Demographic Pressures on Public Pension Systems and Government Budgets in Open Economies

Abstract

Demographic shifts profoundly influence the world economy, directly in the national economies experiencing the shifts and indirectly through changes elsewhere brought about by crossborder transactions. The research summarized in this paper is part of a project to study the global dimensions of demographic change, emphasizing macroeconomic effects working through changes in exchange rates and external-sector variables which in turn have major consequences for saving and investment flows in national economies and the world economy as a whole. Comparing alternative variants of public pension systems, this paper studies the domestic-economy and external-sector consequences of rising elderly dependency ratios brought about by earlier declines in fertility. It shows that alternative ways of operating public pension systems and managing government debt can lead to substantially different macroeconomic outcomes, especially when the openness of economies is fully integrated into the analysis. The paper also challenges the conventional wisdom that population causes unambiguously adverse macroeconomic consequences. For an open economy that is moving faster into or is further along in its demographic transition, negative consequences accompanying the demographic shift are typically cushioned because the negative effects are shared with the rest of the world. Such cushioning and sharing may not be desirable as seen from the perspective of foreigners, but it may produce sizable welfare gains for home residents.