Demographic Change and the Current Account: Theory and Empirical Evidence

This paper examines the effects of population growth on national saving, investment, and the current account. An open-economy overlapping generations model with a pay-as-you-go social security system is used to derive the following theoretical predictions: (i) the investment rate is increasing in the population growth rate; (ii) the saving rate is ambiguously related to the population growth rate but negatively related to the social security tax rate; and, therefore, (iii) the current account is also ambiguously related to population growth and negatively related to the tax rate. The empirical evidence, using data from the 1970 to 2003 period for various subsets of 154 economies, supports the following: (i) both the investment and saving rates are negatively related to population growth and government size, but positively related to growth; and (ii) these effects on saving are stronger, and so the net foreign balance is also negatively related to both population growth and government size.