Effects of longevity and dependency rates on saving and growth: Evidence from a panel of cross countries

Abstract

While earlier empirical studies found a negative saving effect of old-age dependency rates without considering longevity, recent studies have found that longevity has a positive effect on growth without considering old-age dependency rates. In this paper, we first justify the related yet independent roles of longevity and old-age dependency rates in determining saving and growth by using a growth model that encompasses both neoclassical and endogenous growth models as special cases. Using panel data from a recent World Bank data set, we then find that the longevity effect is positive and the dependency effect is negative in savings and investment regressions. The estimates indicate that the differences in the demographic variables across countries or over time can well explain the differences in aggregate savings rates. We also find that both population age structure and life expectancy are important contributing factors to growth.

Introduction

The last century has seen dramatic increases in life expectancy around the world (e.g. Lee and Tuljapurkar, 1997). This has been accompanied by low fertility in industrial countries, causing serious population aging and higher old-age dependency rates. Both individuals and governments are increasingly concerned about the effects of aging, though their concerns differ. Individuals are more concerned about increased longevity because it affects their own financial and labor market plan (Hurd, 1997), whereas governments are more concerned about old-age dependency as an aspect of population aging (Weil, 1997). Yet it is important to realize that individual aging leads to population aging (holding other things constant). The significance of these demographic changes has attracted a great deal of attention among economists (see, e.g., Bos and von Weizsacker, 1989, Cutler et al., 1990, Lee and Skinner, 1999, Lagerlöf, 2003).

One of the issues at the heart of the related empirical investigations is the effect of demographic changes on national savings, investment, and economic growth. There are two separate sets of related studies in the literature. One set of them is concerned with the effect of population dependency rates on aggregate savings, following the seminal work of Leff (1969) that finds a significant negative effect of the old-age dependency rate on the aggregate saving rate. For example, Edwards (1996) finds evidence that supports Leff's early results. However, Adams (1971), Gupta (1971), Goldberger (1973), and Ram, 1982, Ram, 1984 present cases in which the dependency effect on savings may be insignificant or even positive.¹ This debate has concentrated on one important aspect of the issue: the relationship between age and savings. However, the entire debate and related empirical work have ignored another important aspect of the issue: the relationship between savings and expected life span. What happens to savings regressions if life expectancy and old-age dependency are jointly considered?

In contrast to the studies on aggregate saving rates, the other set of the related studies has paid little attention to dependency rates and has instead focused on the effect of longevity in investment and growth regressions. It has typically found a positive effect of longevity on investment and growth (e.g. Ehrlich and Lui, 1991, Barro and Sala-i-Martin, 1995, Ch. 12).² The strong positive effect of longevity on growth is interpreted by Barro and Sala-i-Martin as a reflection of growth enhancing factors (in addition to good health itself ) such as good work habits and high levels of skill. We will offer a different interpretation by giving a more direct role for longevity in life-cycle optimization. In general, this set of studies has omitted dependency rates in growth regressions. Due to this omission, it cannot capture an important aspect of the issue: removing a group of workers from production and adding them to the dependent population will obviously change both the level and growth rate of output per capita.

At a theoretical level, the longevity versus dependency effects we have discussed here simply reflect two aspects of the life-cycle hypothesis. On the one hand, individuals save more when they expect to live longer. On the other hand, when the population becomes older, dissavers increase in number relative to savers. Intuitively, both middle-aged and old-aged individuals contribute to aggregate savings. With increasing life expectancy, at a given point in time, middle-aged individuals save more and raise aggregate savings. However, increasing life expectancy also implies more old people who dissave and reduce aggregate savings. Hence, the effect of rising longevity can only be estimated with the population age structure held constant, and vice versa.

In this paper, we first construct a simple growth model with overlapping generations that encompasses both neoclassical and endogenous growth models as special cases, to shed light on the explicit and separate roles of life expectancy, dependency rates, and fertility (or population growth). We show that rising longevity (life expectancy) raises the saving rate at both the household level and aggregate level, and that it raises the growth rate of output per capita. However, a rising old-age dependency rate lowers the aggregate saving rate, whereas a rising total dependency rate reduces the growth rate of per capita output. Although demographers have long noticed the importance of both fertility and longevity to the dependency ratio, economists have largely ignored one of the factors in their analysis. Thus, we contribute to the economic literature by taking into account these realistic demographic factors.

We then carry out a panel study using the World Bank's World Development Indicators 2005 dataset, which contains more substantial information for over two hundred countries from 1960 to 2004 than previously used data sets.³ Consistent with our intuitive and theoretical predictions, our fixed effects estimations show that the longevity effect is positive and the dependency effect is negative in the saving, investment, and growth regressions. The findings are generally robust when we add other determinants of savings, investment, and growth.

The remainder of this paper is organized as follows. Section 2 justifies the roles of life expectancy, population growth, fertility, and the population age structure in the determination of aggregate savings and per capita income growth in a simple growth model with overlapping generations. Section 3 describes the data and the empirical specifications. Section 4 reports the regression results. The final section provides concluding remarks.