**2.1 Life cycle hypothesis**

The life cycle theory pinpoints the intertemporal allocation of time, effort and money. In its simple form, the standard life cycle hypothesis's (LCH) formulated by Modigliani and Brumberg [6], suggests that individuals save during working life for their consumption needs when they retire, dissave after retirement, and die without wealth. Hence, individuals will smooth consumption over their lifetime regard to the expected lifetime resources. They accumulate wealth during the pre-retirement period by consuming less than their disposable income. So, during retirement, they de-cumulates wealth to finance its consumption. That is, the saving rate should follow a hump-shaped over the life cycle as shown by the **Figure 1** (in the Appendix).

Therefore, one very important implication of the LCH is that the demographic profile of a population should be an important factor influencing the aggregate saving rate. Given that population aging is defined as a shift in the population age distribution towards old age, so a change of the balance between youth and elderly proportion (defined in the following as a person aged over 60 years-old) causes society to age and subsequently to affect the saving pattern.<sup>1</sup> Such a change may change the savers proportion in the economy and diminish the aggregate saving rate according to the LCH.

If there is a large proportion of the population working, then, the saving rate should be high. However, if there is a large population proportion over retirement age or very young, the saving rate would be low. This suggests that aggregate saving rate should be negatively correlated with total dependency ratio.

Even though the theoretical conclusion of the life cycle model is clear, the empirical evidence is not often proved and stays controversial until today as it was decades ago. There is evidence that elderly may not dissave, at least not to the extend hypothesis suggested by the pure life cycle model which abstracts a number of factors that would complicate its prediction.

#### **2.2 The life cycle hypothesis bounds**

The Life cycle theoretical conclusion is understandable given its simplifying assumptions such as no uncertainty, a finite decision horizon, no inheritance and perfect financial market with no credit constraint [7]. According to the LCH, individual takes decisions basically depending to events and fact that are known with certainty in each period of life (such future income, death date, and interest rate). Nevertheless, these assumptions are considered too restrictive. Indeed, events are uncertain [8, 9] and financial market is imperfect with credit constraint. Uncertainty affects consumption and savings behavior as consumers are generally cautious. Moreover, according to the Kotlikoff [10] dynastic model of savings, individuals do not act in a finite horizon, but in an infinite one. In addition, they have a dynastic behavior characterized by a strong preference to let, at their death, a very limited capital de-cumulation [11–13]. Thus, parents, having an altruistic motive, seek to not decumulate wealth to leave inheritance to their children. Consequently, the population aging may not automatically depress national saving. Kotlikoff and Summers [14] conclude that the "life cycle saving" cannot account for more than 20 percent of U.S. capital formation, and the intergenerational transfers

<sup>1</sup> Population aging arises from two demographic phenomena the birth and the mortality decline. As for declining fertility, it reduces the number of children, which is generally considered a main explanation of growing aging. For mortality decline, it increases the longevity and the number of elderly.

play a dominant role in wealth accumulation, accounting for 80 percent or more of observed wealth.

Additionally, it is worth noting that the conflicting evidence on the life cycle saving may also be due to the econometric approaches used and the aging indicator chosen. Indeed, the micro econometric analysis invalidates life cycle model's prediction to support the Kotilkoff hypothesis but their results are difficult to aggregate because of severe problem of heterogeneous behavior at the household level. Conversely, studies based on macro data for a country generally support the prediction. However, most of them refer to developed societies while in developing societies people face different economic challenges and social conditions, which may lead to different evidences. In that way, these studies could not be very useful for understanding saving behavior in developing countries. The difference through countries is in the design of pension systems and health care, taxes and transfers as well as labour market conditions, which are unavoidably depend to the population age distribution. As well, they may alter individual economic behavior and so could be the origin of the inconsistency LCH's evidences.

Also, the choice of the population aging indicator to estimate is crucial. The total dependency ratio which is generally used does not accurately reflect the aged population since it composed of both the old and the child dependency ratio. It is more fitting to use the old-age dependency ratio to explicitly consider the effect of aged population on savings rate [15]. With more cautious in the aging indicator use, the life cycle model's prediction is likely to be endorsed also in macroeconomic approach.

#### **2.3 The life cycle hypothesis and uncertainty**

The LCH analysis has been gradually enriched, to focus on three reasons for accumulation: the foresight for retirement, the intergenerational altruism and inheritance and the wariness of the saver face to risk (of income, health and lifetime span). In this work, we focus more on the third reason of accumulation by looking at how uncertainty, about future income affects the behavior of the individual' saving. Uncertainty consideration has made it possible to highlight precautionary behavior as the future work income is random; consumption (otherwise savings) depends not only on expectation, but also on the variance of the expected income. A risk-averse or aware consumer will save more. In fact, savings play an insurance role against the hazards affecting the household, especially the hazards related to income (unemployment, loss of wages, etc.) [16]. Thus, uncertainty about future income affects the behavior of the individual 'saving by increasing the demand for precautionary assets, and hence savings amount.

As well, there is precautionary behavior as to face health care expenditure at advanced aged when the risk of health problems is potentially great; notably in the context of inefficient health care system [17]. As a result, households are saving not only to offset lower future income, but also to insure against all sorts of risks.

However, empirically it is not easy to estimate uncertainty extent on saving behavior. It is difficult to quantify this relationship given the difficulty to directly and objectively estimate uncertainty. Empirically there are no quantitative measurements of uncertainty that could be used directly. In the case studies, income uncertainty is usually measured indirectly by auxiliary variables such as inflation rate, unemployment rate or a derivative of these variables. In this case of study, we focus on unemployment as an income uncertainty indicator to better understand the aging impact on saving and to find an answer to the crucial question: do population aging depress savings?

Unemployment inevitably alters the savings behavior by its two aspects: (1) a high rate and (2) an increase in the average age of unemployed [18].

#### *The Life Cycle Hypothesis and Uncertainty: Analyzing Aging Savings Relationship in Tunisia DOI: http://dx.doi.org/10.5772/intechopen.100459*

(1) The high and persistent unemployment rate weights on household confidence, prompting them to increase their precautionary savings. Such behavior is accentuated in a setting of unavailability of unemployment allowance (like in Tunisia) [19]. Thus, for precautionary reasons and to finance unexpected income losses, unemployment is viewed as an income uncertainty given the probability to become unemployed alters the savings behavior. Faure et al. [20] shown that unemployment and the deterioration of household confidence accounted for almost 20% of the aggregate consumption decline.

(2) The increase of the unemployed average age implies that the working population becomes occupied at advanced age. Consequently, they would save a less amount of wealth and they would form a low retirement pension. To offset at this lack of savings they do not immediately dissave at the beginning of the retirement. They would even compensate their low pension by working further after retirement, mainly at the beginning of the period (as long as they stay in better health) to face the future' uncertainties. Also, given the granting difficulties for credit liquidity at the retirement period, this insufficient pension nudges them to continue to save to keep up a certain level of consumption. It increases, in addition, the need for retirement savings from private sources.

Furthermore, the high and enduring unemployment increases inter-vivos transfers, which represents a form of precautionary saving [21]. With a dynastic behavior (which is ignored by the LCH) the old generation (parents) saves more throughout the life cycle to help the young generation (their offspring) to facing uncertainty and hard-economic conditions related for instance to unemployment's conditions. Thus, if intergenerational transfers (by purely altruistic incentive or following a kind of implicit contract between parents and children) are an important motive for savings; elderly rarely decumulate their wealth.

Henceforth, given uncertainty about the future income and lifespan, liquidity constraints, and the wish to leave bequests (a dynastic savings) population aging would not drive the decrease of savings. Therefore, aging economic impact on the household saving and so on the cumulative and on national saving, may not be large [22].

Hence, for our empirical evaluation of the life cycle hypothesis, we analyze the aging-savings relationship in a developing country, in particular, Tunisia. It greatly differs, economically and socially, from the developed countries, by its altruistic familial intergenerational relationship, the enduring and high unemployment rate and the inefficient pension system; as detailed in the section below.

### **3. The Tunisian demographic and economic setting**

#### **3.1 Demographic shifts and age structure evolution**

Tunisia after has shortly ended its demographic transition regime, it has well undertaken the population aging process. During the period 1960–2019, the mortality rate fell from 35 to 40 per thousand to a low rate 5.9. Likewise, fertility which was nearby 8 children per woman fell to 2.17. Thus, the life expectancy has attained an average close to that of developed countries 75.4 years (78.1 years for woman and 74.5 years for man) in 2017.

Accordingly, the population age distribution has shifted towards aging. This fertility decline has narrowed the bottom of the age pyramid by the decline of the younger generation size, while the mortality decline has enlarged the top of the pyramid through the life expectancy gain. Thus, the age range proportion less than 15 years-old becomes less important (passing from 46.5 percent to 24.7) and it is likely to continue its decline. In the contrary, a remarkable increase is recorded for

the proportion of person aged over 60 years-old (from 5.5 percent to 12.6) and is expected to increase by 10 points over the future three decades. Therefore, during 1966–2019, the child dependency ratio has sharply declined (from 96.27 percent to 39.36) while the old-age dependency ratio has increased (from 11.60 percent to 20.08). Consequently, the total dependency ratio has decreased (from 107.86 percent to 59.44).

#### **3.2 Economic setting**

Tunisian economy recorded a high and enduring unemployment. Over the period 1966–2000, it has increased by 6.1 points to pass from 12.5 percent to 18.6, and then fell slightly to stabilize during the last two decades (2000–2019) around 15.3 percent. Additionally, aging has hit the age composition of the unemployed. Indeed, the modal age range of the unemployed population has moved from less than 25 years-old (by about 29 percent) to 25–29 years-old (by about 34.2 percent) during 2005–2011. It is worth noting here that Tunisian authorities do not distribute any unemployment allowance.<sup>2</sup>

For the national saving, it has evolved with some fluctuations. During the period 1970–2010, the national saving rate (of gross national disposable income) was relatively stable around an average of 22.8 percent then progressively fell to achieve 9.3 in 2019, mainly due to a steady loss of purchasing power.<sup>3</sup>

According to the Islamic Development Bank, the behavior of Tunisian investors appears to be driven by factors related to consumer demand and/or the income effect [23]. The financial changes in interest rates have more effect on the savings structure than on its volume. Indeed, the financial liberalization policy adopted (since the structural adjustment plan in 1986) has not succeeded to stimulate private savings through the increasing of the real interest rates [24]. In Tunisia, saving behavior seems to comply more to the Keynesian approach.

However, an interest for the long-term financial savings is recorded. During 2010–2017, the listed companies increase from 56 to 81 with a broad sectors diversification. Likewise, the life insurance, as a long-term saving vehicle, has undergone an important increase; the average annual growth rate was 18 percent in 2017. Its share in the insurance market has climbed from 12.05 percent in 2009 to 20.2 in 2017; however, it remains far from the international standards (about 56.2 percent).

This interest for the long-term savings is explained by the failure of the pension system the pay-as-you-go system and the bankruptcy of the provident fund as well as the authority's future intention to withhold a proportion of the retirement pension.<sup>4</sup> Thus, the insured people are driven to form a complementary retirement pension under others retirement savings forms through voluntarily paying into saving schemes in private financial institutions. This savings form is encouraged by the financial authority through the establishment of tax benefits.

Concerning the non-financial savings, it is allocated to buy housing, jewelry or land by household and productive assets by individual corporate. Household saving is particularly oriented to housing savings which has experienced a growth rate of about 5.5 percent during 2000–2017.

<sup>2</sup> Source: NIS employment 1966, 2005, 2007, 2010, 2011.

<sup>3</sup> During 2011–2019 inflation rate has passed from 3.7 percent to 6.2.

<sup>4</sup> For instance, during 2010–2017, the overall financial situation of the three funds of the social security recorded a very serious drop going from 40MD in 2010 to 1326 MD.

*The Life Cycle Hypothesis and Uncertainty: Analyzing Aging Savings Relationship in Tunisia DOI: http://dx.doi.org/10.5772/intechopen.100459*
