Essays on Demographics, Structural Change and the Macroeconomy

Andrea Papetti

ESSAYS ON

DEM

OG

RAPH

ICS, STRUCTU

RAL CH

AN

GE A

ND

THE M

ACRO

ECON

OM

Y

ISBN 978-91-7731-141-6

DOCTORAL DISSERTATION IN ECONOMICS STOCKHOLM SCHOOL OF ECONOMICS, SWEDEN 2019

Andrea Papetti

ESSAYS ON DEMOGRAPHICS, STRUCTURAL CHANGE AND THE MACROECONOMY


This doctoral thesis in Economics consists of three chapters examining the macroeconomic impact of demographic and structural changes.

The first chapter (“Demographics and the real exchange rate”) analyzes how the change in the demand composition due to population aging leads a country aging more than its trading partners to have a significant real ex-change rate appreciation. It is shown that the quantitative estimates depend crucially on the general equilibrium effect of demographic change on the real interest rate. This effect is specifically analyzed in the second chapter (“Demographics and the natural real interest rate”). Calibrating an overlap-ping generation model for the euro area it is shown that aging exerts a per-manent downward pressure on the real interest rate, while only a limited set of structural and policy factors could mitigate this decline. The third chapter (“Structural skill-biased technical change’’) considers another force underly-ing the process of economic growth of advanced economies. It documents that in the process of systematic reallocation of economic activity from the goods sector to the services sector (``structural change’’), the relative hourly wage of the services sector decreases constantly over time. An explanation is provided: “skill-biased technical change” leads the relative skill-intensity in the goods sector to increase over time.

ANDREA PAPETTI holds a B.Sc. and a M.Sc in Economic and Social Sciences from Bocconi University and has worked for the European Central Bank. His main research fields are in monetary and international macroeconomics

Andrea Papetti

ESSAYS ON

DEM

OG

RAPH

ICS, STRUCTU

RAL CH

AN

GE A

ND

THE M

ACRO

ECON

OM

Y

ISBN 978-91-7731-141-6

DOCTORAL DISSERTATION IN ECONOMICS STOCKHOLM SCHOOL OF ECONOMICS, SWEDEN 2019

Andrea Papetti



This doctoral thesis in Economics consists of three chapters examining the macroeconomic impact of demographic and structural changes.

The first chapter (“Demographics and the real exchange rate”) analyzes how the change in the demand composition due to population aging leads a country aging more than its trading partners to have a significant real ex-change rate appreciation. It is shown that the quantitative estimates depend crucially on the general equilibrium effect of demographic change on the real interest rate. This effect is specifically analyzed in the second chapter (“Demographics and the natural real interest rate”). Calibrating an overlap-ping generation model for the euro area it is shown that aging exerts a per-manent downward pressure on the real interest rate, while only a limited set of structural and policy factors could mitigate this decline. The third chapter (“Structural skill-biased technical change’’) considers another force underly-ing the process of economic growth of advanced economies. It documents that in the process of systematic reallocation of economic activity from the goods sector to the services sector (``structural change’’), the relative hourly wage of the services sector decreases constantly over time. An explanation is provided: “skill-biased technical change” leads the relative skill-intensity in the goods sector to increase over time.

ANDREA PAPETTI holds a B.Sc. and a M.Sc in Economic and Social Sciences from Bocconi University and has worked for the European Central Bank. His main research fields are in monetary and international macroeconomics

Essays on Demographics, Structural Change and the Macroeconomy

Andrea Papetti

Akademisk avhandling

som för avläggande av ekonomie doktorsexamen vid Handelshögskolan i Stockholm framläggs för offentlig granskning

onsdagen den 28 augusti 2019, kl 10.15, sal 720, Handelshögskolan,

Sveavägen 65, Stockholm

Essays on Demographics, Structural Change and the Macroeconomy

Andrea Papetti

Akademisk avhandling

som för avläggande av ekonomie doktorsexamen vid Handelshögskolan i Stockholm framläggs för offentlig granskning

onsdagen den 28 augusti 2019, kl 10.15, sal 720, Handelshögskolan,

Sveavägen 65, Stockholm

Essays on Demographics, Structural Change andthe Macroeconomy

Essays on Demographics, StructuralChange and the Macroeconomy

Andrea Papetti

Dissertation for the Degree of Doctor of Philosophy, Ph.D.,in EconomicsStockholm School of Economics, 2019

Essays on Demographics, Structural Change and the Macroeconomyc© SSE and Andrea Papetti, 2019

ISBN 978-91-7731-141-6 (printed)ISBN 978-91-7731-142-3 (pdf)

This book was typeset by the author using LATEX.

Front cover picture: Figure, 1939 (oil on panel), painting by Cuban artist WifredoLam (1902–1982). Image rights: Jacques and Thessa Herold Collection. Photo:Courtesy of Valerie Thessa Herold c© Adagp, Paris 2015

Back cover picture:Courtesy of Juliana Wiklund c©

Printed by:BrandFactory, Goteborg, 2019

Keywords:Demographic transition, population aging, real interest rate, real exchange rate,structural change, skill biased technical change, consumption composition, life-cyclesavings.

iii

A Carolina, Simonetta e Paolo

Foreword

This volume is the result of a research project carried out at the Department of Eco-nomics at the Stockholm School of Economics (SSE).

This volume is submitted as a doctoral thesis at SSE. In keeping with the policiesof SSE, the author has been entirely free to conduct and present his research in themanner of his choosing as an expression of his own ideas.

SSE is grateful for the financial support provided by the Jan Wallander and TomHedelius Foundation which has made it possible to carry out the project.

Goran Lindqvist Tore Ellingsen

Director of Research Professor and Head of theStockholm School of Economics Department of Economics

Stockholm School of Economics

Acknowledgements

Undertaking the path leading to write a Ph.D. thesis involves some isolation which oneis tempted to consider the matter of a superior choice. For me it was rather born ofthe necessity to learn the suitable tools for thinking in economics, thus obtaining in asense ‘the right to speak’ and ultimately allowing for a new beginning associated withthe condition of plurality characterizing the vita activa (Hannah Arendt).

This undertaking would have been much harder without the help of my primarysupervisor, Lars Ljungqvist, to whom I am immensely grateful. He was essential insharing the purity of his economic thinking, to reduce matters to first principles as wellas to provide prompt suggestions to have the thesis timely completed.

My most grateful thanks go also to: David Domeij, who has allowed me to learnfrom his early work – the foundation of the first two chapters of the thesis – and hasbeen always available in case of need; Lars E.O. Svensson, for his support and forhaving allowed me to learn from his pragmatism; to Franco Bruni, who has been ableto not only continuously support me throughout my studies but also convey the civicsense that still guides my choices; to Claus Brand, for his encouragement and forgiving me the possibility to participate in very relevant debates.

I have great pleasure in acknowledging my gratitude to colleagues and fellow re-search scholars of the Stockholm Doctoral Program in Economics, Econometrics andFinance. The overall collaborative environment helped me a lot. In particular, I amvery thankful to Marta Giagheddu – co-author of the first chapter. She had the grace tomake the joint work so easy as well as to foster the first, most difficult, steps.

A final special thanks to Nicolo Cavalli – the third chapter originates from a dis-cussion with him – and to all the friends that managed to be so close to me during mydoctoral studies. Our homeland resides in a act of free will, dear and necessary.

Frankfurt am Main, May 5, 2019

Andrea Papetti

Contents

Introduction 3

1 Demographics and the real exchange rate 51.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61.2 Age-specific sectoral consumption data . . . . . . . . . . . . . . . . 91.3 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

1.3.1 Inspecting the mechanism: two-period version of the model . 171.4 Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211.5 Results: quantifying the long-run effect of demographics on RER . . . 251.6 Sensitivity analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 271.7 Empirical analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

1.7.1 Data and econometric methodology . . . . . . . . . . . . . . 321.7.2 Estimation results . . . . . . . . . . . . . . . . . . . . . . . . 34

1.8 Theoretical and empirical lesson on the relevance of demographics . . 351.9 Concluding remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . 38Appendix 1.A Model appendix . . . . . . . . . . . . . . . . . . . . . . . 40

1.A.1 Stationary equilibrium: optimality conditions . . . . . . . . . 401.A.2 On the role of imperfect substitutability of labor between sectors 421.A.3 Two-period model . . . . . . . . . . . . . . . . . . . . . . . 431.A.4 The role of country specific parameters . . . . . . . . . . . . 47

Appendix 1.B Data pattern and calibration appendix . . . . . . . . . . . . 501.B.1 Age-dependent sectoral consumption shares . . . . . . . . . . 501.B.2 Additional data patterns used in calibration . . . . . . . . . . 57

Appendix 1.C Empirical analysis appendix . . . . . . . . . . . . . . . . . 591.C.1 Panel cointegration analysis . . . . . . . . . . . . . . . . . . 59

2 Demographics and the natural real interest rate 692.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

ix

x DEMOGRAPHICS, STRUCTURAL CHANGE & THE MACROECONOMY

2.2 OLG model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 752.3 Understanding the channels: two-period version of the model . . . . . 782.4 Quantitative analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 82

2.4.1 Experiment and calibration . . . . . . . . . . . . . . . . . . . 822.4.2 Baseline results . . . . . . . . . . . . . . . . . . . . . . . . . 872.4.3 Isolating the drivers . . . . . . . . . . . . . . . . . . . . . . . 912.4.4 Sensitivity analysis . . . . . . . . . . . . . . . . . . . . . . . 92

2.5 On the comparison with data: a discussion . . . . . . . . . . . . . . . 1022.6 Concluding remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . 1052.7 Additional figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107Appendix 2.A OLG model: set of equilibrium equations . . . . . . . . . . 112Appendix 2.B Aggregate approximation of the OLG model . . . . . . . . 113

2.B.1 Aggregate model: set of equilibrium equations . . . . . . . . 1162.B.2 Demographic wedges: derivation . . . . . . . . . . . . . . . 117

3 Structural skill-biased technical change 1253.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1263.2 Stylized facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1313.3 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135

3.3.1 Set-up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1353.3.2 Stationary equilibrium . . . . . . . . . . . . . . . . . . . . . 1363.3.3 Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

3.4 Theoretical prediction vs empirics . . . . . . . . . . . . . . . . . . . 1433.5 Concluding remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . 146Appendix 3.A Stylized facts: tradable vs nontradable . . . . . . . . . . . 149

3.A.1 European countries . . . . . . . . . . . . . . . . . . . . . . . 1493.A.2 Further evidence on United States . . . . . . . . . . . . . . . 152

Appendix 3.B Matching facts in a minimal theoretical framework . . . . . 154Appendix 3.C Sectoral skill composition . . . . . . . . . . . . . . . . . . 161

3.C.1 Prediction of a model with skill premium equal between sectors1623.C.2 EUKLEMS data on sectoral skill composition . . . . . . . . . 163

Appendix 3.D Computerisation probability by sectors: evidence from US 166Appendix 3.E Tradability index for US industries . . . . . . . . . . . . . 167Appendix 3.F Computerisation probability at the industry level . . . . . . 170

Bibliography 174

CONTENTS 1

We have this unusual degree of knowledge concerning the future because of thelong but definite time-lag in the effects of vital statistics. Nevertheless the ideaof the future being different from the present is so repugnant to our conventionalmodes of thought and behaviour that we, most of us, offer a great resistance toacting on it in practice.

— J. M. Keynes 1937, Some Economic Consequences of a Declining Population

A temporary period of policy rates being close to zero or even negative in real termsis not unprecedented by any means. Over the past decades, however, we have seenlong-term yields trending down in real terms as well, independent of the cyclicalstance of monetary policy.

— Mario Draghi 2016, Addressing the Causes of Low Interest Rates

One implication of the mismatch between sectors driving employment and sectorsdriving value added per job is that income inequality has increased and is likely tointensify in coming years.

— Michael Spence and Sandile Hlatshwayo 2012,The Evolving Structure of the American Economy and the Employment Challenge

Introduction

This doctoral thesis consists of three chapters. The first chapter analyzes how thechange in the demand composition due to population aging leads a country aging morethan its trading partners to have a significant real exchange rate appreciation. It isshown that the quantitative estimates depend crucially on the general equilibrium ef-fect of demographic change on the real interest rate. This effect is specifically analyzedin the second chapter. Calibrating an overlapping generation model for the euro areait is shown that aging exerts a permanent downward pressure on the real interest rate,while only a limited set of structural and policy factors could mitigate this decline.The third chapter considers another force underlying the process of economic growthof advanced economies. It documents that in the process of systematic reallocation ofeconomic activity from the goods sector to the services sector (“structural change”),the relative hourly wage of the services sector decreases constantly over time. An ex-planation is provided: “skill-biased technical change” leads the relative skill-intensityin the goods sector to increase over time. Abstracts for each chapter follow below.

Demographics and the real exchange ratewith Marta Giagheddu

We propose a general equilibrium two-country, two-sector overlapping generationsmodel to examine the effect of demographic change on the real exchange rate (RER).A higher proportion of elderly in a country raises the relative demand for nontradableswhich, given imperfect labor mobility between sectors, raises their relative price. Acountry aging more than its trading partners faces a RER appreciation, partially damp-ened by the reduction of the global real interest rate. The quantitative results from themodel find correspondence empirically entailing that demographics account for 15%of the long-run RER mean absolute deviation for advanced economies.

3

4 DEMOGRAPHICS, STRUCTURAL CHANGE & THE MACROECONOMY

Demographics and the natural real interest rate: historical and projected pathsfor the euro area

This paper employs a large-scale overlapping generation (OLG) model quantifying adecrease of the natural real interest rate of about 1.3 percentage points in the euro areabetween 1990 and 2030 due to demographics alone. Two channels prevail providingthe downward impact: the increasing scarcity of effective labor input and the increasingwillingness to save by individuals due to longer life expectancy. Mitigating factorsare: higher substitutability between labor and capital, higher intertemporal elasticityof substitution in consumption, reforms aiming at increasing the relative productivityof older cohorts, the participation rate and, to a lesser extent, the retirement age. Absentpay-as-you-go pension systems the natural rate would stand at a lower level of about0.5 percentage points by 2030. The simulated path of the natural real interest rate isconsistent with recent econometric estimates: a slight upward trend in the 1970s and1980s and a marked decline afterward.

Structural skill-biased technical change

A new stylized fact of structural change is documented: in a sample of 11 Europeaneconomies the hourly wage of the services sector relative to the goods sector has con-stantly decreased over time in the period 1970-2007. Calibrating a two sector modelwith high and low skilled workers it is shown that the driver of such a structural changeis a “skill-biased technical change” which leads the relative skill-intensity in the goodssector to increase over time. This prediction of the model finds support in the data oncethe workers’ type of skill is identified according to the level of educational attainment.The new stylized fact holds also for the United States and is reinforced once indus-tries are classified into tradable and nontradable sectors, while the sectoral skill-biasdifferences are corroborated by measures of job computerization probability.

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English summary

This doctoral thesis in Economics consists of three chapters examining the macroeco-nomic impact of demographic and structural changes.

The first chapter (“Demographics and the real exchange rate”) analyzes how thechange in the demand composition due to population aging leads a country aging morethan its trading partners to have a significant real exchange rate appreciation. It isshown that the quantitative estimates depend crucially on the general equilibrium ef-fect of demographic change on the real interest rate. This effect is specifically analyzedin the second chapter (“Demographics and the natural real interest rate”). Calibratingan overlapping generation model for the euro area it is shown that aging exerts a perma-nent downward pressure on the real interest rate, while only a limited set of structuraland policy factors could mitigate this decline. The third chapter (“Structural skill-biased technical change”) considers another force underlying the process of economicgrowth of advanced economies. It documents that in the process of systematic real-location of economic activity from the goods sector to the services sector (“structuralchange”), the relative hourly wage of the services sector decreases constantly overtime. An explanation is provided: “skill-biased technical change” leads the relativeskill-intensity in the goods sector to increase over time.

ANDREA PAPETTI holds a B.Sc. and a M.Sc in Economic and Social Sciencesfrom Bocconi University and has worked for the European Central Bank. His mainresearch fields are in monetary and international macroeconomics.

Documents

Essays on Demographics, Structural Change and the Macroeconomy