Human capital formation and macroeconomic performance in an ageing small open economy

We study the effects of stylized demographic and fiscal shocks on the macroeconomic performance of an industrialized small open economy. We construct an overlapping-generations model which incorporates a realistic description of the mortality process. Agents engage in educational activities at the start of life and thus create human capital to be used later on in life for production purposes. Simple and intuitive expressions are derived which demonstrate the key economic and demographic mechanisms that are operating in the model. The engine of growth during the demographic transition is an intergenerational externality in the production of human capital. In a calibrated version of our model, we find that the effects of increased longevity on human capital formation are small whereas the reduction in fertility has a rather strong effect. Keywords: Demography; Education; Human capital; Economic growth; Fertility rate; Ageing; Overlapping generations; Small open economy JEL classification codes: E10; D91; O40; F41; J1