Abstract
Owing to a sharp decline in the fertility rate and a rapid increase in longevity, Japan’s population aging is the furthest advanced in the world. This study explores the macroeconomic impact of Japan’s population aging from the 1980s to the 2000s using a full-fledged overlapping generations model. It finds that Japan’s population aging as a whole adversely affects GNP growth by dampening factor inputs. It also negatively impacts on GNP per capita and fiscal variables, especially in the future, mainly due to the decline in the fraction of the population of working-age. For these findings, fertility rate decline plays a dominant role as it reduces both labor force and saver populations. The effects of increased longevity on economic growth are expansionary, but relatively small. The simulations predict that the adverse effects will expand during the next few decades. In addition to closed economy simulations, the paper examines the consequences of population aging in a small open economy setting. In this case a decline in the domestic capital return encourages investment in foreign capital, mitigating the adverse effects of population aging on GNP.
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Notes
Here the dependency ratio is defined as the “old-age” dependency ratio; the number of individuals aged above 64 divided by the number of individuals aged 15 to 64.
Within a growth accounting framework, for instance, Maddaloni and others (2006) analyze the effects of population aging on economic growth, financial markets, and public finance in the euro area, considering the fertility rate, longevity, and immigration.
As more recent work, Ikeda and Saito (2014) analyze, based on a dynamic stochastic general equilibrium model, the implications of demographic changes for real interest rate dynamics in postwar Japan. From a different perspective, Fujiki, Hirakata, and Shioji (2012) conduct an empirical investigation of how population aging affects households’ asset portfolio allocations, particularly between stocks and other assets, in Japan.
Horioka (1997), Horioka and Watanabe (1997), Dekle (2000), and Koga (2005) are examples of sophisticated empirical work providing evidence for the Japanese saving rate decline.
Dekle (2003) and Kozu, Sato, and Inada (2003) offer a broad discussion. İmrohoroğlu and Sudo (2011a and 2011b) and Braun and Joines (2015) utilize neoclassical growth and OG frameworks to address these issues from various angles.
Most studies on the Japanese economy, including Chen and others (2007) and Braun, Ikeda, and Joines (2009), abstract from the public health insurance system. A few exceptions, for example, Ihori and others (2005, 2011) introduce Japanese public health insurance in an OG model. Their models, however, assume an exogenous labor supply and are therefore immune from the distortionary effects of population aging on economic growth through the social security tax.
Hansen and İmrohoroğlu (2015) introduce the “bond-in-utility” into a neoclassical growth model with a representative agent.
In carrying out our long-term projections where the government debt to GNP ratio is endogenously determined, we find that this assumption impedes the convergence of the computed equilibrium transition path. This suggests that introducing the spread between private capital and government bonds is crucial for evaluating the sustainability of government debt.
Since the youngest households in our model are 21 years old, we define the “fertility rate” in the model as the growth rate of the age-21 population. This definition is different from common definitions of the “total fertility rate,” expressing the average number of children per woman during her lifetime.
Although mandatory retirement in Japanese firms is usually set between age 60 and 65, labor force participation above age 65 is never zero according to labor statistics. It is probable that people have an incentive to work more and longer if people live longer but become poorer. This may counteract partly the adverse effects of aging on output and fiscal balance. In our projections, however, we keep this conventional assumption of mandatory retirement age 65 because detailed data sets on workers over 65 are not sufficiently available. In addition, our qualitative results have not changed so much when we have checked some sensitivity on our results by simply postponing the mandatory retirement from 65 to 90 or 100. However, our results can change quantitatively once we explicitly model extensive margin of labor input (households’ decision problem on labor participation after the regulatory retirement age). In this regard, some studies such as İmrohoroğlu and Kitao (2012) and Kitao (2015) have already done this extension. Kitao (2015) assesses a fiscal cost of demographic transition and confirms sizable effects of an increase in labor participation on fiscal burdens in Japan. Extending our model in this direction is an agenda for our future work.
This corresponds conceptually to what is categorized as the sum of the net current transfers and the capital transfers in the Japanese National Income Account.
Following Braun and Joines (2015), we assume that medical expenditures grow along with the per capita GNP. We choose this setting due to the availability of the data regarding the growth rate of medical technology in Japan.
The copay rate is 30 percent for people below 70 years of age and virtually 0 percent for people over 70 years of age until 2002. The copay rate is approximately 10 percent for people over 70 from 2003.
The borrowing constraint is not imposed on households’ assets in our model. In other words, households are allowed to borrow against their future income.
There are some studies introducing an exogenous spread between private capital and government bonds. An important feature of our “bond-in-utility” model is that the model’s spread is endogenous and its size is negatively related to the outstanding amount of government debt.
We do not have a detailed data set on the asset distribution for 1982, which is the initial year in our model. To obtain the initial distribution of assets in 1982, kj,1982 and bj,1982, we first compute the life-cycle profiles of capital stock holdings and government bond holdings,
and 
, from a steady state where it is calibrated to main macroeconomic variables for 1982. In computing the transition path, we multiply at all ages by the same scalar q
k
so that aggregate capital stock to output ratio K1982/Y1982 computed from the model coincides with the data: kj,1982 = q
k
⋅ . We do the same treatment to so that aggregate government bond outstanding to output ratio B1982/Y1982 is the same between the model and the data: bj,1982 = q
b
⋅ . Other variables are computed as a competitive equilibrium from the model.Here we drop the subsample periods that include the “bubble boom” during the 1980s and the global financial crisis from 2008 to 2009 in constructing our benchmark future path for TFP. The average value over the whole sample period is 1.7 percent, which is slightly higher than our benchmark assumption.
For the data part, life-cycle profiles of consumption c j and total asset a j are based on the National Survey of Family Income and Expenditure. A life-cycle profile of labor input is constructed from a life-cycle profile of working hours based on the Basic Survey on Wage Structure, and life-cycle profiles of labor participation rate and labor force based on the Labour Force Survey. Because there is no detailed data available for a life-cycle profile of government bond holding b j , we assume that households at all ages hold government bonds relative to total assets a j by the same proportion as aggregate government bond outstandings to aggregate total asset ratio.
This means that
.This means that
for the entire simulation period.By construction, the payroll income tax rate, τ m,t , is set at zero throughout the periods. Instead, we introduce additional lump-sum tax on all living households satisfying the budget balance requirement of the public health insurance system.
These effects become greater if we consider such a copayment case that its amount increases with age (according to the assumed individual medical cost). In this case all households have an incentive to work more and save more during their working ages because they have to pay more medical costs as they age.
Because government bond holding by entities overseas is small in Japan as of 2010, in this section, we assume that the utility parameter η j for foreign households is zero. Under this assumption, they do not hold Japanese government bonds because the return on government bond is always dominated by the return on capital stock.
Here, we assume that the economy is initially at the steady state, which corresponds to the terminal steady state described in the previous sections.
Most demographic changes are anticipated by households through various future population projections made by government or private institutions and they rarely materialize as shocks. To capture this effect, in this section, we assume that the demographic change is anticipated by households 10 years before it materializes in period t = 1.
Admittedly, the assumed rate of return on foreign capital is critical in determining the extent both of capital outflows and income inflows. For example, in an alternative case where the rate of return on foreign capital declines gradually, as it would if population aging were also taking place abroad, foreign capital also becomes less attractive than before. As long as the foreign return is higher than the domestic one, income flows remain positive; but they will be smaller than those shown in Figure 9 and the decline in GNP due to population aging will be correspondingly less mitigated.
Our result is consistent with the findings of Ferrero (2010), who evaluates the demographic effects on U.S. current account developments, based on the life-cycle model of Gertler (1999).
See footnote to Table 1 for the definition of “more developed countries.”
Admittedly, our discussion here abstracts from the TFP movements considered key determinants of current account dynamics in existing studies such as Ferrero (2010) and Chen, İmrohoroğlu, and İmrohoroğlu (2009). In these studies, a difference in TFP growth rate between the two countries plays a dominant role in their current account dynamics as it substantially affects their respective returns to capital.
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