Demographic Change, Relative Factor Prices, International Capital Flows and Welfare. Alexander Ludwig. Axel Börsch-Supan.

Transcription

1 Demographic Change, Relative Factor Prices, International Capital Flows and Welfare Alexander Ludwig MEA, Universität Mannheim Axel Börsch-Supan MEA, Universität Mannheim and NBER Dirk Krueger Goethe Universität Frankfurt and NBER NBER Conference on Social Security Research Woodstock, U.S., October 19-22, 2006

2 Introduction We are living longer. We are having less babies. Consequently populations in all industrialized countries are aging. Retirement of baby boomers: Acceleration

3 wapr working age population ratio 0.85 US European Union Rest OECD Rest World Year

4 Research Projects Axel Börsch-Supan, Alexander Ludwig and Joachim Winter: Aging, Pension Reform and Capital Flows: A Multi-Country Simulation Model (BSLW) Dirk Krüger and Alexander Ludwig: On the Consequences of Demographic Change for Rates of Returns to Capital, and the Distribution of Wealth and Welfare (KL)

5 The Questions of BSLW What are the effects of population aging on rates of return and wages? What are the additional effect on rates of return if (European) countries reform their PAYG systems? What are the welfare effects of social security reform (winners and losers)? How is the size of these effects impacted by openness / international capital flows?

6 The Questions of KL What are the distributional consequences from changing factor prices induced by demographic transition and what are the welfare consequences (of demographic change itself)? Changes in relative prices and sensitivity to the degree of openness are subsidiary questions. Here: Most of my focus will be on KL

7 The Approach Compute transition path induced by demographic change of a largescale OLG model (Auerbach and Kotlikoff, 87)......where capital flows between regions with different demographics (Börsch-Supan, Ludwig and Winter 06, and others)...with idiosyncratic, uninsurable mortality and labor income risk (Bewley, 86, Imrohoroglu, 89, Huggett, 93, Aiyagari, 94)...in order to quantify welfare consequences from changing factor prices, holding survival probabilities fixed (as in Attanasio et al., 06b)

8 Contribution to the Literature Simple model to derive qualitative results which are at times clear cut, at times ambiguous, at times misleading. Quantitative questions. Key contributions: (i) multi-country model, (ii) welfare analysis, (iii) idiosyncratic risk.

9 Some Answers (Sizeable) Decline in rates of return to capital. Why? Aging of population makes labor scarce relative to capital. Substantial declines in per capita output. Why? Decreasing workforce and decreasing capital accumulation dominates effect from decreasing population. Welfare gains from demographic transition for newborns. Why? Positive effect of higher net wages dominates negative effects of lower returns to savings. This is true only if contribution rates to PAYG system are held constant.

10 Some Answers (cont d) Asset rich households already alive in 2005 loose in terms of welfare. Why? Negative effect of decreasing interest rates leads to lower oldage income. Welfare gains are higher if the retirement age is increased by 5 years. Why? Increasing the retirement age means exploiting higher wages for a longer period and replacement rates decrease by less. These additional gains especially accrue to low productivity households.

11 The Model: Demographics Households start their economic life at age 20 (j =0)retireatage65 (jr = 45) and live at most until age 95 (J =95). Idiosyncratic, time- and country-dependent (conditional) probability to survive from age j to age j + 1, denoted by s t,j,i. No annuity markets. Assume: all migration done before age 20.

12 The Model: Technology, Preferences and Endowments Neoclassical production technology with labor-augmenting technical progress, constant depreciation rate. Households have preferences over consumption and leisure over the life cycle. Labor income is θ k ε j ηl j w where θ k ε j η is labor productivity. The shock η follows a Markov chain and is uninsurable.

13 The Model: Government Policies Government redistributes accidental bequests in lump-sum fashion. Redistributive PAYGO social security systems with budget balance. Replacement levels differ across regions. Three reform scenarios: (i) contribution rates fixed over time, (ii) replacement rates (relative benefit levels) fixed over time, (iii) increasing the retirement age.

14 The Model: Market Structure National markets for labor (we assume migration takes place before labor market entry). Free international goods and capital markets. As sensitivity analysis: U.S., EU and ROECD as a closed economy vs. free international capital flows in entire world.

15 Thought Experiment Exogenous demographic transition from an initial population distribution (in 1950) towards a new steady state population distribution (reached in 2200). Based on United Nations world population projections. Economic transition path from initial steady state, both in terms of aggregate variables as well as cross-sectional distributions of wealth and welfare. Final steady state reached before Benchmark is 3 region world (OECD).

16 Calibration: Technology Depreciation δ, technical progress A t =(1+g) t andproductionfunction Y t,i = Z i K α t,i ³ At L t,i 1 α Parameters {α,g,δ,z 1,Z 2,Z 3 } Choose α,g,δ to match US capital share, investment and labor productivity growth data for Normalize Z 1 =1andchooseZ 2,Z 3 to match relative labor productivity across regions for

17 Calibration: Household Labor Productivity Labor productivity θ k ε j η Average wages ε j over the life cycle are hump-shaped (Hansen 1993) Set K =2and{θ 1, θ 2 } such that average-group productivity is 1, variance of labor incomes of newborns coincides with that reported by Storesletten et al. (2004). Requires θ 1 =0.57 and θ 2 =1.43. η follows a 2 state Markov chain with annual persistence ρ =0.98 and conditional variance of 8%. Motivated by Storesletten et al. (2004).

18 Calibration: Household Preferences Discount factor β andwithinperiodutilityfunction u(c, l) = 1 ³ c ω i (1 l) 1 ω i 1 σ 1 σ Parameters {β, σ, ω 1, ω 2, ω 3 } Set σ =1andchooseβ such that model matches average capitaloutput ratio for US between 1950 and Choose ω i such that model matches average hours worked in the three regions between 1950 and 2004.

19 Results Benchmark model (3 regions w/o social security): i) rates of returns, ii) per capita output, iii) net foreign asset positions, iv) welfare consequences. The role of social security (reform). Open (OECD) vs. closed economies.

20 Rate of Return: Intuition Labor will be scarce, relative to capital. Decreasing working-age population ratios reduce labor supply. Savings (and thus the future capital stock) go down. Partly because dis-saving of baby boomers when they retire. Net effect: Decreasing rates of return

21 Interest Rate in % Old-Age to Population Ratio 8.5 Evolution of Interest Rate over Time Interest rate (left scale) Fraction of Elderly (right scale) Year

22 Per Capita Output: Intuition Population size goes down (positive effect). Scarcity of labor and decreasing rate of capital accumulation (negative effect). Net effect: Decreasing per capita output (output per population in the working age)

23 Y/N Output per capita US European Union Rest OECD Year

24 Net Foreign Asset Positions: Intuition Countries with high working age to population ratios should have negative net foreign asset positions (level effect) Countries with relatively increasing working age to population ratios should have declining net foreign asset positions (trend effect).

25 F/Y Ratio of Net Foreign Assets to GDP US European Union Rest OECD Year

26 wapr working age population ratio 0.85 US European Union Rest OECD Rest World Year

27 CA/Y current account / output ratio US European Union Rest OECD Year

28 Welfare Consequences of the Demographic Transition Want to isolate the effect of changing factor prices (and social security taxes/benefits) induced by population aging. Thought experiment: a) fix a household s survival probabilities at their 2005 (age-dependent) values and b) compare welfare under constant 2005 prices, taxes and transfers to welfare under equilibrium paths. Welfare measure: consumption equivalent variation.

29 Welfare Consequences Reduction in rates of return make it harder to save (for retirement). Because of borrowing constraint this effect is unambiguously negative. Modest increase in net wages (in the absence of social security or with constant contribution rates) Net effect: small welfare gains for newborns. TableIV:WelfareCons.,US Productivity η 1 Productivity η 2 0.9% 0.6%

30 Welfare Consequences (cont d) Households already alive in 2005 who already have accumulated substantial assets loose from changing factor prices (the negative interest rate effect dominates). Asset rich households experience higher welfare losses. Overall, a fraction of 62 percent of agents economically alive in 2005 loose from the changing factor prices.

31 The Role of Social Security: Intuition Contribution rate τ fixed: benefits are reduced. Replacement rate ρ fixed: contribution rates τ increase: Reduction in private savings Lower decrease of rate of return. Net wages decrease substantially welfare losses. Increasing the retirement age: higher welfare gains for newborns, less losses for households already alive

32 The Role of Social Security: Results Table V. Evolution of Aggregates in US, Var. No Soc.Sec. τ fixed ρ fixed Adj of jr r 0.89% 0.86% 0.18% 0.87% w 4.2% 4.1% 0.8% 4.0% τ 0% 0% 7.3% 0% ρ 0% 7.9% 0% 5.0% Y/N 7.6% 7.2% 12.6% 5.7% Table VI: Welfare Consequences, Newborns in U.S. No Soc.Sec. τ Fixed ρ Fixed Change in jr Type η 1 η 2 η 1 η 2 η 1 η 2 η 1 η 2 k 1 0.9% 0.6% 0.8% 0.2% 1.6% 1.8% 1.4% 0.6%

33 Open vs. Closed Economy: Intuition Aging processes are more pronounced in rest of the world relative to the U.S. Therefore: stronger decrease of rate of return in the open economy However: Welfare differences between closed and open economy scenarios are small.

34 Additional Results Thought experiment in BSWL: Social security reform with zero probability in one region only. Increasing savings and increasing labor supply. Strong capital outflows in open economy from reform region to rest of the world. Neteffect on rate of return: small. Slightly stronger decreases of rate of return than in KL.

35 Conclusions Population aging has substantial effects on rates of return. They decrease by roughly percentage points until Welfare gains for newborns living through demographic transition in the order of % of life-time consumption. Welfare losses for asset rich households. Overall approximately 60% of those alive in 2005 experience welfare losses.

36 Conclusions (cont d) Welfare gains increase from 0.9% to 1.4% for low type, low productivity agents when the retirement age is increased by 5 years (which is a bit more than half of the projected increase in life expectancy). Numerous open issues which are left for future research. Is living longer a good or a bad thing?