Demographic Dividends and National Transfer Accounts

1. Demographic Dividends and National Transfer Accounts Andrew Mason University of Hawaii at Manoa East-West Center Andrew Mason

2. The Issues • How will changes in age structure over the demographic transition affect the macro economy? • How are macroeconomic outcomes influenced by • the economic lifecycle • the economic support system • What policies should be pursued? Andrew Mason

3. Results • Changes in population age structure have important implications for economic performance. • Population aging may lead to substantial increases in income and wealth. • Avoiding excessive reliance on public and familial transfer programs is critical. • Large regional shifts in the size of Asia-Pacific economies seems highly likely. Andrew Mason

4. Outline • The Consumption Identity • The Support Ratio • The first demographic dividend – the benefit of a population concentrated at the working ages • The second demographic dividend – the benefit of a population concentrated at old ages • Concluding remarks Andrew Mason

5. I. The Consumption Identity Output per effective producer Consumption per effective consumer Support ratio: effective producers per effective consumer Consumption as a fraction of labor income Andrew Mason

6. In Growth Terms Andrew Mason

7. II. The Support Ratio Andrew Mason

8. Japan’s Economic Lifecycle, 1999 Labor Income Consumption Andrew Mason

9. Transforming people into consumers Population of Japan, 2000 Effective Consumers in Japan, 2000 Adjust to reflect needs Children consume less than adults Andrew Mason

10. Transforming people into producers Population of Japan, 2000 Effective producers in Japan, 2000 Adjust to reflect productivity Andrew Mason

11. Japan’s Age Structure Transition1950-2050 Andrew Mason

12. Effective number of consumers and producers by age Effective Producers Effective Consumers Large non-producing child population 1950 Andrew Mason

13. Effective number of consumers and producers by age Effective Producers Effective Consumers 1955 Andrew Mason

14. Effective number of consumers and producers by age Effective Producers Effective Consumers 1965 Andrew Mason

15. Effective number of consumers and producers by age Effective Producers Effective Consumers 1975 Andrew Mason

16. Effective number of consumers and producers by age Effective Producers Effective Consumers 1985 Andrew Mason

17. Effective number of consumers and producers by age Effective Producers Effective Consumers 1995 Andrew Mason

18. Effective number of consumers and producers by age Effective Producers Effective Consumers Large producing population 2005 Andrew Mason

19. Effective number of consumers and producers by age Effective Producers Effective Consumers 2010 Andrew Mason

20. Effective number of consumers and producers by age Effective Producers Effective Consumers 2020 Andrew Mason

21. Effective number of consumers and producers by age Effective Producers Effective Consumers 2030 Andrew Mason

22. Effective number of consumers and producers by age Effective Producers Effective Consumers 2040 Andrew Mason

23. Effective number of consumers and producers by age Effective Producers Effective Consumers Large non-producing old population 2050 Andrew Mason

24. Summarizing the Balance Between Producers and Consumers The support ratio measures the number of producers per consumer. Andrew Mason

25. Total number of producers and consumers and support ratio by year, 1950-2050 Andrew Mason

26. II. The First Demographic Dividend Andrew Mason

27. The First Dividend Labor productivity may increase due to techno progress and capital deepening, but is independent of L/N An increase in the support ratio (L/N) leads to an equal percentage rise in C/N c(t) is held constant (as in Solow model) Andrew Mason

28. Total number of producers and consumers and support ratio by year, 1950-2050 +28% Andrew Mason

29. Japan’s First Dividend Labor Income (t) Consumption 2005 1950 C/N rises by 28% relative to labor income Andrew Mason

30. Total number of producers and consumers and support ratio by year, 1950-2050 -25% Andrew Mason

31. The End of Japan’s Dividend Labor Income (t) Consumption 2005 1950 2050 C/N ends up 3% lower than in 1950 relative to Yl/L Andrew Mason

32. The First Dividend Andrew Mason

33. Andrew Mason

34. The End of the First DividendJapan, US, India, China China Japan India US Andrew Mason

35. Net Effect of the Support Ratio, 1950 - 2050 Andrew Mason

36. First Dividend Summary • Demographic transition leads to favorable change in age structure (increase in support ratio). • If the saving rate is held constant, consumption increases relative to labor income by the same percentage as the support ratio – the First Dividend. • The First Dividend is transitory. Andrew Mason

37. III. The Second Demographic Dividend Andrew Mason

38. The Second Dividend • First dividend creates a “window of opportunity”. • Rise in support ratio makes it possible to increase per capita consumption and the saving rate at the same time. • Population aging leads to an increase in the demand for wealth to meet pension needs. • If workers save more (increase asset-based reallocations), higher consumption is possible even after the first dividend period has come to an end. Andrew Mason

39. The Second Dividend: Closed Economy Increase in labor productivity in the future c(t) declines in the current period Increase in domestic capital Andrew Mason

40. The Second Dividend: Open Economy Increase in c(t) in future periods c(t) declines in the current period Increase in foreign assets Andrew Mason

41. Critical Issue: How will population aging influence c(t) and assets? • Population aging will lead to an increase in the old-age lifecycle deficit. • Reallocations from the working ages to old ages must increase. • Either transfers from workers to the elderly must increase; asset-based reallocations must increase; or both. • To the extent that asset-based reallocations increase (higher saving), the Second Dividend is realized. Andrew Mason

42. Model of Consumption/Saving • Cross-sectional profile of labor income is fixed • No changes in labor force participation • Age profile of productivity is fixed • Cross-sectional profile of consumption is fixed • Generational differences in consumption reflect unchanging altruism • Different from the lifecycle hypothesis Andrew Mason

43. Lifecycle wealth (W) W = PV[C]-PV[Yl] • PV[C] is the present value of current and future consumption for those who are currently adults. • PV[Yl] is the present value of current and future labor income for those who are currently adults. Andrew Mason

44. Two Components of W W = Tk + Wp • Child transfer wealth (Tk) • The present value of future transfers to children • Tk is a liability and negative • Pension wealth (Wp) • The present value of consumption in excess of labor income (the old age lifecycle deficit) in future periods Andrew Mason

45. Components of Pension Wealth • Transfer wealth • Assets (A(t)) • Key assumption: assets is a constant fraction of pension wealth. Andrew Mason

46. Financing Old-age Consumption Taiwan, Korea, US US relies more on saving option Japan relies more on public transfers Taiwan and Korea rely on a combination of public and private transfers Source: Mason et al. 2006 Andrew Mason

47. Will aging lead to greater wealth? • Fewer children leads to less spending on children. • Older adults are wealthier than young adults. • Increase in life expectancy leads to longer retirement and greater demand for wealth. • Increased reliance on transfer option undermines these effects. Andrew Mason

48. Simulations I • Detailed methodology described in Mason et al. 2006. • Current consumption and production profiles persist into the future. Japanese profiles used except for US. • Asset-based reallocations provide 65% of old-age support; transfers provide 35% of old-age support. Andrew Mason

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50. Total Pension Wealth, National Shares, Simulated Values Andrew Mason