Aging, Factor Prices, and Capital Flows

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 and productivity growth rates, 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), 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 and productivity growth in studying capital flows across regions. Japan starts out as a net lender but turns into a net borrower in 2045 and the pattern is driven by much earlier and larger-scale demographic aging than in other regions and the TFP level that remains higher than in MI region. Higher productivity levels in Japan and the HI region would lead the MI region to be a net lender throughout 1990-2070 with the HI region remaining a net borrower. We conduct alternative computations to quantify roles of the future TFP paths and differential aging dynamics across regions in determining future capital flows