general » Demographics and Foreign Trade: What Are the Effects of an Aging Population on the Current Account Balance of an Economy?

Demographics and Foreign Trade: What Are the Effects of an Aging Population on the Current Account Balance of an Economy?

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The change in the age structure of a society has an impact on key macroeconomic variables, including the savings and investment ratios, the inflation rate and overall economic productivity. Our forthcoming paper outlines some central relationships between the ageing of population in developed industrial economies and their current account balances.

Current account balance and demographics – fundamental relationships

A country’s current account records all its external transactions with the rest of the world. Empirically, foreign trade activities – i.e. a country’s exports and imports – make up by far the largest part of the current account. Consequently, changes in exports and imports are decisive for the development of the current account balance.

In developed industrial economies, the population will age in the following decades. As a result, the working population is ageing and shrinking. At the same time, the ratio of people of working age to those of retirement age is declining. This demographic development has considerable macroeconomic consequences, which also affect exports and imports. Of particular relevance are age-related changes in productivity, savings and inflation.

 

1 Age-related dampening of macroeconomic labor productivity

With regard to the relationship between the labor productivity of an individual worker and his or her age, a reverse U-shaped relationship can be expected:

  • Young people are either still in education or at the beginning of their careers. They have usually low labor productivity.
  • With increasing age, the knowledge gained through experience increases, so that the productivity of the workers also increases.
  • At a higher age, physical and cognitive performance decreases. Initially, this can still be compensated for by experience, but a decline in labor productivity can be expected with increasing age.

 

People in developed economies currently achieve the highest productivity on average at around 50 years of age. If the ageing the workforce leads to large parts of the workforce exceeding this age, this will have a productivity dampening effect on the economy.

 

2 Age-related decline in the savings ratio

Three age groups can be roughly distinguished in terms of the ability to accumulate savings:

  • Young people and young people in employment: These people either do not earn any income at all or earn only a small income. Their ability to make savings is therefore extremely limited or non-existent.
  • Older workers: With increasing age and work experience, earned incomes generally rise. This extends the possibility of accumulating savings. At the same time, this age group also has a high incentive to save for old age.
  • People of retirement age: As pension payments are lower than income from work, the ability of people of retirement age to accumulate savings decreases. At the same time, the assets accumulated during the employment phase are partially dissolved in order to maintain the material standard of living. This leads to a de-saving.

 

In a society where there are many people of retirement age and relatively few of working age, the macroeconomic savings ratio (defined as the ratio of macroeconomic savings to GDP) hence falls.

 

3 Age-related rise in inflation rate

The influence of population ageing on a country’s inflation rate can be estimated by comparing the quantity of goods produced by different age groups with the quantity of goods consumed:

  • If a certain age group consumes more goods and services than it produces itself, this has a price-increasing effect. This is the case with children, young people and pensioners, so that an inflation-increasing effect can be expected from these groups of persons or ages.
  • The age groups whose members are involved in the production of goods, on the other hand, tend to have a dampening effect on inflation. This applies to all those in employment who make savings.

 

As the number of people of retirement age rises, inflation can therefore be expected to rise.

 

Consequence: age-related decline in current account balance

Important determinants of the current account balance are international competitiveness and domestic demand (see Chart 1).

  • As an ageing society is characterised by declining labor productivity and rising price levels, the international competitiveness of the economy is declining. As a result, this society will export fewer goods and services and tend to import more instead. This will result in a decline in the current account balance.
  • A high proportion of older people leads to a decline in the overall savings rate. At the same time, this means that the share of consumer demand in GDP is increasing. As a result, fewer goods and services are left for export. Thus, the difference between exports and imports is shrinking. If the country already has a current account deficit, it will become larger.

effects of ageing population

 

 

Outlook

In a next step, the theoretically expected effects of population ageing on a country’s current account can be combined with the predicted demographic developments of the coming decades. We will describe the resulting effects on foreign trade next week when the project “Demographic Resilience and Participation” publishes a study on the macroeconomic effects of ageing in selected industrial nations.

 

 

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