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Wednesday, October 19, 2005

Adult Longevity and Saving

Here's another part of the life cycle mystery getting solved. Do oldest old societies save or dis-save. Many think that the life cycle modle predicts dis-saving. Tomoko Kinugasa and Andrew Mason say it shouldn't, it depends on how rapidly life expectancy is rising. Rising life-expectancy produces a behavioural change which (ceteris paribus of course) leads to more saving, people need to support themselves for longer. The paper is based on Kinugasa's PhD research. I need time to think more about this, but my initial impression is that this is definitely a step in the right direction, and helps us understand China a little bit more, since in China, of course, life expectancy is currently rising very rapidly. (Incidentally, this may also have something to offer on the old East Germany, since life expectancy rates jumped dramatically in very few years to a level very close to their counterparts in the west.

Previous research has emphasized two channels through which the demographic transition may influence the accumulation of wealth. First, the transition produces changes in age structure that will have compositional effects if saving rates vary by age.Second, changes in demographic variables may influence behavior.... Empirical research has supports the hypothesis that a decline in the share of the dependent population, the child dependent population in particular, leads to higher saving rates. The magnitude of compositional effects, however, is a controversial and important empirical issue. The controversy is particularly salient in light of East Asia’s successful development experience. Large increases in aggregate saving rates, leading to rapid capital accumulation, is widely recognized as one the key ingredients to the region’s success. Several recent empirical studies, based on the analysis of aggregate cross-national panel data, have identified changes in age structure as the most important or perhaps even the exclusive reason why aggregate saving rates increased (Higgins 1994; Kelley and Schmidt 1996; Higgins and Williamson 1997; Williamson and Higgins 2001).

An alternative approach, employed by Deaton and Paxson (2000), reaches very different conclusions. They use a series of consumer expenditure surveys from Taiwan to estimate individual age profiles of consumption and earning. They combine these estimated profiles with observed and projected changes in age structure to simulate aggregate saving rates over Taiwan’s demographic transition. They conclude that changes in age structure had modest effects on saving rates and can not explain the dramatic increase in aggregate saving rates in Taiwan. One possible resolution of this empirical controversy is that the changes in fertility and mortality have behavioral, as well as, compositional effects.

Labor force behavior varies with fertility. Expectations about old-age support – either from public or familial systems – may shift in anticipation of changes in age structure. The decline in adult mortality may influence saving by affecting the expected duration of retirement. It is the last possibility that is explored in this paper.

The effect of mortality on saving has been explored in a number of previous studies (Yaari 1965; Davies 1981; Zilcha and Friedman 1985; Cutler, Poterba et al. 1990; Kuehlwein 1993; Leung 1994; Borsch-Supan 1996; Schieber and Shoven 1996; Bloom, Canning et al. 2003; Kageyama 2003). Our interest was stimulated in particular by recent simulation results that show that increases in life expectancy can have large effects on aggregate saving if household saving is governed by the lifecycle model (Lee, Mason et al. 2000; 2001a; 2001b).

Changes in adult survival influence aggregate saving in two ways. First, as the survival rate increases the expected duration of retirement rises. Thus, individuals will consume less and save more during their working years in order to support more expected years of consumption during retirement. Second, increases in the adult survival rate lead to an increase in the share of retirees in the adult population. Given that retirees are saving at a lower rate than workers, the compositional effect of an increase in adult survival is to reduce aggregate saving. What is the net effect on improvements in adult survival on aggregate saving?

Providing a clear answer to this question requires a careful examination of the dynamics in addition to the comparison of steady states......

The second important feature of the results is the implication for population aging and aggregate saving. There is widespread concern, though limited empirical support, that population aging will lead to a decline in aggregate saving rates. The empirical results presented do not support that conclusion. If old-age survival rates continue to increase, as is widely expected, our empirical results imply that saving rates will continue to rise.

Demographic Dividends in developing and Developed Countries

Andrew Mason had another paper at the UN experts meeting on ageing: DEMOGRAPHIC TRANSITION AND DEMOGRAPHIC DIVIDENDSIN DEVELOPED AND DEVELOPING COUNTRIES. Well worth a read. Mason is very aware of the issues.

This paper has several objectives. The first is to explain the demographic dividends in a conceptual and formal way. This draws on earlier work that identifies two demographic dividends (Mason and others, forthcoming). The first dividend arises because changes in age structure influence the share of the population concentrated in the working ages. The second dividend arises to the extent that anticipated changes in the share of the population concentrated in the retirement ages induce individuals, firms, and/or governments to accumulate capital.

The first dividend is inherently transitory. Demographic transition around the world has led to an increase in the share of the working age population that has lasted for many decades. But when large cohorts of prime age adults pass into their retirement years, the first dividend ends. The share of the population in the working ages begins to decline and the first dividend turns negative. The first dividend can have a lasting effect on economic growth if the gains in per capita income are used to create human capital by investing in health and education, to accumulate physical capital, to support technological innovation, to create growth-inducing institutions, etc.

The second dividend is permanent in nature because it is driven by the rising share of the elderly in our populations. It is not self-evident that lifecycle wealth would necessarily continue to rise as the share of the retired population increases. The estimates presented here do not extend beyond the year 2000, but detailed simulations to 2150 show that for the US and Taiwan life cycle wealth stabilizes at a high plateau or continues to increase depending on the mortality assumptions employed (Lee and others, 2003). Thus, the second dividend does not turn negative as the demographic transition proceeds.

China's Demographic Dividends

I am hard at work trying to write something, so I don't have much time or energy to blog, but two pieces on China that cannot go unremarked. Firstly And Xie again: this time he has picked up on the demographic issues related to China's high savings rate. Also the UN held an experts meeting on ageing in August, and one of the papers was on China: DEMOGRAPHIC DIVIDEND AND PROSPECTS FOR ECONOMIC DEVELOPMENT IN CHINA by Wang Feng, of the University of California Irvine and Andrew Mason, of the University of Hawaii and the East West Center. Just a short couple of extracts to give a taste:

During the last two and half decades, China has undergone demographic as well as economic changes of historic proportions. Demographically, China has transformed itself from a "demographic transitional" society, where reductions in mortality led to rapid population growth and subsequent reductions in fertility led to a slower population growth, to a "post-transitional" society, where life expectancy has reached new heights, fertility has declined to below-replacement level, and rapid population aging is on the horizon. In the not-too-distant future -- in a matter of a few decades -- China’s population will start to shrink, an unprecedented demographic turn in Chinese history in the absence of wars, epidemics, and famines of massive scales. In this process, China will also lose its position as the most populous country in the world.

The rationale for China’s one-child policy was a neo-Malthusian perspective on the relationship between population and development – a view largely dismissed by mainstream economists. The architects of China’s population policy can point, however, to the post-reform economic record as evidence of the success of the policy. This assertion can be questioned on two grounds. The first is the extent to which the transition to low fertility was accelerated by the one-child policy (Wang, 2005). The second, considered in this paper, is the extent to which fertility decline, the slow-down in population growth, and changes in age structure contributed to China’s economic success. In light of the recent and future changes in China's age structure, we also examine and speculate in this paper the role of population age structure changes in affecting China's prospect for economic development in the coming decades of the twenty-first century.

Monday, October 17, 2005

The BoJ is Convinced

The entire nine-member board of the Bank of Japan is convinced that deflation in Japan will be over by the end of this year: I only wish I was.

Minutes of the bank's board meeting earlier this month show board members expect year-on-year changes in consumer prices to be zero or to rise slightly at the end of the year.

In recent weeks, senior members of the BoJ, including governor Toshihiko Fukui, have been making statements saying the time is approaching when the bank can consider abandoning quantitative easing and considering raising interest rates.

Inflationary Pressure From China?

Andy Xie had an interesting and important article in the MS GEF last Friday. He asks whether the epoch of China as a deflationary force on global prices may not be coming to an end. This is an interesting change of tack for Andy, since to date he has been on of the principal exponents of the Chinese 'reserve army of labour' argument wherby internal labour migration (estimated variously to have been of a magnitude of over 150 million people) drives down unit labour costs globally.

Andy is now speculating that this 'broad river' may now be reaching its limits. In particular difficulty in finding new migrants may be having an upwards impact on the 'cheapest cheap' wages. This has to happen at some stage, it is hard to tell whether we are there yet.

Xie speculates that this will impact on prices of products at 'big box retailers'. It will also influence the extent to which the cost push element of rising oil can be adsorbed. Otoh, Xie speculates that, as China moves up the value chain, the deflationary impact may still be felt in a broader range of end products.

China is not deflationary for the global economy at present, I believe. It could be an inflationary factor for one or two years due to cyclical and political reasons. Over time, China may become deflationary again when it moves up the value chain to re-price higher value-added products with Chinese costs. What matters to the market now is that China’s impact on global economy is becoming inflationary

The deflation winners, mainly big-box retailers, could see their gains reversed in the next year or two. Also, the major central banks may have to tighten into a slowing global economy, as the China factor no longer holds inflation back.

Growth or Inflation?

An interesting piece in the FT today highlights some of the issues I've been raising (here, and here) about central bank statements and economic realities.

As the FT points out UK retail sales for September, due on Thursday, are expected to confirm consumer survey reports of weak high street activity. The consensus forecast is for an increase of 0.2 per cent, slowing year-on-year growth rate from 0.8 per cent in August to zero. Employment data have also recently been consistently weak.

Menatime oil price rises have been pushing inflation steadily upwards.

This highlights the problem with the different 'measures' of inflation - the European HICP or 'core inflation' (less the 'volatile' fuel and food ite,s). How you feel about this in part depends on where you are looking from. Vis -a-vis the 'consumer', what they feel is the real and important rise in their expenses, as indicated by the HICP. This hits them where it hurts, in the pocket. This is certainly one extremely valid point of view. Getting through to the end of the month.

The central banker, however, has a different problem set. The issue facing the central banker is whether this year's increase in oil prices (the CPI/HICP level effect) will feed through to next years inflation in the core areas (the rate effect). This is why if you want to decide what to do about interest rate policy the core CPI is important. The fact that it is trending downwards must indicate something (the harder part of the question would be what).

So the central banker needs to decide whether those consumer expectations are valid, and hence raise rates, or whether consumers are feeling a temporary squeeze and so put rates on hold to help them get through the 'soft spot' (which post Katrina may be a rather hard 'soft spot').

I can't help feeling that those who claim the 'core inflation' readings are missing the Big Picture are rather shooting themselves in the foot here. They are, I think, concerned with the strain being placed on the low income consumer (for which well done) but by making so much fuss about the importance of the 'unadjusted' CPI they are in danger of seeming to argue for a faster pace of interest rate rises.

This would give the consumer 2005/2006 the worst of both worlds: a high real inflation rate, and extra mortgage (etc) payments to boot.

The central banker's problem is complicated by the fact that that he may well want to take into account other issues like house prices and the US current account deficit, and give all these things a relative weighting.

The FT quotes Morgan Stanley's Melanie Baker as warning that inflation could stick above the BoE’s 2 per cent target until December 2006 (this would be the knock-on year on year impact of the oil hike) and that a prolonged overshoot, lasting until the third quarter of 2008, is possible (and this would be the secondary impact problem) depending on oil price developments.

The decision set is all about how to evealuate the risk of the latter.

Meantime Brandeis economist (and former Fed research director) Stephen Cecchetti has some sound explanation of all this here (Hat Tip to Dave Altig at MacroBlog)

Cecchetti also raises the valid point that in real terms, and taking the actual US CPI readings as the yardstick (currently running at 4.7% y-o-y), with a fed funds rate of 3.75%, real rates are still negative and hence pretty 'accommodative'. But then we are in the aftermath of Katrina, and the consumer is getting the 'big squeeze'. Also if the CPI does peak, and inflation trend down even while the fed continues raising the situation could soon normalise to the target 'neutral' real rate of around 2 tyo 2.5%. In fact my advice would be to watch for the backdraft, since a much bigger problem may come with strong disinflation when there is a serious slowdown in the US economy (which isn't, btw, now).