 1985 to 2100 with a full demographic transition where countries are adjusting towards a common steady state with the same birth and death rates but from very different initial conditions 26 Calculating the Impact of Demographic Change • Solve the model again from 1985 to 2100 setting the birth rates of children at the steady state rates – The initial conditions in 1985 will already have the expectations of a demographic transition in the initial asset stocks. – Allow some time for the asset adjustment to occur – then examine the difference between the results with and without the demographic transition from 2005. 27 Figure 5: Removing the Demographics (A stylized Representation) 3.5 3 population growth 2.5 projection with demographic shock 2 1.5 1 0.5 0 1985 1994 2003 2012 2021 2030 2039 2048 2057 2066 2075 2084 -0.5 -1 Developing countries Industrial countries No Demographics Figure 6: Change in Child Birth Rate (relative to steady state) 6 DCs USA 4 Japan India Europe 3 ROECD Latin America Asia 2 Asia ROECD USA Latin America India 1 China FSU 0 DCs -1 Japan FSU Europe China -2 19 85 19 95 20 05 20 15 20 25 20 35 20 45 20 55 20 65 20 75 20 85 20 95 21 05 21 15 21 25 21 35 21 45 21 55 21 65 21 75 21 85 percentage deviation from steady state 5 Figure 7: Change in Adult Maturity Rate (relative to steady state) 3 DCs India USA 2 Japan Latin America Europe 2 Asia ROECD ROECD Asia 1 USA Latin America India 1 China FSU 0 DCs -1 Japan -1 FSU Europe China 19 85 19 95 20 05 20 15 20 25 20 35 20 45 20 55 20 65 20 75 20 85 20 95 21 05 21 15 21 25 21 35 21 45 21 55 21 65 21 75 21 85 percentage deviation from steady state 3 Figure 8: Contribution to GDP growth of Own versus Global Demographic Change US GDP Growth Japan GDP Grow th ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 0.5 0.8 % point change 0.6 0.4 0.2 0 -0.2 0 -0.5 -1 2045 2049 2045 2049 2037 2041 China GDP Growth 2033 2029 2025 2021 2017 global ow n Latin Am erica GDP Grow th ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 1.2 1 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) % point change 1.5 1 0.5 0 -0.5 global ow n global 2037 2033 2029 2025 2021 2017 2013 2005 -1 20 05 20 10 20 15 20 20 20 25 20 30 20 35 20 40 20 45 20 50 % point change 2013 ow n 2041 global 2009 20 05 20 10 20 15 20 20 20 25 20 30 20 35 20 40 20 45 20 50 2005 -1.5 2009 % point change 1 ow n Figure 10: Contribution to Total Savings of Own versus Global Demographic Change US Total Savings/ GDP Japan Total Savings/GDP ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 20 05 20 09 20 13 20 17 20 21 20 25 20 29 20 33 20 37 20 41 20 45 20 49 2049 ow n global China Total Savings/ GDP ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) global ow n global ow n 2049 2045 2041 2037 2033 2029 2025 -0.5 2017 0 2013 0.5 4 3.5 3 2.5 2 1.5 1 0.5 0 -0.5 2005 % point change 1 20 05 20 10 20 15 20 20 20 25 20 30 20 35 20 40 20 45 20 50 % point change 2 1.5 ow n Latin Am erica Total Savings/GDP ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 2021 2045 2041 2037 7 6 5 4 3 2 1 0 2009 global 2033 2029 2025 2021 2017 2013 2009 % point change 4 3 2 1 0 -1 -2 -3 -4 2005 % point change ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) Figure 11: Contribution to Private Investment of Own versus Global Demographic Change US Investment/ GDP Japan Investm ent/GDP ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 5 4 3 2 1 0 -1 -2 -3 % point change 4 3 2 1 0 -1 2041 2045 2049 2045 2049 2037 2033 2029 2025 2021 2017 2041 China Investment/ GDP ow n Latin Am erica Investm ent/GDP ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) ow n global 2037 2033 2029 20 05 20 10 20 15 20 20 20 25 20 30 20 35 20 40 20 45 20 50 -1 2025 -0.5 2021 0 2017 1 0.5 4 3.5 3 2.5 2 1.5 1 0.5 0 2013 % point change 1.5 2005 2 % point change 2013 global ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) global 2009 2005 2049 2045 2041 2037 ow n 2009 global 2033 2029 2025 2021 2017 2013 2009 -2 2005 % point change ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) ow n Figure 12: Contribution to Current Accounts of Own versus Global Demographic Change US Current Account/ GDP Japan Current Account/GDP ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 5 % point change 1 0.5 0 -0.5 3 2 1 global 20 05 20 09 20 13 20 17 20 21 20 25 20 29 20 33 20 37 20 41 20 45 20 49 0 20 05 20 10 20 15 20 20 20 25 20 30 20 35 20 40 20 45 20 50 -1 4 ow n global China Current Account/ GDP ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 % point change 1.5 1 0.5 0 -0.5 global ow n global ow n 2049 2045 2041 2037 2033 2029 2025 2021 2017 2013 2005 2049 2045 2041 2037 2033 2029 2025 2021 2017 2013 2009 -1 2005 % point change ow n Latin Am erica Current Account/GDP ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 2009 % point change 1.5 Figure 13 : Contribution to Long Term Real Interest Rates of Own versus Global Demographic Change US Real 10 Year Bond Rate Japan Real 10 Year Bond Rate ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 0.5 1 % point change 0.5 0 -0.5 -1 -1.5 0 -0.5 -1 -1.5 2049 2049 2041 2037 2033 2045 2 % point change 3 1 0.5 -2 2029 ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 1.5 -1 -1.5 ow n Latin Am erica Real 10 Year Bond Rate ( r e l a t i v e t o n o d e mo g r a p h i c t r a n s i t i o n ) 0 -0.5 2025 2021 2017 global China Real 10 Year Bond Rate 1 0 -1 -2 global ow n global ow n 2041 2037 2033 2029 2025 2021 2017 2009 2005 -3 20 05 20 10 20 15 20 20 20 25 20 30 20 35 20 40 20 45 20 50 % point change 2013 ow n 2045 global 2009 20 05 20 10 20 15 20 20 20 25 20 30 20 35 20 40 20 45 20 50 2005 -2 2013 % point change 1.5 Implications • Several adjustment mechanisms possible – Reallocate inputs within economies – Raise productivity growth to generate more resources to deal with macroeconomic adjustments • In an open economy – Allow labor to flow across borders from labour abundant into labour scarce countries – Allow goods which embody labour to flow from labour abundant countries into labour scarce countries – Allow capital to flow from labour scarce countries to labour abundant countries 36 Policy Implications to be explored Further • Open economies to international trade so that more labour can be imported into labour scarce countries embodied in goods • Deregulate protected sectors such as the service sector in economies such as Japan to raise productivity growth and free up scarce labour • Allowing greater capital mobility (and better allocation of capital) so that capital can flow to labour rather than labour flow to capital. 37 Policy Implications • Batini, Callen and McKibbin (2005) find that raising productivity growth and reducing the risk of investing in developing countries can swamp the macroeconomic impacts of demographic change 38 Conclusions • Demographic change projected over the next century has a significant impact on aggregate economic variables within countries as well as economic outcomes between countries • It is not sufficient to examine demographic change in a country without some allowance for what is happening in the world as a whole 39 Background Websites www.sensiblepolicy.com www.gcubed.com 40