Will China Eat Our Lunch or Take Us to Dinner? Simulating the Transition Paths of the US, EU, Japan and China

This paper develops a dynamic, life-cycle, general equilibrium model to study the interdependent demographic, fiscal, and economic transition paths of China, Japan, the U.S.,and the EU. Each of these countries/regions is entering a period of rapid and significant aging that will require major fiscal adjustments. But the aging of these societies may be a cloud with a silver lining coming, in this case, in the form of capital deepening that will raise real wages. In a previous model that excluded China we predicted that tax hikes needed to pay benefits along the developed world’s demographic transition would lead to a major capital shortage, reducing real wages per unit of human capital over time by one fifth. A recalibration of our original model that treats government purchases of capital goods as investment rather than current consumption suggests this concern was overstated. With government investment included, we find much less crowding out over the course of the century and only a 4 percent long-run decline in real wages. Adding China to the model further alters, indeed, dramatically alters, the model’s predictions. Even though China is aging rapidly, its saving behavior, growth rate, and fiscal policies are currently very different from those of developed countries. If successive cohorts of Chinese continue to save like current cohorts, if the Chinese government can restrain growth in expenditures, and if Chinese technology and education levels ultimately catch up with those of the West and Japan, 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 percent by 2030 and by three fifths by 2100. These wage increases are over and above those associated with technical progress, which we mod(This abstract was borrowed from another version of this item.)