Aging, Factor Prices and Capital Flows

Although populations are aging in all economies, projections for coming decades describe differential timing and extent of aging. Advanced economies are aging earlier and faster than the developing and emerging economies, with Japan leading the way. In a world with integrated capital markets, these differences in demographic trends, with different social security environments, will have differential implications on national or regional capital accumulation, investment, factor prices and capital flows across borders. This paper develops a general equilibrium model of the world economy under imperfect capital mobility, populated by overlapping generations of individuals in three regions: the High-income (HI) and Middle-income (MI) regions and Japan. We compute equilibrium transitions from the 1990s toward a future balanced growth path and numerically characterize the first few decades. Our findings highlight the quantitative importance of the differential aging mechanism in studying capital flows across regions. In particular, we find that the projected decline in national saving in Japan, not matched with a similar decline in domestic investment, will lead to a reversal of capital flows into Japan, which will become a net borrower before 2050. The reason for Japan's attractiveness for foreign capital from the MI region is the initially rising but soon flattening path of its capital labor ratio while the MI region experiences a monotonically increasing capital labor ratio. This projection, coupled with the slow speed with which the MI region's TFP catches up with that of Japan, necessitates an outflow of capital from the MI region to the HI region and Japan in order for the world capital market to clear.

Published: Bonfatti, Andrea, Selahattin İmrohoroglu, and Sagiri Kitao, 2022. "Japan and the allocation puzzle in an aging world," Journal of Economic Dynamics & Control, Volume 145 (2022), 104544.
https://www.sciencedirect.com/science/article/abs/pii/S0165188922002470