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Will China Eat Our Lunch or Take us to Dinner? - Simulating the Transition Paths of the U.S., Eu, Japan and China

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Author Info

  • Hans Fehr

    (University of Wuerzburg)

  • Sabine Jokisch

    (Univeristy of Wuerzburg)

  • Laurence J. Kotlikoff

    ()
    (Institute for Economic Development, Boston University)

Abstract

This paper develops a dynamic, life-cycle, general equilibrium model to study the interdependent demographic, fiscal, and economic transition paths of China, Japan, the U.S.,and the EU. Each of these countries/regions is entering a period of rapid and significant aging that will require major fiscal adjustments. But the aging of these societies may be a cloud with a silver lining coming, in this case, in the form of capital deepening that will raise real wages. In a previous model that excluded China we predicted that tax hikes needed to pay benefits along the developed world’s demographic transition would lead to a major capital shortage, reducing real wages per unit of human capital over time by one fifth. A recalibration of our original model that treats government purchases of capital goods as investment rather than current consumption suggests this concern was overstated. With government investment included, we find much less crowding out over the course of the century and only a 4 percent long-run decline in real wages. Adding China to the model further alters, indeed, dramatically alters, the model’s predictions. Even though China is aging rapidly, its saving behavior, growth rate, and fiscal policies are currently very different from those of developed countries. If successive cohorts of Chinese continue to save like current cohorts, if the Chinese government can restrain growth in expenditures, and if Chinese technology and education levels ultimately catch up with those of the West and Japan, the model’s long run looks much brighter. China eventually becomes the world’s saver and, thereby, the developed world’s savoir with respect to its long-run supply of capital and long-run general equilibrium prospects. And, rather than seeing the real wage per unit of human capital fall, the West and Japan see it rise by one fifth percent by 2030 and by three fifths by 2100. These wage increases are over and above those associated with technical progress, which we model as increasing the human capital endowments of successive cohorts. Even if the Chinese saving behavior (captured by its time preference rate) gradually approaches that of Americans, developed world real wages per unit of human capital are roughly 17 percent higher in 2030 and 4 percent higher at the end of the century. Without China they’d be only 2 percent higher in 2030 and, as mentioned, 4 percent lower at Century’s end. What’s more, the major short-run outflow of the developed world’s capital to China predicted by our model does not come at the cost of lower wages in the developed world. The reason is that the knowledge that their future wages will be higher (thanks to China’s future capital accumulation) leads our model’s workers to cut back on their current labor supply. So the shortrun outflow of capital to China is met with a commensurate short-run reduction in developed world labor supply, leaving the short-run ratio of physical capital to human capital, on which wages positively depend, actually somewhat higher than would otherwise be the case. Our model does not capture the endogenous determination of skill premiums studied by Heckman and Taber (1996). Doing so could well show that trade with China, at least in the short run, explains much of the relative decline in the wages of low-skilled workers in the developed world. Hence, we don’t mean to suggest here that all US, EU, and Japanese workers are being helped by trade with China, but rather that trade with China is, on average, raising the wages of developed world workers and will continue to do so. The notion that China, India, and other developing countries will alleviate the developed world’s demographic problems has been stressed by Siegel (2005). Our paper, although it includes only one developing country – China – supports Siegel’s optimistic long-term macroeconomic view. On the other hand, our findings about the developed world’s fiscal condition are quite troubling. Even under the most favorable macroeconomic scenario, tax rates will rise dramatically over time in the developed world to pay baby boomers their government-promised pension and health benefits. As Argentina has so recently shown, countries can grow quite well for years even with unsustainable fiscal policies. But if they wait too long to address those policies, the financial markets will do it for them, with often quite ruinous consequences.

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Bibliographic Info

Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - The Institute for Economic Development Working Papers Series with number dp-151.

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Length: 70
Date of creation: Sep 2005
Date of revision:
Handle: RePEc:bos:iedwpr:dp-151

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  1. Laurence J. Kotlikoff & Kent Smetters & Jan Walliser, 1999. "Privatizing Social Security in the U.S. -- Comparing the Options," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(3), pages 532-574, July.
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  7. Whitehouse, Edward, 2001. "Pension systems in 15 countries compared: the value of entitlements," MPRA Paper 14751, University Library of Munich, Germany.
  8. Hans Fehr & Sabine Jokisch & Larry Kotlikoff, 2003. "The Developed World's Demographic Transition - the Roles of Capital Flows, Immigration, and Policy," Boston University - Department of Economics - The Institute for Economic Development Working Papers Series, Boston University - Department of Economics dp-133, Boston University - Department of Economics.
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Citations

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Cited by:
  1. Luca MARCHIORI & Olivier PIERRARD & Henri R. SNEESSENS, 2011. "Demography, capital flows and unemployment," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales), Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) 2011040, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  2. Loretti I. Dobrescu & Laurence J. Kotlikoff & Alberto F. Motta, 2008. "Why Aren't Developed Countries Saving?," NBER Working Papers 14580, National Bureau of Economic Research, Inc.
  3. Jianjun Miao, 2004. "Risk, uncertainty and option exercise," Finance, EconWPA 0410013, EconWPA.
  4. Kuijs, Louis, 2006. "How will China's saving-investment balance evolve ?," Policy Research Working Paper Series 3958, The World Bank.
  5. Sabine Jokisch & Laurence J. Kotlikoff, 2005. "Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax," NBER Working Papers 11858, National Bureau of Economic Research, Inc.
  6. Laurence J. Kotlikoff, 2007. "Is the U.S. Bankrupt?," Boston University - Department of Economics - Working Papers Series, Boston University - Department of Economics WP2007-015, Boston University - Department of Economics.
  7. Laurence J. Kotlikoff, 2006. "Is the United States bankrupt?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 235-250.
  8. Georges, Patrick & Lisenkova, Katerina & Mérette, Marcel, 2013. "Can the ageing North benefit from expanding trade with the South?," Economic Modelling, Elsevier, Elsevier, vol. 35(C), pages 990-998.
  9. Marcel Mérette & Patrick Georges & Katerina Lisenkova, 2013. "Can Ageing North Benefit from Expanding Trade with South?," EcoMod2013 6162, EcoMod.

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