Aging in Europe: Reforms, International Diversification, and Behavioral Reactions

This project extends a line of research based on multi-country overlapping generations models to study the effects of population aging on the interactions between economic growth and living standards with relatively mild labor market, pension, and educational reforms, behavioral adaptations, and international capital flows. It focuses on the three largest Continental European countries— France, Germany, and Italy—and juxtaposes them with the United States. A key question is which policy mixes are suitable to maintain living standards despite the strong decline in the support ratio. The main message of the project is twofold. First, it is misleading to argue that Europe could resolve all aging related problems by mobilizing the employment pool. Such policy proposals target the extensive margin of labor supply and ignore behavioral reactions at the intensive margin. Hence, responses to demographic change require not only structural reforms of labor markets and pension systems but also changes in the attitudes towards reform. Second, these attitudes are embedded in the interplay between preference parameters and the number of constrained households in our model. The strong substitution between the endogenous and exogenous part of labor supply for the unconstrained households may generate too pessimistic an estimate of the reform backlash and its effects on economic growth and living standards. On the other hand, all three new governments in France, Germany, and Italy are currently reversing pension and labor market reforms enacted by their predecessors, giving credibility to the force of reform backlash. The results were published in the American Economic Review, P&P in May 2014.