Facebook Blogging

Edward Hugh has a lively and enjoyable Facebook community where he publishes frequent breaking news economics links and short updates. If you would like to receive these updates on a regular basis and join the debate please invite Edward as a friend by clicking the Facebook link at the top of the right sidebar.

Tuesday, September 06, 2005

The Oecd Ageing Model

This is - I hope - a relatively brief follow-up to my last post on fertility. This is a quick account of a paper - THE IMPACT OF AGEING ON DEMAND, FACTOR MARKETS AND GROWTH, by OECD economists Joaquim Oliveira Martins, Frédéric Gonand, Pablo Antolin, Christine de la Maisonneuve and Kwang-Yeol Yoo which really is mainly interesting for the fact that it is the economic support for the above-mentioned fertility paper.

What really amazes me in all this is that the OECD work seesm to go on as if the IMF didn't exist. There is only really one paper that they seem to mention in the bibliography that is common to the two approaches - Yaari, M. (1965), “Uncertain Lifetime, Life Insurance, and the Theory of Consumer”, Review of Economic Studies, 32(2) - and this is really so old that this fact in itself is curious. Obviously the IMF economists are much further advanced in their work, and I don't understand why the OECD economists don't simply try and stand on their shoulders (or perhaps I do, and that's what worries me).

Be that as it may, I will do my best. The majority of this paper seems to consist of covering already well-known facts about the situation, eg that there is both increased life expectancy and reduced fertility.

One finding they note which is perhaps worthwhile is:

Moving the old-age threshold in line with longevity gains would only affect old-age dependency if aged workers participate in the labour force, are employed and remain in good health. Labour force participation and employability of older workers will be discussed in Section 5. With regard to healthy ageing, the evidence is scattered and points to many unknowns. No clear pattern emerges from the comparison of trends in life expectancy (LE) and disability-free life expectancy (DFLE) based on available cross-country data (Table 2.4). In some countries, there is a balanced increase, in others the DFLE progresses faster than LE and in a few the reverse is observed.

It's interesting that they find no clear pattern, it's also interesting that they don't mention along with the other factors important to the effectivity of moving the old-age threshold "if aged workers maintain the level of aggregate productivity". This, I would have thought is the key question.

On the consumption impact, which is obviously one of the key areas, they note the following:

"Household survey data suggest that total consumption displays a hump-shaped profile across agegroups (Figure 3.1). These profiles are subject to uncertainties and are not equivalent to saying that the consumption profile is hump-shaped over the life cycle, mainly due to the existence of cohort and time effects.8 Nonetheless, they would suggest that the pure consumption-smoothing hypothesis is only partly supported by the micro data."

This is all broadly in line with other findings, including the consumption smoothing, but is subject to the same caveats as I offered in the Bryant case.

On consumption generally they reach this hardly earth shattering conclusion: "With these orders of magnitude, ageing-induced changes in consumption shares are not expected to generate major structural changes in the economy."

Which is fine, but hardly helps us understand what we are already seeing in Germany and Japan.

As far as capital markets goes they use an Overlapping Generations model The specification of the model draws principally on Börsch-Supan, A., F. Heiss, A. Ludwig and J. Winter (2002), “Pension Reform, Capital Markets, and the Rate of Return". This paper will now need looking at. In particular they inform us that to simplify, "each country is viewed as a closed economy and the labour market is exogenous".This is obviously at variance with the Bryant and McKibbin models where the international dimension is paramount.

They then test three reform scenarious against a baseline 'doing nothing' approach. As they inform us:

"In the two reform scenarios, policy changes are implemented from 2005 onwards. After the reform is announced, households revise their optimal saving paths in order to smooth future consumption levels. This implies that before 2005 consumption for each cohort remains equal to its level in the noreform 'rising contribution rate' scenario. The economies return to a stable population level and structure by 2080, when a steady state equilibrium is reached. In this situation, GDP per capita growth is exclusively determined by the (exogenous) growth in total factor productivity (TFP) and capital deepening grows in line with TFP, at 0.45% per annum.17 By contrast, during the demographic transition, the dynamic equilibrium is driven by ageing trends and pension reforms."

Now its not clear how realistic this is in the first place, since it isn't evident where we will find a stable population structure by 2080, but this is so far out it may be beside the point. We need to understand here the difference between stationary and stable population. A stationary population maintains the same numeric level, but it's stucture may change due to below replacement fertility and increasing longevity (setting each other off). A structurally stable population is one which maintains the shape of the pyramid. It is this latter that I am doubting.

This finding anyway many will find re-assuring.

"The results give little support to the so-called "asset meltdown hypothesis", according to which the massive pension withdrawals during the second phase of the ageing process could induce a large decline in asset prices (see Box 2). Other quantitative studies using general equilibrium models also tend to reject this hypothesis. This is because the asset meltdown hypothesis reflects a partial equilibrium view where changes in economic agents’ behaviour spurred by interest rates movements are not taken into account. Also, the hypothesis may also be based on an exclusive focus on the impacts of ageing on savings, ignoring the impacts via labour supply on investment. In a general equilibrium setting, accounting for these mechanisms largely offsets the asset meltdown effect."

This result is broadly similar to the findings of Börsch Supan et al, but again this isn't so surprising, since they use the same model. I'm not sure what weighting they are giving to house prices in private wealth, and what evolution they see for these. I am aslo not clear whether they do not rely excessively on capital deepening, since this has well known diminishing returns induced limits.

Of course none of these studies seem to take into account the existence of a zero-bound downward limit on interest rates. It is OK to speculate that interest rates may rise later, but the stylised fact we are getting from the 'first wave agers' is that savings first go up, and global interest rates come down.

Now they get onto productivity:

"In the most optimistic scenario, assuming a flat productivity profile for old-age workers, the resulting aggregate productivity levels would increase over the next two decades and stabilise thereafter (Figure 5.3). In the other two scenarios, productivity would uniformly decrease. However, in all three scenarios the order of magnitude of the change is small (+/-2.5%) and this level effect would stabilise after a certain time. This result is related to the evolution of the average age of the labour force (Figure 5.4), which is increasing but will stabilise over the next decades if retirement patterns remain unchanged. This explains why, despite contrasting assumptions about individual age-productivity profiles, ageing per se does not have a major impact on the aggregate productivity level. In this context, concerns about the current "greying" of the labour force have to be seen as a rebound from a previous sharp decrease in the average age of the labour force, the "rejuvenating" shock that took place during the 1970s, from which OECD economies are just recovering. In fact, in the 1990s Japan already experienced the average age of the labour force that is projected to occur in Europe and in North America by 2050."

I remain very sceptical of all this. I think the principal think to say is that we really don't know. We don't know the pace of technical change going out into the future, and we don't know how a greying workforce will adapt to that change. The mention of Japan is tendentious, since it highlights the fact that *some* EU countries face relatively benign ageing (UK, France), while others (Germany, Italy, Spain) face a much more severe problem. Germany eg isn't that different from Japan now, while the UK won't be where Germany is now for at least another twenty years.

Before leaving this perhaps its worth mentioning that alot of the attention is given to the impact of PAYGO pension systems. Obviously these complicate matters enormously, and lead coutries like France with much more moderate birthrate issues to have serious sustainability issues at govt finance level. But these are relatively easy to comprehend. So I don't think they are where the main thrust of our effort should be going right now. What we need to be able to do is model the impact of the demographic changes without the incidentals like PAYGO. We are still some way from doing this, and I think it the pressing issue here. Without adequate models we will not be able to orient our assessments at all.

I suppose it goes without saying: I don't think that this paper is a very useful or important contribution to our knowlege bank.

However, having been so critical, I would like to say that the technical annex 2 which outlines the overlapping generations model is precise and clear. Whoever did this bit knew their sausages.


Anonymous said...

"and lead coutries like France with much more moderate birthrate issues to have serious sustainability issues at govt finance level" : I don't understand, do you mean that since birthrate is higher in France than say Germany, PAYGO systems are in worse shape in France than in Germany?


Edward Hugh said...

This is the impression I have Laurent. Germany has far worse demographic problems but has already made a number of reforms (and people may well soon start working to 67). France has yet to really get to grips with pension reform. This is why people worry about sustainability issues in the French case.

Both countries will also have to do something about their health systems.

Edward Hugh said...

Consider this from a recent OECD document:

From a functional point of view, "France spends more than any other OECD country on income transfers,
with disbursements on old age and survivors’ pensions and unemployment among the highest in the
OECD. Currently, 62 per cent of French citizens live in households that receive at least one social benefit3
(Marlier and Cohen-Solal, 2000). Including pensions, raises this ratio to 80 per cent."

"As elsewhere in the OECD, the ageing of the population will significantly determine both the nature of public expenditure and France's ability to finance it over the next several decades...During the next 30 years, the population over 65 years of age is projected to increase by almost 75 per cent, while the working-age population (15-64) will be broadly stable or decline.As a result, the ratio of workers per person aged 65 or more is expected to decline from about 2.4 workers per person over 65 to 1.5 workers in 2030 and 1.3 workers by 2050. Taking into account the high incidence of early retirement and the official retirement age of 60, the ratio of workers per retiree is expected to decline from 2:1 to 1:1 by 2030. In the absence of reforms to the pension system, ageing is expected to increase the pension system’s funding shortfall by 8 per cent of GDP. Even assuming substantial improvements in
labour force participation and unemployment rates, rising pension expenditures are expected to increase
the deficit by 4.7 per cent of GDP (COR, 2001)."

Edward Hugh said...

This is the summary of the OECD country survey for France, and in the meantime nothing significant has changed:

France faces a daunting task in meeting the fiscal challenge posed by the ageing of its population, which is
expected to result in the ratio of people retired to those employed doubling by 2030. As a result, there will be only one worker to support every retiree. This has obvious implications for the sustainability of the country’s pay-as-you-go pension scheme, but will also add further impetus to healthcare costs that are already rising strongly as a share of GDP.

The challenge posed is all the greater because, at the same time as ageing raises spending pressures, the exit from the workforce of the large baby-boom cohorts will reduce the
rate at which employment and therefore potential output grow – thereby slowing the increase in the tax base needed to pay for these services. Notwithstanding continued
improvements in productivity and income levels, the operational deficit of the health and pension systems would increase by some 5 per cent of GDP by 2030 in the absence of far-reaching policy changes. Allowing such deficits to accumulate over time is not a realistic option because the
resulting build-up of debt would be unsustainable. OECD estimates suggest that the debt to GDP ratio could more
than double by 2030. While the ageing challenge is a longrun one, actions to deal with it are nonetheless urgent, both because deep reforms can only yield results over time and because reform options become fewer and more costly the longer they are deferred.

Anonymous said...

Thanks for your answer, so the reason behind your conclusion is political: since the problem is made less accute by higher birthrate in France, there is less incentive to change things.

I must admit I haven't seen clear and convincing argument on why PAYGO systems are worse off than personnal investment systems in the long run vs demographics.

The latest piece I've been reading is this:


but it seems to assume that the current historical performance differencial between stocks and rates is a given constant but in no period in history yet people have been selling stocks continuously to ensure their retirement (CALPERS will start soon to be net seller IIRC). When more people sell stocks than people buy them, stock wealth goes down.

One of the argument there is also that less capital could lead to less growth, however in recent times we've been really overloaded with capital and I don't believe people would really want more capital flowing around for the foreseeable future. I've even read somewhere that the markets are currently net negative in capital flows (new stock issues and IPO offseted by huge share buy backs).

One of these days I'm going to play with small Monte Carlo based models to make my mind on these issues :).


Edward Hugh said...

Nice to meet you Laurent.

"so the reason behind your conclusion is political: since the problem is made less accute by higher birthrate in France, there is less incentive to change things."

Well, this is part of it, but it is also economic, France's economic problems aren't as serious as those of Germany. Internal consumption isn't flat. France is more or less like the UK. The two have the same median age 38, while Germany and Japan, which have very similar problems, have a median age nearer 42 and both are near the point where absolute population numbers fall.

You can find some explanation of the theory behind this here:


Also a comparison between Germany and Japan can be found here:


"why PAYGO systems are worse off than personnal investment systems in the long run vs demographics."

I'm not suggesting that. I'm not making any comparison, I'm just suggesting that the dynamics of paygo - without reform which risks pushing the contributory pension to the same level as the automatic social security one - becomes non-sustainable as the generations contract, if ageing slows down growth substantially (which I imagine) and in a globalised world were firms can go elsewhere in search of lower non-wage costs. There are too many negative feedback elements.

however in recent times we've been really overloaded with capital and I don't believe people would really want more capital flowing around for the foreseeable future.

Oh yes, the weight of so much saving in the ageing societies, and so much saving in the petrol producing, but pre consumer, young societies (petro dollars) means there is no shortage of saving.This, for me, isn't the issue.

Nice talking to you. You have caught me online as I am watching Spain-Serbia on the TV, and chatting like this is, in all honesty, less boring :).

Anonymous said...

Thanks again for taking the time to answer my questions :).

If I understand correctly you say PAYGO can't work in the future, but you don't say capitalization will work any better, so no real solution :).

For demographics, I believe that France has a brighter demographic perspective than Germany and Japan:

- French birthrate could increase in the future: I assume the 62% receiving social benefit includes every household that has young children and so gets money from the state... and I believe it's reasonable for the state to make having children at least somewhat flat at the economic level, it's a good investment for the future.

- French immigration policies are currently stupid and there is a large immigration potential which is currently under used. Germany has Turkey but it looks like it's not without problem, for Japan I believe the country is not that foreigner friendly.

Also change in sociology can have a huge impact, I believe Japanese are using a non monetary system for elder care, but I can't find the reference (I read a paper a few years ago in a paper discussing what is a currency and alternative currencies by one of the father of the convergence criterium for euro creation).

In the long run, if older people have to work more and/or get less from pension, I believe only an harmonious society will be able to make those hard decisions, in this view having a full old stock owners vs young workers fares worse than taxpayer vs retirees in PAYGO IMHO.

Productivity in elder care could take a boost too (who knows, robots, new social standards, ...) so they would need relatively less pension money to enjoy their retirement. Expensive drugs are patented for 20 years, so in the future this burden could be lessened, etc...

The only thing I know for sure is that bakers & finance people are the only people 100% sure to benefit from a move from PAYGO to capitalization, and a large share of economists have big ties with the banker world. Disclaimer: I work for a big bank in a trading room :).


Edward Hugh said...

"I believe only an harmonious society will be able to make those hard decisions"

Well I'm not against harmonious societies, but we don't - any of us seem terribly good at taking 'hard' decisions. This is one of the issues - like climatic change - the time horizon is so long that it doesn't fit our electoral horizon cycle.

"French immigration policies are currently stupid and there is a large immigration potential which is currently under used."

Well I agree with this, IMHO the strongest real argument in favour of labour market reform in France is to get unemployement round the 5% mark (I'm not necessarily convinced this will have a huge impact on GDP, labour productivity may even go down). If you don't do that you're never going to get people to seriously consider having a positive immigration policy.

"Productivity in elder care could take a boost too"
I strongly doubt this argument, but haven't time to go into it here. Read A fistful of euros, you'll find plenty of opportunity to come at me there :).

This blog is becoming much more a personal note keeping diary. That's what they say weblogs are, don't they, personal web diaries :).

"The only thing I know for sure is.."

The only thing I know for sure is that I still don't understand much of this (no, sorry, I'm ripping off Socrates), whuich is why I'm still reading thru papers on the internet while others are better occupied.

Oh, and yes, Serbia drew (which mildly pleases me). So I'm off to bed and a sound nights sleep. See you again one day perhaps on AFOE :).