some macroeconomic consequences of the demographic transition

Some Macroeconomic Consequences of the

Demographic Transition

Ronald LeeUC Berkeley

October 27 and 28, 2008Research supported by NIA R37 AG025247

Thanks to Andy Mason and NTA country teams

Ronald Lee Oct 2008; based on NTA for each country

Main points, using National Transfer Accounts data

1. Demographic transition first raises support ratio, then with population aging reduces it.

2. Per capita consumption is proportionate to Support ratios, other things equal. “First dividend”, pop aging.

3. Longer life, lower fertility, slower pop growth and older population all raise capital/labor ratio, raising labor productivity. “Second dividend”.

4. This depends on importance of assets vs transfers. 5. Lower fertility goes with greater investment in human

capital per child, raising labor productivity.6. Effects on physical and human capital accumulation

are more important than on dependency.


I. Demographic Transition


Pre fertility decline; child dependency ratio rises During fertility decline, child

dependency ratio declines

Population aging: old age dep ratio rises


The total dep ratio rises, falls, then rises again, ending up where it started.The changes in the total dependency ratio are transitory.


But there is a big permanentchange: At start, many children and few elderly.At end, few children and Many elderly.


Support ratio

• Effective workers per effective consumers

• Like inverse of dependency ratio

• But based on age profiles of labor income and consumption (more on this later)


Support Ratio for China, 1950-2100, Based on UN population projections and average LDC age profiles from NTA

0.5

0.6

0.7

0.8

0.9

1

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ecti

ve

Pro

du

cers

Per

Co

nsu

mer

2007

Population aging

First Dividend


II. The economic life cycle:

• Concern about pop aging is mostly about old age dependency.

• Sharpest concerns for age-sensitive public sector programs– pensions– health care– Long term care

• But should place these in broader context– Full range of public programs– Private consumption– Labor across the life cycle

Ronald Lee Oct 2008; based An-Chi Tung, Taiwan NTA

A Typical Asian Economic Lifecycle: National Transfer Accounts estimates for Taiwan, 1998

0

100

200

300

400

500

600

0 20 40 60 80

Age

Per

Cap

ita

Co

nsu

mp

tio

n a

nd

L

abo

r In

com

e

Consumption

Labor Income

Includes both private expends and in-kind public transfers (health, education, long term care)

Includes self employment, wages,unpaid family labor, & fringe benefits.

Averages 0’s and both male and female.



0

100

200

300

400

500

600

0 20 40 60 80

Age

Per

Cap

ita

Co

nsu

mp

tio

n a

nd

L

abo

r In

com

e

Consumption

Labor Income

Flat cons age profile in adult years reflects extended family sharing.

Quite different than most industrial nations.



0

100

200

300

400

500

600

0 20 40 60 80

Age

Per

Cap

ita

Co

nsu

mp

tio

n a

nd

L

abo

r In

com

e

Consumption

Labor Income

Large deficits at young and old ages.



0

100

200

300

400

500

600

0 20 40 60 80

Age

Per

Cap

ita C

on

su

mp

tio

n a

nd

Lab

or

Inco

me Consumption

Labor Income

Reallocations from surplus to deficitages required.



0

100

200

300

400

500

600

0 20 40 60 80

Age

Per

Cap

ita C

on

su

mp

tio

n a

nd

Lab

or

Inco

me Consumption

Labor Income

Other income comes from assets, foreign loans, and remittances from abroad—it’s not all labor income.



0

100

200

300

400

500

600

0 20 40 60 80

Age

Per

Cap

ita

Co

nsu

mp

tio

n a

nd

L

abo

r In

com

e

Consumption

Labor Income

Asset income is particImpt for old age


Age Profiles of Labor Income and Consumption: averaged for Four Rich and Four Poor Countries (Relative to average labor income)

0

0.2

0.4

0.6

0.8

1

1.2

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91

Age

Rat

io t

o a

v y

l(3

0-49

)

Rich: US, Japan, Sweden, Finland

Poor: India, Indonesia, Philippines, Kenya


Age Profiles of Labor Income and Consumption: averaged for Four Rich and Four Poor Countries (Relative to average labor income)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91

Age

Rat

io t

o a

v y

l(3

0-49

)

Rich: US, Japan, Sweden, Finland

Poor: India, Indonesia, Philippines, Kenya


Components of US Consumption, 2003

Public Other

Private Other

Private DurablesPrivate Health

Private Edu

Public Edu

Public Health

0

20000

40000

0 10 20 30 40 50 60 70 80 90

Age

Do

llar

s (U

S,

2000

)

Later I will measure HK investmentAs sum of pub and priv spendingon hlth and educ as shown here.

Unlike Taiwan and other Third World, in US cons rises strongly with age. True in other industrial too.


• Levels of age profiles change fast with economic development.

• Shapes of age profiles change slowly,

• Are broadly similar across countries at very different levels of development.


Many policy possibilities to change the age profiles

• labor income– Later retirement (pension structure)– Earlier entry into labor force– Higher female labor force participation– Reform seniority system

• Change the age profile of consumption– In many industrial nations, the elderly consume much

more than younger adults.– Makes population aging more costly– Role of public transfer policy: pensions, health care,

long term care


III. Support Ratios

• Effective labor is weighted sum of pop using labor income age profile.

• Effective consumers is similar.• Ratio of effective labor to effective consumers is

the “Support Ratio” (with fixed age profiles).• Other things equal, consumption per effective

consumer is proportional to the support ratio.

0

0

Effective WorkersSupport Ratio

Effective ConsumerslPop x y x

Pop x c x

Ronald Lee Oct 2008; based on average NTA data

Support Ratios for Five Less Developed Countries, 1950-2100, Based on UN population projections and average LDC age profiles from NTA

India

Brazil Niger

ChinaS. Korea

0.5

0.6

0.7

0.8

0.9

1

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ecti

ve

Pro

du

cers

Per

Co

nsu

mer

20072008


Support Ratios for Five Less Developed Countries, 1950-2100, Based on UN population projections and average LDC age profiles from NTA

India

Brazil Niger

ChinaS. Korea

0.5

0.6

0.7

0.8

0.9

1

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ecti

ve

Pro

du

cers

Per

Co

nsu

mer

2007

Niger S. Korea China India Brazil2050/08 1.20 0.78 0.86 1.09 0.96

Rate %/yr 0.43 -0.59 -0.35 0.22 -0.09


Spain

Italy

US

Japan

Germany

Spain, Low Fert.

Italy, Low Fert.

0.5

0.6

0.7

0.8

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ecti

ve P

rod

uce

rs P

er C

on

sum

erSupport Ratios for Five More Developed Countries, 1950-2100, based on UN long term population projections and the NTA age profile for the US.


Spain

Italy

US

Japan

Germany

Spain, Low Fert.

Italy, Low Fert.

0.5

0.6

0.7

0.8

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ecti

ve P

rod

uce

rs P

er C

on

sum

erSupport Ratios for Five More Developed Countries, 1950-2100, based on UN long term population projections and the NTA age profile for the US.

US Spain Italy Japan Germany2050/08 0.91 0.72 0.75 0.75 0.81

Rate %/yr -0.2 -0.8 -0.7 -0.7 -0.5


IV. The Life Cycle Deficit

Indonesia NTA Maliki; Japan NTA Ogawa

Per capita consumption and labor income by age for Indonesia and Japan

-

200,000

400,000

600,000

800,000

1,000,000

0 20 40 60 80 100

Age

Per c

apita

co

nsum

ptio

n or

labo

r in

com

e

-

100,000

200,000

300,000

400,000

500,000

0 20 40 60 80 100

Age

Per

cap

ita

con

sum

pti

on

o

r la

bo

r in

com

e in

Yen

Indonesia, 2002

Japan, 2004


Here are the aggregate flows: population by age times per capita age profiles

Aggregate Life Cycle Deficit for Indonesia (2005) in Rupiah

(30,000)

(20,000)

(10,000)

-

10,000

20,000

30,000

40,000

0 20 40 60 80 100

Age

Ag

gre

gate

d C

on

su

mp

tio

n -

Lab

or

Inco

me

Aggregate Life Cycle Deficit for Japan (2004) in Yen

(5,000)

(4,000)

(3,000)

(2,000)

(1,000)

-

1,000

2,000

3,000

4,000

5,000

0 20 40 60 80 100

Age

Ag

gre

ga

ted

Co

ns

um

pti

on

- L

ab

or

Inc

om

e


Aggregate flows

Aggregate Life Cycle Deficit for Indonesia (2005) in Rupiah

(30,000)

(20,000)

(10,000)

-

10,000

20,000

30,000

40,000

0 20 40 60 80 100

Age

Ag

gre

gat

ed C

on

sum

pti

on

-

Lab

or

Inco

me

Aggregate Life Cycle Deficit for Japan (2004) in Yen

(5,000)

(4,000)

(3,000)

(2,000)

(1,000)

-

1,000

2,000

3,000

4,000

5,000

0 20 40 60 80 100

Age

Ag

gre

ga

ted

Co

ns

um

pti

on

- L

ab

or

Inc

om

e

• Green arrows show transfers from surplus of prime working years.

• Red arrows show asset income consumed by elderly out of earlier savings.


Life cycle deficit

• Consumption at age x not funded by labor income at that age

• c(x) – yl(x) is per capita LCD

• C(x) – Yl(x) is aggregate LCD

• Or for an age segment:

• C(65+) - Yl(65+), consumption by all those over 65 minus labor income for same.

• Now measure as ratio to total consumption


Life Cycle Deficit (LCD) by Population Share 65+

0

0.05

0.1

0.15

0.2

0.25

0 0.05 0.1 0.15 0.2 0.25

Proportion of population 65+

LC

D 6

5+

Kenya

Japan


Life Cycle Deficit (LCD) by Population Share 65+ Compared to Simulated with Actual Population but Age Profile Av of Four Poorest

0

0.05

0.1

0.15

0.2

0.25

0 0.05 0.1 0.15 0.2 0.25

Proportion of population 65+

LC

D 6

5+

Actual is 50% higher for oldest, Japan


The rising LCDs as the population ages translate into a rising demand

for wealth.

Individuals need some kind of claim on future resources to consume more than they expect in labor

income.

These claims are called “wealth”


Why does the demand for wealth rise over the demographic

transition?

• Pure demographic composition effect – Older people need more wealth and hold more weatlh– in old population, there are more of them.

• Also behavioral effects driven by demographic change:– Longer life means workers need to accumulate more

wealth for longer old age (or work longer).– Lower fertility means adults consume more and need

to save more to maintain in old age.


VI. The role of intergenerational transfers

• Wealth can be held in two forms: – Transfer wealth (expected future transfers

received minus expected future transfers made)

– Assets or Capital


NTA data gives shares of old age support from different sources

• Asset income (land, equities, interest, etc.)

• Family transfers (not including bequests at death)

• Public transfers (Pay As You Go pensions, health care, and long term care)

• Triangle graph shows shares, not levels, so must add to 100%.

• Bequests not included; just old age cons.

Ronald Lee 2008; from Andy Mason, NTA

Old-age Reallocation System, Selected Countries.

0

50

75

100

75

75

50

50

25

25

0

0

25

100

100

Asset-based (%)

Public transfers (%)

Family Transfers (%)

US

Thailand

Costa Rica

JapanTaiw an

Korea

Familial transfers equally important in Thailand, Korea, and Taiwan (36-

40%). Net familial

transfers near zero in US, CR, and J. Large

public transfers in CR and J

Net public transfers to elderly are zero in

Thailand; about 25% in Taiwan and Korea.



0

50

75

100

75

75

50

50

25

25

0

0

25

100

100

Asset-based (%)



US

Thailand

Costa Rica

JapanTaiw an

Korea

Public transfers: Thailand none,

Japan and Costa Rica around 70%

US, Korea, Taiwan, middling



0

50

75

100

75

75

50

50

25

25

0

0

25

100

100

Asset-based (%)



US

Thailand

Costa Rica

JapanTaiw an

Korea

Reliance on assets : Japan, Taiwan, C.R.

are low; Thailand high; US middling


VII. Demographic Transition and Capital Accumulation

• Changing dependency gets most attention for ec dev and pop aging.

• Changes in capital accumulation may be more important.


Simulating the demand for wealth and capital over the demographic transition

• There are different theoretical approaches. We have used several.– Social Planner maximizing discounted social

welfare function.– Individuals saving and consuming over their

life cycles to maximize their life time utility, given different transfer systems.

• Yield qualitatively similar result: capital intensity rises strongly over the demog transition.


Here take a different approach – no optimization--emphasizes institutional

setting• Assume

– share of old age consumption supported by asset income stays constant over time.

– altruistic sharing maintains the shape of the cross sectional consumption age profile.

– Demography is known in advance.

• Can solve recursively for unique growth path and asset holdings.


Two scenarios: high level of transfers to elderly (65%) or low level (35%) as

share of life cycle deficit.

• Other assumptions– Productivity growth raises income age profile by 2%

per year.– Open economy, so wages, interest rates are given.– rate of return on assets is 3%.

• Aggregate saving is calculated to maintain asset share of old age consumption support.

• Results will be shown relative to a 2% growth trajectory from prod gr.

Ronald Lee Oct 2008; from Mason, Lee and Lee, 2008

0

0.05

0.1

0.15

0.2

0.25

1940 1960 1980 2000 2020 2040 2060

Net

Savin

g R

ate

High IG Transfers

Low IG Transfers

Simulated Saving Rate, ASEAN (S.E. Asian countries), 1950-2050


Simulated Assets/Labor Income, ASEAN

0

2

4

6

8

1940 1960 1980 2000 2020 2040 2060

Ass

ets/

Labo

r In

com

e .

Low IG Transfers

High IG Transfers

Ratio of assets to labor income rises greatly in any case, but 3 or 4 times as much with low IG transfers.


Simulated Consumption, ASEAN

60

80

100

120

140

160

1940 1960 1980 2000 2020 2040 2060

Co

nsu

mp

tio

n In

dex

(19

50=

100)

.

Low IG Transfers

High IG Transfers

With low IG transfers, saving is higher from 1990 to 2020, reducing consumption.

Thereafter, consumption is higher.


These sorts of results are qualitatively like those from optimization approaches

• Timing of swings differs• Level of savings rates differs• Capital/labor income ratios differ

Big picture is the same:1. The demographic transition leads to a major increase

in capital per worker.2. The greater the role of transfers to the elderly, the

smaller is the increase in capital intensity.3. Eventually consumption rises with lower transfers, but

initially it is lower.4. Population aging leads to a decline in savings

rates but an increase in capital intensity.


VIII. Human capital and the demographic transition

• Measure public and private expenditures on health and education at each age.– Sum these for health ages 0-18– Sum for education ages 0-26– Gives synthetic cohort HK investment per

child

• Construct ratio of HK to average yl(x)= , ages 30-49.

• Plot log of HK/ against log of TFR.ˆly

Ronald Lee Oct 2008; from Lee and Mason, 2008, NTA

Figure 1. Per Child HK Spending (Public and Private) vs. Fertility

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40

ln(TFR)

ln(H

K p

er C

hild

/Av

Lab

Inc

30-

49)



AustBrz

Chl

CR

Fin

FrHng

India

Indonesia

Jpn

Mex

Phil

Slv

Kor

SwdTwn

Thai

Urg

US

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40

ln(TFR)

ln(H

K p

er C

hild

/Av

Lab

Inc

30-

49)



0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40

ln(TFR)

ln(H

K p

er C

hild

/Av

Lab

Inc

30-

49)

y = -1.05*x + 1.92R2 = 0.62


Now calculate total HK spending on all children

• Multiply TFR times HK per child, and plot its log against log(TFR).


Figure 5. Total Expenditures Per Woman for All Children's HK vs. Fertility

for 18 NTA countries (log scale)

0.00

0.50

1.00

1.50

2.00

2.50

0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40

ln(TFR)

ln(T

FR

X P

er C

hil

d H

K S

pen

din

g/

Av

Lab

In

c 3

0-49

)

6.8 years of labor income are invested in total HK on average.

1/12 of lifetime labor income for a couple.


The standard Quantity-Quality model

• Assume that the share of total labor income spent on HK is fixed, consistent with scatter plot.

• Draw budget constraints for differing levels of income.

• Quantity and quality interact multiplicatively in the budget constraint, both with positive income elasticities for constant price.


The Standard Model: Rising Income Leads to Choice of Lower Fertility and Higher HK Investment per Child

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8

Number of children

Hu

man

Cap

ital

In

vest

men

t p

er

chil

d

Yn=1

Yn=6

Yn=4

Nonlinear Quantity-Quality budget constraint.

Yn = lifetime income of a couple.

Lines show different combinations of number and HK that = Yn/12


The Standard Model: Rising Income Leads to Choice of Lower Fertility and Higher HK Investment per Child

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8

Number of children

Hu

man

Cap

ital

In

vest

men

t p

er

chil

d

Yn=1

Yn=6

Yn=4

B

A

C

With same data, plot ln(HK/w) instead of HK, against ln(TFR) instead of n.

The budget lines collapse onto a single straight line.


Ln(n)

Ln(pqq/w)

A

C

B

D

ln(d)

Figure: The transformed budget constraint showing different quantity-quality choices.

Ln(HK)/Yn

Ln(TFR)


Ln(n)

Ln(pqq/w)

A

C

B

D

ln(d)

Figure: The transformed budget constraint showing different quantity-quality choices.

Slope (elasticity) = -1

Similar to empirical cross-national scatter plot.


Association is non-causal

• We don’t know whether fertility decline causes rising HK investments per child.

• Desire to make bigger HK investments causes fertility decline.

• Some other factor like rising income causes both fertility and HK changes as in quantity-quality theory.


Production and Human capital

• Human capital (HK)– Portion of wage, W(t),

workers invest in their children is inversely related to their fertility, F(t)

– Human capital of workers one period later is

– HK(t+1) = h(F(t)) W(t)

• Wage (W)– Wage is increasing in

human capital– W(t) = g(HK(t))

112

W tHK t

F t

.33W t HK t

Baseline Specifications


Model—basic structure

• Take fertility variations as given, trace out consequences for HK, wage, consumption.

• 3 generations: children, workers, retirees; usual accounting identities.

• No saving or physical capital.

• HK drives wage growth; wage growth drives HK growth. (Lee and Mason 2008)


Figure 6. Macro Indicators: Baseline Results

60.0

70.0

80.0

90.0

100.0

110.0

120.0

130.0

0 1 2 3 4 5 6

Period

Va

lue

(p

erc

en

t o

f y

ea

r 0

)

Support ratio

C/ EA

Boom (demoraphic

dividend)

Fertility bust, but consumption remains high

Fertility recovers: modest effect on C/EA

Bottom line: Low fertility leads to higher consumption. Human capital investment has moderated

the impact of fertility swings on standards of living.


Figure 6. Macro Indicators: Baseline Results

60.0

70.0

80.0

90.0

100.0

110.0

120.0

130.0

0 1 2 3 4 5 6

Period

Va

lue

(p

erc

en

t o

f y

ea

r 0

)

Support ratio

C/ EA

During first dividend phase, consumption does not rise as much as support ratio.

The difference is invested in HK.

That is why ih later periods, consumption is proportionately higher than the support ratio.


IX. Conclusions for changes over the transition

• Support ratios change over demographic transition; ending where started, roughly. – Importance in long view may be exaggerated. – In shorter view, pop aging is a painful payback phase.

• Bigger effect is on capital intensity– Raises productivity per worker– Raises wealth and asset income

• However, increased demand for wealth can be met either by increased asset holdings or through increased transfer wealth.

• Major role for policy and institutions at every point; nothing inevitable.

• Increased human capital results from low fertility—so closely related to aging: same cause for both.– Raises productivity.


END

some macroeconomic consequences of the demographic transition

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