Aging, the World Economy and the Coming Generational Storm

Studies | Economy

No. 273
Friday, February 04, 2005
by Laurence Kotlikoff, Hans Fehr, and Sabine Jokisch


“Population aging is more dramatic in Europe and Japan, but all three regions’ economies will be damaged without reform.”

In this paper, we assume that governments collect the taxes needed to pay all entitlement benefits. We use a new dynamic simulation model to analyze the general equilibrium economic impact on the world’s three major industrialized regions: the United States, Europe and Japan. Our simulations show that aging will greatly damage all three regional economies. In particular, it will generate a significant capital shortage.

However, population aging is not identical in all three areas. It is more dramatic in Japan and Europe than in the United States. Consequently, the macroeconomic impacts of aging are somewhat different in the three regions. These differences will cause capital to flow from the United States to Europe and Japan. Stated differently, the U.S. capital shortage will be exacerbated by the need to supply capital to Japan and the European Union.

Although increased immigration has some beneficial macroeconomic effects, they are extremely small. On the other hand, one can expect a significant long-run improvement from eliminating current pay-as-you-go pension systems and replacing them with funded, private retirement accounts, financed by an earmarked consumption tax. While the welfare losses of the elderly and near-elderly are modest, the welfare gains for younger and future generations (especially those with low and middle incomes) are extraordinarily large.

In conclusion, the generational storm approaching the shores of the developed world is much more threatening than is commonly believed. However, the situation is not completely hopeless. There are policies, albeit painful ones, that can materially improve the developed world’s long-term prospects.

NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.

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