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Monday, September 19, 2005

Angus Deaton on Saving in Taiwan

Another interesting and relevant paper: Growth, demographic structure, and national saving in Taiwan by Angus Deaton and Christina Paxson (this paper goes back to 1968). As the authors say:

This paper is concerned with the effects that changes in demographic structure have had on Taiwan's national saving rate, and how coming changes in its age structure—notably population aging—will affect the future saving rate. We examine this topic within the framework of the life-cycle hypothesis (LCH).

In doing this they present a very important argument:

"A related implication of the LCH is that changes in the rate of growth of per capita income affect saving: higher rates of economic growth increase the life-time wealth of the young relative to the old, and the effects on saving of higher growth are much the same as the effects of increasing the numbers of young relative to the old."

This indicates a kind of positive-feedback, negative-feedback situation. Relatively younger societies (like the US now) have higher growth rates, that raises the expectation of continuing higher growth rates and raise the economic weight of the young vs the old (mainly via the credit/willingness to borrow channel).

"Asian Development Bank (1997), attribute about a third of East Asia’s recent growth performance to the increases in saving and in labor supply relative to population provided by the “demographic gift” of low fractions of children and the elderly associated with post-war baby booms and the rapid subsequent drops in fertility. Since the “gift” will have to be repaid as the baby-boomers age, once again there are concerns for the future, not only for saving rates, but also for growth."

If saving rates are negatively correlated with age - as in the simplest saving for retirement model - higher growth redistributes resources towards high savers, and will increase saving. In Paxson (1996) and Deaton and Paxson (1997, 1998), we find that age-saving profiles for Taiwan, Thailand, Indonesia, the United States, and Britain show little negative correlation with age, which implies little effect of growth on aggregate household saving. These results also have implications for the relationship between demographic structure and saving. Because our estimated age profiles of saving are uncorrelated with age, changes in the rate of population growth have little or no effect on aggregate saving, at least for comparisons between demographic equilibria. The absence of such equilibrium effects for Taiwan (and other countries) is documented in Deaton and Paxson (1997). However, the changes in demographic structure that take place during a demographic transition are quite distinct from differences in structure across demographic equilibria with different fertility rates, so that the absence of an effect of population growth rates on aggregate savings does not imply that there will be no effects of demographic structure on saving during a transition. In consequence, our earlier results are not necessarily inconsistent with either those of Higgins and Williamson’s (from macroeconomic cross-country evidence) or those of Lee, Mason, and Miller (from simulations.

In this paper, we use improved techniques and updated data from Taiwan to see if, after all, it is possible to tell a story in which demographic change has large effects on saving. We do this not because we have any reason to revise our previous empirical results—indeed they are replicated on the most recent data—but because our previous work paid too little explicit attention to demographic factors, and because our results looked only at demographic structures in equilibrium, rather than at the actual transition. Furthermore, our previous work relied on information about households, and on how saving rates vary over the household life-cycle, where the latter is defined by the age of the household head.

This approach, which is dictated by the data, poses problems when we try to translate demographic change, which makes predictions about people, into predictions about households, whose saving is what we know about from the data. It is far from obvious how changes in the age structure of population translate into changes in the age structure of household heads, and whether the age-profiles of saving by head’s age can be expected to be invariant to changes in demographic structure. In consequence, results about growth and saving are determined as much by assumptions about household structure as by our measurements of the age profiles of saving.

In this paper, we follow the more recent approach of Deaton and Paxson (1998), and construct lifecycle saving profiles for individuals, not households. This new approach, like the household approach, makes its own assumptions, and requires its own suspensions of disbelief. But the assumptions and suspensions are different, and it turns out that the new approach gives different results. Specifically, our estimated life-cycle saving profile for Taiwan has a pronounced “hump” shape that is consistent with the hypothesis that greater old-age and youth dependency rates depress saving. These negative effects of children and the elderly on saving are masked when working at the level of the household, since few elderly and virtually no children live in independent households.Given the hump-shaped age-saving profile we estimate, the LCH implies that increases in the rate of population growth can either increase or reduce the aggregate saving rate. At higher rates of population growth, there will be fewer elderly dissavers relative to middle-aged savers, and this will cause the saving rate to rise. However, children will make up a greater fraction of the population, and this will depress the saving rate. Which effect dominates depends on the rate of economic growth. At very high rates of per capita income growth—in excess of six percent per annum—the life-time wealth of the elderly is small relative to those who are younger, and their dissaving contributes little to the aggregate saving rate. In this case, the depressing effect on saving of relatively more children predominates, and increases in the rate of population growth are predicted to reduce the aggregate saving rate. Conversely, at slow rates of economic growth—in the range of zero to three percent per annum—the life-time wealth of the elderly is relatively large, as is their (negative) contribution to aggregate saving. Increases in the rate of population growth that reduce the fraction of the population that is elderly increase the aggregate saving rate.

Woo Hoo. I was debating indirectly China this morning with Brad Setser. I think the argument I've just cited from Deaton helps a lot in understanding China.

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