Aging, the World Economy and the Coming Generational Storm

Policy Reports | Economy

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

Simulations for Open Economies

Table IV - VI

“International competition for capital will raise the interest rate by 440 basis points.”

As noted, the key assumption behind our closed economy simulations is that capital does not flow across borders. In all three regions, a relative capital shortage causes real interest rates to rise. In fact, by the end of the century they will be 3.2 percentage points higher in the United States, and 6.6 and 4.8 percentage points higher in Europe and Japan, respectively.

“By mid-century, the standard of living of U.S. workers will be one-third lower than otherwise.”

Ordinarily, one would expect that access to international capital markets (as is assumed in the open economies simulation) would benefit a U.S. economy in need of capital. However, in this case, conditions in Europe and Japan are much worse. So the other two regions end up bidding capital away from the United States. By the end of the century, the uniform international interest rate will be 4.4 percentage points (440 basis points) higher than at the beginning. As a result, international competition for capital raises rates in the United States, even as it lowers rates in Europe and Japan.

“In Europe and Japan, the fall in living standards will be close to 40%.”

As Table IV, V and VI show, the macroeconomic structures of the open and closed economy models are very similar, with some differences worth mentioning. In the closed economy baseline, interest rates increase the most in Europe and the least in the United States. Consequently, in the open economy, capital flows predominantly from the U.S. toward Europe. The baseline path of the open economy, therefore, in contrast to the respective closed economy cases, allows for more capital accumulation for Europe and less for the United States. Japan experiences initial capital outflows that eventually change to inflows. Due to these changes, the United States and Japan experience short-run current account surpluses while the European Union faces current account deficits. As a result:

“Because the problem of aging will be worse in Europe and Japan, economic deterioration in those regions will affect the U.S. economy.”

  • U.S. real wages by 2100 are about 2 percentage points lower than in the closed economy model, reflecting a lower capital stock thanks to the export of capital to Europe and Japan (see Table IV).
  • Roughly the reverse happens in Europe, where the long-run real wage is about 3 percent higher than in the closed economy model, reflecting the relatively smaller reduction in the capital stock thanks to the import of capital from the United States (see Table V).
  • In the long run, Japan is largely unaffected by the choice of models. (See Table VI.)

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