From Transfers to Individual Responsibility: Implications for Savings and Capital Accumulation in Taiwan and the United States

Abstract

A transition in a Third World society from a system of familial support for the elderly to a system of individual responsibility through saving and investment would have effects in some respects similar to a transition from a Pay As You Go public pension system to a funded system. Such a transition might lead to "super-saving" as individuals find themselves behind the normal life cycle trajectory of asset accumulation, and as the elderly continue to be supported by their adult children (or the public pension) so that their dissaving does not offset that of the working age population. But there are other factors at work as well, and the net effect is difficult to intuit. This paper uses a demographically realistic model which incorporates life cycle saving motives in the presence of changing familial or public transfers. We use it to simulate the effects of the change from transfer-based old-age support to a funded system, for Taiwan and for the US, and examine changes in aggregate saving and capital accumulation. We consider a variety of possibilities regarding the degree of foresight and the degree to which pre-existing transfer obligations are honored. Under pure life cycle saving, the demographic transition leads to a large surge in aggregate saving during the later phase of fertility decline, followed by a decline in saving as the population ages. Capital per worker, however, increases substantially and permanently over the transition. Population aging contributes to growth in output per worker, because old hold large capital stocks. This is evident in simulations for both Taiwan and the US. With a transfer system in place to provide for old age support at least partially, these effects on saving rates and capital per worker are muted, and both saving rates and capital follow a substantially lower path. Population aging causes a much smaller increase in capital under transfer systems. Population aging dramatically increases the implicit debt in a transfer system, making a change of system more costly and difficult. An early change to a funded system, while still costly, harnesses the power of population aging to drive capital accumulation, despite falling saving rates. Transfer systems for old age support generate large transfer wealth and corresponding implicit debts in the US Social Security system and in the family transfer system of Taiwan. In our simulations, there are between 1 and 4 times annual GDP. If obligations are honored, these implicit debts must be repaid during a transition toward individual responsibility for old age support through saving, prolonging the effects of the transfer system past the system's dissolution. The working age population at the start of the transition and for some time after bears the cost of the transition, and has reduced consumption, at least under the relatively low interest rates we have assumed.

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