Demographics, Old-Age Transfers and the Current Account

IMF Working Papers, December 7, 2018

Source details

Paper authors: Mai Dao, Callum Jones.
Publication date: December 7, 2018.
Core focus: Reviews the relationship between demographics and long-run capital flows in both theory and in the data.
Approach: Develops a two region overlapping generations model where countries differ in their population growth and mortality risk.
Main finding (model): Population structure and life expectancy (which affects the need to save to meet old age consumption) affect current account levels.
Main finding (transfers): Countries with more generous unfunded transfer schemes tend to have lower saving and more capital inflows over the long-run, although this effect may be dampened by natural limits (on taxation) of these schemes.
Empirical support: The key predictions of the model are generally supported by a rich panel dataset.

Model type: two region overlapping generations (OLG) model.
Cross-country differences modeled: population growth and mortality risk.
Mechanism emphasized: life expectancy affects the need to save for old-age consumption, thereby influencing saving rates and current account levels.
Role of transfer schemes:
- Unfunded (pay-as-you-go) old-age transfer schemes reduce private saving incentives.
- More generous unfunded transfer schemes are predicted to generate more capital inflows (i.e., lower current account balances), subject to constraints.
- Dampening factor: natural limits on taxation that finance these schemes can limit the magnitude of the effect.

Data: A rich panel dataset is used to test model predictions.
Result: The key predictions of the OLG model are generally supported by the panel evidence presented.

Demographic changes (population structure and life expectancy) should inform assessments of countries’ long-run saving behavior and current account positions.
Design and sustainability of old-age transfer schemes matter for cross-border capital flows:
- Generosity of unfunded schemes can lower national saving and increase capital inflows.
- Fiscal and political constraints on taxation to finance unfunded schemes can limit these effects, implying trade-offs between intergenerational redistribution and external balance dynamics.

Demographics, Old-Age Transfers and the Current Account, WP/18/264, December 2018
- Demographics, Old-Age Transfers and the Current Account, WP/18/264, December 2018 (Markdown version)
- Demographics, Old-Age Transfers and the Current Account, WP/18/264, December 2018 (PDF)