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The world is in the midst of a historically unprecedented demographic transition that is having—and will continue to have—profound effects on the size and age structure of its population (Figure 1). Before 1900, world population growth was slow, the age structure of the population was broadly constant, and relatively few people lived beyond age 65. This began to change during the first half of the twentieth century as rising life expectancy boosted population growth, although initially there was little change in the age structure of the population.4 The second half of the twentieth century saw the start of another phase in this transition. Fertility rates declined dramatically—by almost one-half—causing population growth to slow, the share of the young in the population to decline, and the share of the elderly to increase. The share of the working-age population, however, changed little.
These global developments mask considerable variation between countries and regions that are the result of very different fertility, mortality, and migration trends. For example, although fertility rates have fallen almost universally in recent decades, they remain much higher in developing than in advanced countries, where they are generally below the replacement rate.5 Even among developing countries, considerable differences exist—fertility rates are high in Africa and the Middle East, but are below replacement rates in east Asia and central and eastern Europe. Likewise, while life expectancy has risen across the globe over the past 50 years—and the largest gains have generally been made in developing countries— life expectancy still remains much higher in advanced countries. Exceptions to the generalized increase in life expectancy are Africa—where as a result of the HIV/AIDS

This paper examines the economic implications of this demographic transition for Japan, the United States, other industrial countries (largely in Europe), and developing regions of the world using a four-country version of the MSG3 dynamic intertemporal general equilibrium model (or DSGE model from the macroeconomics literature) extended with an OLG Blanchard approximation. This model was developed by McKibbin and Nguyen (2004). The demographic transition is calibrated to the “medium variant” of the United Nations population projections. The model innovates upon existing OLG multicountry models by introducing a three-sector production technology, rule-of-thumb behavior, real and nominal rigidities, and different types of capital into more basic general equilibrium optimizing OLG setups. In doing this it brings together features of real business cycle models—with a fully articulated analysis of forward-looking producers and consumers—and modern macroeconometric DSGE models—describing the effects of demand downturns in the face of wage (and price) stickiness.

We find four main results:

•    Population aging in industrial countries will reduce growth, beginning in Japan in the next decade and then the rest of other industrial countries by the middle of the century.

•    In contrast, as the relative size of their working-age populations increases, developing countries will enjoy a “demographic dividend” that should result in stronger growth over the next 20–30 years, before aging sets in.

•    Demographic change will also affect saving, investment, and capital flows. Japan and to a much lesser extent the other industrial countries—the fastest aging countries— could see large declines in saving and a deterioration in their current account positions as the elderly run down their assets in retirement.

•    Results are sensitive to assumptions made about productivity growth and external risk premia.

IMF