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October 18, 2005

Pessimist Turns Optimist

Michael Mandel

Can Chinese savings bail out the developed countries over the long run? In a very interesting new study, three economists, including long-time fiscal pessimist Larry Kotlikoff, say yes:

In previous studies that excluded China we predicted that tax hikes needed to pay benefits along the developed world's demographic transition would lead to capital shortage, reducing real wages per unit of human capital. Adding China to the model dramatically alters this prediction. Even though China is aging rapidly, its saving behavior, growth rate, and fiscal policies are very different from those of developed countries. If this continues to be the case, the model's long run looks much brighter. China eventually becomes the world's saver and, thereby, the developed world's savoir with respect to its long-run supply of capital and long-run general equilibrium prospects. And, rather than seeing the real wage per unit of human capital fall, the West and Japan see it rise by one fifth by 2030 and by three fifths by 2100. These wage increases are over and above those associated with technical progress.

In the study, called "Will China eat our lunch or take us out the dinner?", the three authors, Hans Fehr, Sabine Jokisch, and Kotlikoff say:

our earlier studies, with their dismal forecasts that the interaction of aging and huge fiscal commitments to the elderly will undermine the macro economies of the developed world, omitted two issues. Both of these issues are taken up here, and both militate against a severe capital shortage.

The first is government investment. In our prior studies we treated all government purchases as current consumption. There is some logic for doing so, since many so-called government investment goods (e.g., tanks, office buildings to house bureaucrats, space vehicles) may make little or no contribution to the nation?? output and productivity and, indeed, may do the opposite. On the other hand,the lion?? share of government investment, be it in constructing roads, erecting schools, building research labs, does seem to be productive.

Treating what governments call investment as investment in the model doesn?? entirely eliminate the predicted long-term capital shortage, but it does significantly mitigate it. Compared with its 2004 value, the model?? real wage per unit of human capital in 2100 is reduced by only 4 percent rather than by 20 percent.

The second omission is China. As everyone knows, China is already a major producer of world output. Its GDP now equals roughly one ninth of U.S. output. China is also absorbing Western and Japanese technology at a rapid clip. This acquisition of technology, in combination with improved education, holds the prospect for ongoing real income growth in China. But, given China?? exceptionally high saving rate, more income growth in China means more Chinese saving that can be invested in the developed world as well as in China.

What about the fiscal situations in the U.S. and the other advanced countries? The study says:

Due to the dramatic aging of populations,social security tax rates increase through 2050 by 5.5 percentage points in the U.S., by 12.8 percentage points in the EU, by 13.8 percentage points in Japan, and by 7.8 percentage points in China. Over the century the respective increases are 11.4 percentage points in the U.S. and the EU, 10.7 percentage points in Japan and 16.6 percentage points in China. These changes constitute very major percentage payroll tax hikes given the base-year values. In the U.S. and China, for example, the model is predicting more than a 100 percent rise in payroll tax rates.

Despite the rising payroll tax burden, capital stocks rise dramatically in all regions over the course of the century.

Conclusion: Yes, we will pay a lot of taxes, but our living standards will rise.

More to come on this very important paper.

08:47 AM

Fiscal Policy

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I had mentioned to my family about moving to any country in Asia. They told me that there is no freedom there. I told them the same hold true for U.S.

My belief now is that the healthcare is going down; the belief of eating healthier is increasing -unlike the 90's and now, obseity is on the rise- and the usage of alternative medicine is increasing. It is no wonder that the Asian and the Latin countries are living longer than the U.S. citizens!

Your statement is on point, and I hope that the rest of the world would "wake up and smell the coffee (decaf please)!"

Posted by: Amethyst at October 19, 2005 04:26 PM


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