ESSAYS ON DEMOGRAPHICS, STRUCTURAL CHANGE AND THE MACROECONOMY

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Andrea Papetti ESSAYS ON DEMOGRAPHICS, STRUCTURAL CHANGE AND THE MACROECONOMY

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 exchange 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 overlapping generation model for the euro area it 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 (“Structural skill-biased technical change’’) considers another force underlying 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

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Andrea Papetti ESSAYS ON DEMOGRAPHICS, STRUCTURAL CHANGE AND THE MACROECONOMY

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 exchange 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 overlapping generation model for the euro area it 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 (“Structural skill-biased technical change’’) considers another force underlying 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

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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

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Essays on Demographics, Structural Change and

the Macroeconomy

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Essays on Demographics, Structural Change and the Macroeconomy

Andrea Papetti

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

Stockholm School of Economics, 2019

Essays on Demographics, Structural Change and the Macroeconomy SSE and Andrea Papetti, 2019c

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

This book was typeset by the author using L^ATEX.

Front cover picture: Figure, 1939 (oil on panel), painting by Cuban artist Wifredo Lam (1902–1982). Image rights: Jacques and Thessa Herold Collection. Photo:

Courtesy of Val´erie Thessa Herold^c Adagp, Paris 2015 Back cover picture:

Courtesy of Juliana Wiklund^c Printed by:

BrandFactory, G¨oteborg, 2019 Keywords:

Demographic transition, population aging, real interest rate, real exchange rate, structural change, skill biased technical change, consumption composition, life-cycle savings.

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iii

A Carolina, Simonetta e Paolo

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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 policies of SSE, the author has been entirely free to conduct and present his research in the manner of his choosing as an expression of his own ideas.

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

G¨oran Lindqvist Tore Ellingsen

Director of Research Professor and Head of the Stockholm School of Economics Department of Economics

Stockholm School of Economics

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Acknowledgements

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

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

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

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

A final special thanks to Nicol´o Cavalli – the third chapter originates from a discussion with him – and to all the friends that managed to be so close to me during my doctoral studies. Our homeland resides in a act of free will, dear and necessary.

Frankfurt am Main, May 5, 2019 Andrea Papetti

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We have this unusual degree of knowledge concerning the future because of the long but definite time-lag in the effects of vital statistics. Nevertheless the idea of the future being different from the present is so repugnant to our conventional modes of thought and behaviour that we, most of us, offer a great resistance to acting 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 terms is not unprecedented by any means. Over the past decades, however, we have seen long-term yields trending down in real terms as well, independent of the cyclical stance of monetary policy.

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

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

— Michael Spence and Sandile Hlatshwayo 2012,

The Evolving Structure of the American Economy and the Employment Challenge

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Introduction

This doctoral thesis consists of three chapters. The first chapter 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 exchange 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. Calibrating an overlapping generation model for the euro area it 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 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. Abstracts for each chapter follow below.

Demographics and the real exchange rate with Marta Giagheddu

We propose a general equilibrium two-country, two-sector overlapping generations model 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 nontradables which, given imperfect labor mobility between sectors, raises their relative price. A country 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 the model find correspondence empirically entailing that demographics account for 15%

of the long-run RER mean absolute deviation for advanced economies.

3

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4 DEMOGRAPHICS, STRUCTURAL CHANGE & THE MACROECONOMY Demographics and the natural real interest rate: historical and projected paths

for the euro area

This paper employs a large-scale overlapping generation (OLG) model quantifying a decrease of the natural real interest rate of about 1.3 percentage points in the euro area between 1990 and 2030 due to demographics alone. Two channels prevail providing the downward impact: the increasing scarcity of effective labor input and the increasing willingness to save by individuals due to longer life expectancy. Mitigating factors are: higher substitutability between labor and capital, higher intertemporal elasticity of substitution in consumption, reforms aiming at increasing the relative productivity of older cohorts, the participation rate and, to a lesser extent, the retirement age. Absent pay-as-you-go pension systems the natural rate would stand at a lower level of about 0.5 percentage points by 2030. The simulated path of the natural real interest rate is consistent with recent econometric estimates: a slight upward trend in the 1970s and 1980s and a marked decline afterward.

Structural skill-biased technical change

A new stylized fact of structural change is documented: in a sample of 11 European economies the hourly wage of the services sector relative to the goods sector has constantly decreased over time in the period 1970-2007. Calibrating a two sector model with high and low skilled workers it is shown that the driver of such a structural change is a “skill-biased technical change” which leads the relative skill-intensity in the goods sector to increase over time. This prediction of the model finds support in the data once the 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-bias differences 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 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 exchange 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 overlapping generation model for the euro area it 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 (“Structural skill- biased technical change”) considers another force underlying 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

ESSAYS ON DEMOGRAPHICS, STRUCTURAL CHANGE AND THE MACROECONOMY

Andrea Papetti

ESSAYS ON DEMOGRAPHICS, STRUCTURAL CHANGE AND THE MACROECONOMY

Essays on Demographics, Structural Change and the Macroeconomy

Andrea Papetti

Akademisk avhandling

Essays on Demographics, Structural Change and the Macroeconomy

Andrea Papetti

Akademisk avhandling

Essays on Demographics, Structural Change and

the Macroeconomy

Essays on Demographics, Structural Change and the Macroeconomy

Andrea Papetti

Foreword

Acknowledgements

Contents

Introduction

Bibliography

English summary