Macroeconomic and distributional effects of demographic change in an open economy - The case of Belgium -

In the absence of behavioural adjustments, demographic change may cut off about 0.4 to 0.5%-points on average from the annual per capita growth rate in EU countries in the next 25 years. The behavioural responses of households and firms to reduced fertility and rising life expectancy may significantly change this outcome, but the sign and the size of this change are unclear. We construct and parameterize a large-scale overlapping generations model for an open economy to quantify (the net effect of) these behavioural adjustments. Individuals in the model differ not only by age, but also by innate ability. Key endogenous variables are hours worked, investment in human and physical capital and per capita growth. Applying the model to the case of Belgium, we find that it replicates key data since about 1960 remarkably well. Simulating the model, we observe that behavioural adjustments by households and firms contribute to reverse the negative arithmetical effect of projected future demographic change on per capita growth. However, under the current policies and the current pension system, these are not strong enough. In Belgium, a net negative effect on annual per capita growth remains of almost 0.3%-points on average, mainly because of reduced fertility and a declining population at working age. Our model also allows to study the income distributional effects of demographic change. Our projections point to rising inequality.