The Demographic Transition in Closed and Open Economy: A Tale of Two Regions

This paper constructs a general equilibrium overlapping generation model to evaluate quantitatively how a demographic transition (falling mortality and fertility rates) a ects aggregate variables (wages, interest rate, output), and inter-generational welfare in closed and open economy. We perform this analysis for two economies calibrated to resemble to the North (US and Europe) and Latin America. Our simulations suggest that the demographic transition could have generated income per capita growth up to .5% per year in excess of steady-state growth in the past 50 years in Latin America and .3% in the North. When we assume that the two regions will not open to capital ows, the main nding is that while the bene cial e ects for the North will quickly fade away in the next decade, Latin America should still bene t from higher than average growth rates for the next half century at least. In terms of welfare, the demographic transition in closed economy is costly for the North, while in Latin America it will generate welfare gains up to 20% of lifetime consumption. When we allow for perfect capital mobility across the two regions, starting from the mid 90's, the key result is that international capital ows accelerate the adjustment process in Latin America by exacerbating income growth in the short-run and reducing it in the long-run. The largest relative welfare gains from opening the economy (relative to the closed economy transition) accrue to the baby-boom generations in the North (+2%), and to the cohorts born around the opening in Latin America (+6%). The reason is that the implied capital ows across regions raise the interest rate in the North and the wage rate in Latin America.