Piggy Bank to the World


By Michael Mandel If you made a list of respected pessimistic economists, Laurence J. Kotlikoff of Boston University would be near the top. For years he has warned that an aging population and overspending on entitlements were going to send budget deficits and tax rates skyrocketing, driving up interest rates and creating a capital shortage for decades. In 2004, Kotlikoff wrote: "We are heading into one God-awful fiscal storm, the full dimensions of which are hard to fathom."

But now this notable gloom-and-doom type has turned a bit cheerier. The reason: the China effect (see BW Online, 10/20/05, "Betting on China's Banks"). In a new paper, Kotlikoff and his two German co-authors, Hans Fehr and Sabine Jokisch, find that a flood of Chinese savings over the next 40 years could turn the anticipated capital shortages into capital gluts instead -- not just in the U.S, but in Europe and Japan as well.

"GENERATIONAL ACCOUNTING." According to their calculations, the potential impact of China is so large that global interest rates could drop by as much as a third by 2050, even with all the expected government borrowing. Those lower rates, in turn, could finance more business investment, boost productivity, and raise national incomes across the developed world. "It's potential good news in a very bleak fiscal picture," says Kotlikoff.

Their study, entitled Will China Eat Our Lunch or Take Us Out to Dinner?, represents a serious attempt to project China's long-term effect on the global economy. Kotlikoff's expertise is in long-run projections, as one of the creators of "generational accounting," a way of measuring how tax and spending policies affect different age groups over time.

For the China study, the three economists accounted for a host of variables, including the aging of the Chinese, European, Japanese, and American populations, shifts in savings behavior, immigration, and the future of health-care costs. In the end, it turned out that even if Chinese growth slows, it still could generate enough savings to hold down global interest rates, at least through the middle of the century.

WAGE GAINS, TOO? Surprisingly, the study also predicts that the China effect could boost average wages in developed countries by more than 15% by 2030. The reason? Lower interest rates will make it easier for U.S., European, and Japanese companies to invest in productivity-enhancing equipment -- and at least some of the benefits will be won by labor.

At the same time, real wages will rise fast enough in China to greatly close the gap with the developed countries, making competitive pressures less intense.

True, any economic model that projects out 50 years or more must be taken with a big dose of skepticism. Nevertheless, the potential size of the China effect could help justify the willingness of foreign investors to risk buying into Chinese state-owned banks. If Kotlikoff and his two co-authors are right, China will be the source of savings for the world for a long time.

Mandel is chief economist for BusinessWeek


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