The Discovery Of Age Structure II

The East Asian Tigers


The East Asian development experience has often been cited in support of the age transition demographic dividend view, since in the south east Asia "tiger" countries, as the transition progressed a successful export-oriented growth-strategy produced more than enough jobs to absorb the rapidly growing workforce. At the same time, a relatively stable macroeconomic environment – at least until the financial crisis of the late 90s – provided a fertile and attractive investment environment.

Ongoing work by a number of researchers has enticingly suggested that a significant part of the impressive rise in Asian savings rates can be explained by the equally impressive decline in dependency burdens, and that some of the notable difference in savings rates between a previously sluggish South Asia and a booming East Asia can be attributed to differences in the relative dependency burdens. This view also fuels the rather optimistic hypothesis that some of the savings gap between the two regions should reduce as youth dependency rates fall in South Asia over the next three decades.


Debate over the East Asian "miracle" really begins with the work of Alwyn Young, who, in a couple of extraordinarily provocative papers (Young, 1994, 1995), attempted to demonstrate that the rapid economic growth that was only too evident in the Asian Tiger countries was principally attributable to increases in factor inputs - notably labor, capital, and education - rather than to general improvements in total factor productivity. If Young was right, then the key to understanding the rise in income levels in East Asia lay in understanding the driving mechanisms such a growth in inputs.

All of the Asian Tiger economies enjoyed a surge in savings and investment during the high-growth period. The private savings rate in Taiwan, for example, rose from around 5% in the 1950s to well over 20% in the 1980s and 1990s. (It is perhaps worth noting that much of the debate surrounding the savings issue has focused on Taiwan since the data on household savings in Taiwan is fairly comprehensive).

As predicted by the life cycle hypothesis, savings rates in Taiwan were found to vary by age, being highest in Taiwan for households whose heads were in the 50-60 age range. Using this date Bloom and Williamson argued that changing age structure was a plausible explanation for the evident increase in aggregate saving. In support of this view they cited a number of previous studies (both "historic" and more recent ones) that had also found a strong connection between these two variables (Fry and Mason, 1982; Higgins, 1998; Higgins and Williamson, 1997; Kelley and Schmidt, 1996; Leff, 1969; Mason, 1987, 1988).


In terms of prior work, Higgins and Williamson (1996, 1997) had estimated the largest macro impacts. Higgins and Williamson attempted to estimate the effect of changes in population age distribution on changes in, rather than levels of, the savings rate as it deviated around the 1950–92 mean. Thus East Asia’s savings rate in 1990–92 was 8.4 percentage points above its 1950–92 average due to the transition to a much lower dependency burden. Similarly, East Asia’s savings rate in 1970–74 was 5.2 percentage points below its 1950–92 average due, in part, to the size of the dependency burden.

They found the value of the total demographic swing to be a sizeable 13.6%, a swing which would appear to account for almost the entire rise in the savings rate in East Asia over the 20 years in question. The figures for Southeast Asia are similar, but not quite so dramatic. Southeast Asia’s savings rate was 7.9% higher in 1990–92 than the 1950–92 average and the mean was 3.6% between 1970–74. The total demographic swing was 11.5%, a smaller figure than for East Asia, but still apparently sufficient to account for the entire post 1970 rise in the Southeast Asia savings rate. Since the demographic transition had been slower in South Asia, the more modest changes in the savings rate were, more or less, to be anticipated.


Higgins (1998) carried out an econometric investigation of the relations between national age distributions and savings and investment rates for a sample of 100 countries, using both time-series and cross-section data. The results once more point to substantial demographic effects, with increases in both the youth and old-age dependency ratios associated with lower saving rates.

Perhaps more important for the agenda it would set for subsequent work, the results pointed to differential demographic effects on savings supply and investment demand, and thus, to a role for demography in determining the residual between the two: net capital flows or the current account balance (CAB).

In particular, he found that high youth dependency rates demonstrated a strong relation with current account deficits, with nations being found to join the ranks of the capital exporters as they mature. The estimated demographic effect on the CAB has exceeded four percent of GDP over the last three decades in many countries.


This Hiigins paper (which was based on his earlier doctoral thesis: he was one of Jeffrey Williamson's students) is best interpreted as extending the youth-dependency thesis Coale and Hoover (1958) had advanced almost forty years earlier, moving from an exclusive focus on saving rates to incorporating the associated impacts on investment and the CAB.

His finding that maturing nations tend to graduate from reliance on capital imports also has important implications concerning the possible evolution of the global savings pool in the decades which lie ahead. In particular, currently developing nations should be expected to be increasingly able to finance their own investment needs — a prospect which stands in in stark contrast to the pessimistic prognoses of the early 1990s ( For example, Depak Lal, 1991)

Higgin's other major finding was that population dynamics accounted for a substantial share of East Asia’s economic miracle. Population dynamics accounted for something between 1.4 and 1.9% of East Asia’s annual growth in GDP per capita from 1965 to 1990, or as much as one-third of observed economic growth during the period. Using a modified definition of "miracle" (and assuming, as Higgins does, that hypothetical "steady-state" growth in East Asia was a rate of about 2% a year) as everything in excess of steady state growth, or about 4.1% (subtracting the notional 2 from the acieved 6.1 % growth rate). Population dynamics could then account for almost half of this observed difference or miracle. Now accounting for one-third or one-half of the East Asian growth certainly does not explain everything, but it does suggest that population dynamics may have been the single most important determinant of this 'extra' growth.

Within Asia itself, the evidence also suggests that demographic divergence contributed significantly to economic divergence during this same period.

Deaton and Paxson (2000) however throw something of a bucket of cold water on all of this since, using household savings data for Taiwan, they find that changes in age structure account for only a modest increase in the overall savings rate, perhaps 4 percentage points. They argue that the rise in the aggregate savings rate has not been mainly due to changes in the age composition of the population but, rather, to a secular rise in the savings rates of all age groups.

Accepting this finding at face value, the question then arises as to why savings rates should have risen at each age. One possible - and intriguing - explanation, proposed by Lee, Mason, and Miller (2000) is that increased savings rates are due to rising life expectancy and an increasing need to fund retirement income. In support of this idea Tsai, Chu, and Chung (2000) show that the timing of the rise in household savings rates does indeed match the recorded increases in the life expectancy of the population.

With a fixed retirement age we would expect such a savings effect. However, Deaton and Paxson (2000) argue that in a flexible economy, without mandatory retirement, the main effect of a rise in longevity will be on the span of the working life, with no obvious prediction for the rate of saving. Bloom, Canning, and Moore (2004) formalize this argument to show that under reasonable assumptions the optimal response to an improvement in health and a rise in life expectancy is to increase the length of working life, though less than proportionately, with no need to raise saving rates at all (due to the gains from enjoying compound interest over a longer life span).

Schultz (2005) has also argued that the estimated magnitude of the dynamic aggregate relationship identified by Higgins and williamson may be appears smaller than reported, as well as suggesting that the HW effect may be sensitive to the choice of econometric methods used to describe it. referring directly to the Deaton and Paxson finding that savings behavior at the household level does not demonstrate sufficient life cycle variation, he asks whether there might not be alternative explanations for the observed trends in savings? One possibility explanation for the empirical regularities would be the substitution of savings for children, and this in fact could be explained within a household lifetime demand framework.

There may also be a demographic effect as a longer prospective life span can change life-cycle behavior, leading to a longer working life or higher savings for retirement. Recent empirical literature on economic growth does indeed provide compelling evidence that health status, longevity and the age distribution do indeed have strong connections to economic growth (Bloom, Canning, and Graham, 2003; Bloom, Canning, and Moore, 2004, Kinugasa, 2004, Kinugasa and Mason, 2005, Mason 2005).


While in theory a longer life span should be associated with a longer working life, in practice this may not be the case. Bloom, Canning, and Graham (2003) find that, even allowing for age structure effects, longer life expectancy is strongly associated with higher national savings rates across countries, which suggests that there is a savings effect.

While the optimal response with perfect markets may be for workers to have a longer working life as their health improves and they have longer life expectancies, mandatory or conventional retirement ages, coupled with the strong financial incentives to retire that are inherent in many social security systems, seem to result in early retirement and increased needs for saving for old age.

Also old age "dependency" is something of a misnomer. Lee (2000) shows that, in all pre-industrial societies for which he was able to assemble evidence, the flow of transfers is from the middle-aged and old to the young. In developed countries, on the other hand, both the young and the old benefit from government transfers, and the net pattern of transfers is towards the elderly. However, at the level in the United States and elsewhere, elderly households in fact make significant transfers to middle-aged households, undoing to some extent the effects of government policy. This seems to suggest that the dependency burden of the elderly is a function of the institutional welfare systems that are in place rather than an immutable state of affairs.


Beyond East Asia, a number of other studies appear to have leant more support to the demographic dividend idea. Bloom and Canning (2003), for example, look at the case of Egypt. Between 1965 and 1990 Egypt’s working-age population grew at the rate of 2.61% per annum. This rate was about about 30 % faster than the growth rate in the dependent population and is closely comparable to the corresponding rates of population change among slow-growing South Asian countries. By contrast, the working-age population of the East Asian countries grew at approximately ten times the rate of the dependent population during the "miracle" years, as the "baby bulge" cohort entered the prime-age worker group. In East Asia this was also associeted with a drop in fertility beyond the replacement level. Using simple econometric regressions Bloom and Canning estimated that - not unexpectedly - during the early phases of Egypt’s demographic transition age changes contributed a modest, but not insignificant, 0.4 percentage points to Egypt’s economic growth rate during 1965–1990.


New section

Despite having achieved a certain degree of recognition and empirical successes, the variable rate-of-growth effect model is unlikely to provide a complete theoretical framework for understanding the behavior of saving rates and capital flows over whole course of the demographic transition. In particular, the variable rate-of growth effect model describes only one possible relation - that of a hypothetical steady-state relationship between dependency and saving rates - a shortcoming which in part from its life-cycle theory ancestry.

Continuing demographic change over the past half century, however, suggests that we look more to transitional dynamics if we want to more fully understand the observed correlation between dependency and saving rates and capital flows.

In this vein Higgins and Williamson (1996) show that the variable rate-of-growth effect model can be subsumed under the standard textbook neoclassical growth model, suitably modified to incorporate an overlapping generations population (see e.g., Blanchard and Fischer, 1988). The standard growth model is, in essence, simply an open-economy, steady-state version of the latter. The textbook overlapping generations model need only be augmented by adding a third period of life - childhood alogside old age — in order to accommodate a more comprehensive study of dependency effects.


References:

Bloom, D. and D. Canning, 2003. From demographic lift to economic lift-off: the case of Egypt, Applied Population and Policy 2003:1(1) 15–24.

Kinugasa, T. (2004). Life Expectancy, Labor Force, and Saving, Ph.D. Dissertation. University of Hawaii, Manoa.

Kinugasa, T. and A. Mason, 2005, The Effects of Adult Longevity on Saving, mimeo, University of Hawaii, Manoa

LAL, Deepak, 1991, "World Savings and Growth in Developing Countries", Discussion Papers in Economics No. 91-05, University College, London.

Mason, A. 2005, Demographic Transition and Demographic Dividends in Developed and Developing Countries, Paper presented at the United Nations Expert Group Meeting on Social and Economic Implications of Changing Population Age Structures, United Nations Department of Economic and Social affairs, Mexico City, Mexico, September 2005

Schultz, P.T. 2004, Demographic Determinants of Savings: Estimating and Interpreting the Aggregate Association in Asia, Economic Growth Centre, Discussion Paper No. 901, Yale university, New Haven.