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While the patterns of population ageing are similar in most countries, timing differs substantially, in particular between industrialized and less developed countries. It is well known that within each country, demographic change alters the time path of aggregate savings, even more so in countries where fundamental pension reforms – that is, a shift towards more pre-funding – are implemented. To the extent that capital is internationally mobile, population aging will also induce capital flows between countries.

Paper presents a quantitative analysis of the capital flows induced by differential aging processes across countries and by pension reforms. Authors develop a stylized multi-country overlapping generations model which is new to the literature, and they use long-term demographic projections for different sets of countries to project international capital flows over a 50 year horizon. Paper uses the example of Germany as a country with one of the most severe aging problems in the world and with a public pay-as-you-go (PAYG) pension system in an ongoing reform process.

To separate the direct effect of population aging on capital markets and potential feedback effects from pension reform, projections are presented for both two counterfactual scenarios:

• maintaining Germany’s current generous pension system, and
• introducing a one-third transition to a funded pension system

The most likely development will be in between these two scenarios.

Simulations predict substantial capital flows due to population aging. Results confirm that population aging results, at least initially, in a higher capital stock, but when the baby boom generations begin to consume their retirement savings, the capital stock will decrease. International capital flows follow this trend.

Moreover, simulations show that a transition to a partially funded system does not crowd out existing savings totally. Capital exports from Germany to the OECD countries – again, mainly to EU-countries – will be higher in this case, never falling below 2% after a peak of about 9% in the year 2020. The decrease in the rate of return, which results from both population aging and pre-funded pensions, is modest, approximately one percentage point if we assume a closed economy. The return on capital can be improved substantially by international diversification, that is, by investing pension savings in countries with a more favorable demographic transition path than Germany.

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