DP5834 On the Consequences of Demographic Change for Rates of Return to Capital, and the Distribution of Wealth and Welfare

Author(s): Dirk Krueger , Alexander Ludwig

Publication Date: September 2006

Keyword(s): population aging , international capital flows , distribution of welfare

JEL(s): C68 , D33 , E17 , E25

Programme Areas: International Macroeconomics , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP5834.asp.asp

This paper employs a multi-country large scale Overlapping Generations model with uninsurable labour productivity and mortality risk to quantify the impact of the demographic transition towards an older population in industrialized countries on world-wide rates of return, international capital flows and the distribution of wealth and welfare in the OECD. We find that for the US as an open economy, rates of return are predicted to decline by 86 basis points between 2005 and 2080 and wages increase by about 4.1%. If the US were a closed economy, rates of return would decline and wages increase by less. This is due to the fact that other regions in the OECD will age even more rapidly; therefore the US is 'importing' the more severe demographic transition from the rest of the OECD in the form of larger factor price changes. In terms of welfare, our model suggests that young agents with little assets and currently low labour productivity gain, up to 1% in consumption, from higher wages associated with population aging. Older, asset-rich households tend to lose, because of the predicted decline in real returns to capital.