Demographics and the Macroeconomic Environment

Actually, our tussle hasn’t only been with the research institutes, and the bank analysts, from time to time we have also engaged with some of the better known cases of mainstream journalism, as, for example in the case of The Economist, and in particular their Central and Eastern Europe correspondent. This exchange of views (which went up on the Economists own Certain Ideas of Europe blog in October 2007), is a good example of the range of issues involved (which go from Germany, to Japan, to India). And now for the second of our Bologna abstracts.

Demographics and the Macroeconomic Environment
A theoretical model to asses some macroeconomic implications of population ageing

Authors: Claus Vistesen and Edward Hugh

Despite the rather distinct and specific characteristics in the ageing process across the EU countries, population ageing is in fact a global phenomenon. The specificities of the European ageing process are a legacy of the fact that it was in Europe that the process known as the demographic transition was first initiated. Two important points need to be kept clearly in mind about the population ageing process in a macroeconomic context. Firstly the process of the demographic transition is an ongoing one, with no evident end point. As such the trajectory of the process is associated with a considerable degree of uncertainty, and this kind of uncertainty presents important problems from a forecasting point of view, problems which most conventional models find it hard to address. However, as will be argued in this paper, some of these problems may be reduced if we simply focus on the evolution of the process in the short and medium term, since, from a macroeconomic point of view, some important structural features of the population ageing process are already becoming evident.

In the second place, it is important to take clear note of the fact that the demographic transition itself – and hence population ageing – is far being a uniform and symmetric process. Thus, while it may well be possible to postulate a theoretical ‘end-state’ limit towards which all OECD countries may be progressing, the duration and transition dynamics of the process are far from clear, and the presence of important feedback loops and significant path dependence components only serve to complicate the problem even further for analysis given that important differences exist in the speed of transition, and the fact that the very presence of such differing velocities and current states produces a certain dynamic interaction between macroeconomic performance, migration flows, fertility levels and life expectancy patterns both within and between countries, an interaction which is hard to both grasp and model.

In its most general terms, the demographic transition process is already a familiar one, and as such relatively uncontroversial. It is also relatively well accepted that the whole transition process is associated with (and indeed could easily be defined by) a steadily rise in population median ages. What have been much less well-explored to date are the structural macroeconomic consequences of such changes in median ages, in particular given that the pace and pattern of the associated age structure changes differ widely across OECD countries. As will be argued in this paper, cross-border transmissions arising from differing national demographic evolutions significantly modify national macroeconomic growth rates and levels of social welfare (Bryant 2006) . In particular the asymmetric character of the demographic transition may be thought to already be having notable effects on exchange rates, domestic demand and saving-investment shares in GDP in the highest median age countries, as well as on current account balances and imbalances, and, hence, on global liquidity and net capital flows.

Clearly at any given time, there are a variety of processes at work in the global economy (geopolitical shocks, technological changes, sectoral shifts, institutional developments, etc) many of which are either totally unrelated to demographic trends, or at best only indirectly connected to such trends. Such processes and shocks have consequences for global macroeconomic interaction which may well be, and especially in the short term, much more powerful than the impact of the ongoing transition. Demographic processes are by their very nature slower-moving and cumulative, however over the medium and long term demographic forces can and do exert powerful effects, and it is to some of these that this paper will address itself.

At the individual country level when we talk of median ages, two countries immediately stand out – Germany and Japan – since they currently hold the somewhat dubious honor of being the oldest societies on earth in median age terms. Examining the recent economic performance of these two countries from a macroeconomic perspective, it is evident that some common structural features immediately stand out: weak domestic consumption; consequent strong dependence of export shares of GDP; relatively high savings rates; declining real trade-weighted exchange rates; demographically related labour market tightening which does not provoke domestic wage inflation. Starting from such common structural patterns this paper will develop a simple theoretical model which seeks to explain the consequences and effects of ageing on the macroeconomic environment via the impact on median age. The paper will draw on country-level evidence from Japan, Germany, and Italy. It will be argued that there are both sound theoretical reasons (Modgiliani’s life cycle saving and consumption model, as applied to populations) for anticipating, as well as clear empirical evidence to confirm, the idea that as population median age passes the 40 year mark an ongoing process of weakening in domestic consumption can be identified (as evidenced by the declining GDP consumption share as societies move forward) and, as a consequence, a growing dependence on exports becomes the key structural driver of economic growth. Having initially examined the Japanese, German, and Italian cases, the model will then be extended to take into account recent experience in Switzerland, as well as in Scandinavia (specifically the Swedish and Finnish cases).

In conclusion, two points seem to be important here. In the first place the implications of this growing export dependency of the most ‘elderly’ societies needs to be explored in a global context, and in particular in the context of the so-called ‘macroeconomic imbalances’. Clearly the demographic transition is far from its end point, and meanwhile the impact of the uneven pace of the transition continues to make its presence felt. Globally the net sum of trade deficits and surpluses needs to be zero, so logically some societies will need to sustain substantial current account deficits to compensate for the ongoing export dependency of some of the currently richest economies. Without attempting any generalised solution to this issue at the theoretical level, a brief examination of the problem and of the most probable short-term scenarios will be presented.

Secondly, whilst it is clear that in the medium term, societies with median ages over 40 will tend to have a growing savings (and hence declining consumption) GDP share, it is far from clear that this net increase in saving will continue indefinitely as median ages approach the 50 mark and beyond (it is not even clear at this point whether median ages will stabilise at this level or continue to rise). There are theoretical reasons for anticipating a growing tendency to dis-saving at some point (although this depends on the relative ‘thickness’ of succeeding cohorts and their respective income levels as the population pyramid evolves). The problem will be outlined theoretically, although no attempt will be made to evaluate the levels of probability associated with each of the scenarios presented, since, in the opinion of the authors, the complete absence of empirical data makes such an exercise impossible in practical terms (and rather dubious in theoretical ones) at this point.

Finally it should be underlined that the theoretical aim of this paper is to outline ongoing macroeconomic impacts of ageing, independently of institutional changes and without reference to cultural specificities. This approach is not taken as a result of the authors’ belief that institutions and culture have no bearing on the macroeconomic environment but rather because of the paper’s fundamental assumption that ageing has a marked effect on macroeconomic variables which goes beyond and transcends the evident differences which exist on the institutional, structural and cultural levels. The paper thus situates itself in the long established tradition of partial analytics and our main purpose is to isolate the effects of ageing as they occur ‘other things being equal’. It is our contention that having established a consensus on this level, a much more substantial platform would then exist upon which the various ‘path dependency’ issues which inevitably arise could be explored.

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