Washington DC: The World Bank, 2003. 118 p.
Most existing estimates of the macroeconomic costs of AIDS, as measured by the reduction in the growth rate of GDP, are modest. For Africa - the continent where the epidemic has hit the hardest - they range between 0.3 and 1.5 per cent annually. The reason is that these estimates are based on an underlying assumption that the main effect of increased mortality is to relieve pressure on existing land and physical capital so that output per head is little affected. We argue that this emphasis is misplaced and that, with a more plausible view of how the economy functions over the long run, the economic costs of AIDS are almost certain to be much higher. Not only does AIDS destroy existing human capital, but by killing mostly young adults, it also weakens the mechanism through which knowledge and abilities are transmitted from one generation to the next; for the children of AIDS victims will be left without one or both parents to love, raise and educate them.To analyze this problem, we use an overlapping generations (OLG) model, in which parents have preferences over current consumption and the (expected) human capital attained by their children. Two family structures are analyzed: 'nuclear' and 'pooling', whereby under the latter all children are cared for within an extended family. The decision about how much to invest in education is influenced by premature adult mortality in two ways: first, the family's lifetime income depends on the adults' health status, and second, the expected pay-off depends on the level of premature mortality among the children when they attain adulthood. Furthermore, if one or both parents die while their offspring are still children, the transmission of knowledge across generations is weakened.The outbreak of AIDS leads to an increase in premature adult mortality, and if the prevalence of the disease becomes sufficiently high, there may be a progressive collapse of human capital and productivity. The policy problem, therefore, is to avoid such a collapse. The instruments available for this purpose are (i) spending on measures to contain the disease and treat the infected, (ii) aiding orphans, in the form of either income-support or subsidies contingent on school attendance, and (iii) taxes to finance these expenditures.When calibrated to South Africa, the model yields the following results. In the absence of AIDS, the counterfactual benchmark, there is modest growth, with universal and complete education attained within three generations. If nothing is done to combat the epidemic, however, a complete economic collapse will occur within three generations. With optimal spending on combating the disease, and if there is pooling, growth is maintained, albeit at a somewhat slower rate than in the benchmark case in the absence of AIDS. If pooling breaks down, and is replaced by nuclear families, growth will be slower still. Indeed, if school-attendance subsidies are not possible, growth will be distinctly sluggish. In all three cases, the additional fiscal burden of intervention will be large, which reinforces the gravity of the findings. Sensitivity analysis suggests that these findings are robust to changes in a variety of key assumptions and parameter values concerning mortality, the efficiency of measures taken to combat it, and the formation of expectations. A delay in responding to the outbreak of the epidemic, however, can lead to a collapse.
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