EUROPEAN PAPERS ON THE NEW WELFARE

Implications of Demographic Change in Enlarged Eu on Patterns of Saving and Consumption and in Related Consumer’s Behaviour­­

3. The relation between consumption and ageing

3.1 Ageing, Saving and Consumption: A Survey of the Issues Relevant to our Projections

One of the implications of lifetime utility maximization within the Life Cycle Model (LCM) is that consumption must be smooth over time: wealth, earnings or annuity changes which are foreseeable should cause no change in the consumption path because the lifetime budget constraint has not changed.
In particular consumption should not change at retirement if retirement occurs as planned. Simple extensions of this model, however, lead to a change in consumption at retirement. The implications of retirement on consumption, for example, may depend on whether the utility function is separable; that is, whether the marginal utility of consumption depends on leisure. Indeed, consumption and leisure may be seen from different perspectives as substitutes or complements, and it is an empirical question whether a substitution or complementarity relationship dominates.
A convincing defence of the LCM is provided in Browning and Crossley (2001). They assert that most of the empirical evidence on consumption can be reconciled within this theoretical framework. In its more general formulation, in fact, the LCM simply asserts that “agents make sequential decisions to achieve a coherent (and stable) goal using currently available information as best as they can”. Smoothing is not keeping expenditure constant over time, but the marginal utility of money (which can imply variable expenditure). This view does not rule out many models which would not be consistent with the more restrictive formulations of the LCM (e.g. the permanent income model). It also allows us to accommodate important features of consumption such as habits, capital market imperfections and limited computational capabilities.
Given these premises, empirical literature is expected to provide mixed evidence on the effects of ageing on consumption, and indeed it does. Our goal is to investigate the aggregate effect of ageing on consumption and saving, and to find relevant implications for the economic performance of the countries under consideration as well as for the sustainability of the welfare system.
To achieve that goal we estimated an age-consumption profile for selected European countries, then we used it as an input for a projection model delivering macroeconomic results as well as a forecast of the social expenditures.

3.2 The Estimation of Age-consumption Profiles

We provide an empirical analysis on consumption for selected European countries. The aim of the study is twofold. First, we investigate the existence of a consumption drop at retirement and we evaluate whether its magnitude is compatible with the life-cycle theory of consumption (i.e. we explore whether a ‘retirement-consumption puzzle’ really exists). Second, we estimate a life-cycle profile by consumption of the individual. Thus, this part of the study provides a crucial input for the simulation model. The estimated life-time consumption profiles, together with occupational status and demographic projections will, in fact, allow us to evaluate the effects of ageing on consumption patterns.
We make use of information from SHARE (Survey of Health, Ageing and Retirement in Europe) data. This is a multidisciplinary and cross-national database of micro data on health, socio-economic status and social and family networks of some 22000 Continental European individuals over the age of 50. Eleven countries have contributed micro data to the 2004 SHARE baseline study. Data collected include economic variables, social support variables, together with health and psychological variables.
Although the characteristics of SHARE pose important limits in several dimensions of our analysis, this is the only dataset which contains information on consumption for several countries, and we use it to make cross-countries comparisons3 easier.
So far, only the 2004 wave of the data is available, and therefore we are forced to carry out our analysis on a single cross-section; this data limitation requires particular caution when interpreting the shape of the life-time consumption profiles and additional assumptions are needed in the interpretation.
Given that we do not have information on young households (those whose head is younger than 50), it is impossible to estimate directly a life-cycle profile within this framework; in order to solve this problem, we use an ad hoc methodology which, starting from consumption at the household level splits it between the members of the household. Resulting life-cycle profiles constitute the input required by the simulation model.

4. The Economic Projections

4.1 The Simulation Framework

The analysis is based on a projection model and is strongly demographically driven. The model is quite a radical modification and extension of the Macroeconomic Model the authors already built and successfully used for a study assigned by the Commission and performed in conjunction with CeRP of Turin, and the Social and Cultural Planning Office of The Netherlands.

Figure 1: Outline of the economic projections
macaroni-fig1.gif

Although the approach remains a partial equilibrium one; the effect of ageing induced modifications of average saving behaviour on growth and capital accumulation are taken into account. Feedbacks effects are also allowed within the social security system, introduced to take into account the fact that modifying the welfare system in one respect is likely to have consequences both on other aspects of the same system and on the overall economic performance. Thus, for example, reducing the beneficiaries of a particular subsidy is likely to vary the number of people asking for another one, or trying to find a job, thus affecting labor market participation rates too. Data for model parameterization are derived mainly from cross-national studies, in particular ECHP and SHARE data constitute the main source of information.
The model forecasts the developments of the labour market on the basis of demographic projections to 2050. It also derives projections of different components of household income and social security expenditure. In particular the analysis of social transfers, such as old-age and survivors’ pensions, invalidity benefits, unemployment benefits, family-related benefits, education-related benefits, housing allowances and social assistance is included. For each income or benefit category, the number of earners or recipients and the average amount in Euros (at 2003 constant prices) are calculated, in a way consistent with the projected trend in the age profile of the population.

3 The other dataset available for European cross-countries comparisons, the European Community Household Panel (ECHP), does not provide information on consumption.


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