Population aging will have dramatic effects on local, regional, and global economies. Most significantly, financial expenditures, labor supply, and total savings will be affected.
In the past 5 years, academics and policymakers have begun to direct attention to the potential economic impact of unprecedented demographic change. Currently, however, we do not fully understand the interaction between policies and economic growth. A good deal will depend on how well markets function.
Population aging will strain some national budgets. Countries with extensive social programs targeted to the older population—principally health care and income support programs—find the costs of these programs escalating as the number of eligible recipients grows and the duration of eligibility lengthens. Further, few countries have fully funded programs; most countries fund these programs on a pay-as-you-go basis or finance them using general revenue streams. Governments may be limited in how much they can reshape social insurance programs by raising the age of eligibility, increasing contribution rates, and reducing benefits. Consequently, shortfalls may need to be financed using general revenues. Projections of government expenditures in the United States and other OECD countries show major increases in the share of gross domestic product devoted to social entitlements for older populations. In some cases, this share more than doubles as a result of population aging.
As countries reach a relatively high level of population aging, the proportion of workers tends to decline. Some European countries, including France, Germany, Greece, Italy, Russia, and the Ukraine, already have seen an absolute decline in the size of their workforce. And in countries where tax hikes are needed to pay for transfers to growing older populations, the tax burden may discourage future workforce participation. The impact on a country’s gross domestic product will depend on increases in labor productivity and that country’s ability to substitute capital for labor. Less developed countries can shift their economies from labor-intensive to capital-intensive sectors as population aging advances. Options for more developed countries may be more constrained.
Because countries age at different paces, it is possible for the elements of production—labor and capital—to flow across national boundaries and mitigate the impact of population aging. Studies predict that, in the near term, surplus capital will flow from Europe and North America to emerging markets in Asia and Latin America, where the population is younger and supplies of capital relatively low. In another 20 years, when the baby boom generation in the West has mostly retired, capital likely will flow in the opposite direction. However, these studies rest on the uncertain assumption that capital will flow easily across national boundaries.
Traditionally, labor is viewed as less mobile than capital, although migration could offset partially the effects of population aging. Currently, 22 percent of physicians and 12 percent of nurses in the United States are foreign born, representing primarily English-speaking African countries, the Caribbean, and Southeast Asia. The foreign-born workforce also is growing in most OECD countries. Over the next 10 years, the European experience will be particularly instructive in terms of the interplay of aging and migration.
The life-cycle theory of consumption and savings is that households accumulate wealth during working years to maintain consumption in retirement. The total of a country’s individual life-cycle savings profiles determines whether households in that country are net savers or nonsavers at any point in time. A country with a high proportion of workers will tend to be dominated by savers, placing downward pressure on the rate of return to capital in that economy. Countries with older populations will be tapping their savings and driving rates of return higher because of the scarcity of capital.
Retirement resources typically include public and private pensions, financial assets, and property. The relative importance of these resources varies across countries. For example, a groundbreaking study revealed that only 3 percent of Spanish households with at least one member age 50 or older own stocks (shares), compared to 38 percent of Swedish households (Figure 14). The largest component of household wealth in many countries is housing value. This value could fall if large numbers of older homeowners try to sell houses to smaller numbers of younger buyers.
Financial markets need to be flexible and innovative to meet the needs of aging populations. Undoubtedly, population aging will create new economic pressures. At the same time, however, it will create exciting opportunities for expanding our collection of financial tools to accommodate a changing world (see box on “Expanding Opportunities for Economic Growth”).
Source: Börsch-Supan A, Brugiavini A, Jurges H, Mackenbach J, Siegrist J, Weber G, eds. Health, Ageing and Retirement in Europe. First Results from the Survey of Health, Ageing and Retirement in Europe. Mannheim: Mannheim Research Institute for the Economics of Aging, 2005.
Expanding Opportunities for Economic Growth
Because of fertility declines, nearly all countries have experienced, or will soon experience, a large increase in the share of their population concentrated in the working ages. This increase should raise per capita income and government tax revenues, leading to the first demographic dividend. An analysis of 228 regions suggests that the first dividend lasted 30 to 35 years in most developed and transitional economies. It was considerably longer in much of Asia and Latin America, and it likely will be longer still in sub-Saharan Africa. The economic gain resulting from larger numbers of young workers critically depends on the policy environment. In several countries in East and Southeast Asia, for example, large birth cohorts reached working ages with valuable skills and high educational attainment, and export-oriented economies were flexible enough to put their skills to productive uses. In other countries, however, weak educational systems and labor market rigidities have resulted in a youth employment crisis rather than the hoped-for demographic dividend.
In the decades following the youth bulge in the labor force, as the large cohorts move into their middle and later working years, a second demographic dividend is possible. This is because the peak productive ages in a modern economy are also peak ages for saving, and in a modern economy, savings can be mobilized for productive investment. With an unusually large proportion of the population consisting of workers in their 40s and 50s, countries should be able to increase their savings rates, and thus investment rates, which can produce a long-lasting increase in national output. As with the first demographic dividend, the second one works only in the right institutional and policy settings. Many countries, including the United States, did not experience higher personal savings rates during the decades when Baby Boomers were in their 40s and 50s.
Researchers differ in their estimates of the importance of these dividends. One estimate is that demographic dividends, if fully exploited, would have contributed between 1 and 2 percentage points to income growth between 1970 and 2000 for most regions of the world. However, demographic dividends are not automatic; they depend on the existence of strong institutions and policies that transform population aging into economic growth. Weaknesses in the governance and management of pension programs—for instance, significant tax evasion and unsustainable increases in public pension benefits—can offset the benefits of demographic dividends, as can persistent high levels of unemployment and underemployment. As a result, governments and employers may be tempted to make promises to the working-age population that prove difficult to keep.
A useful tool for understanding dividends and their impact is to estimate production and consumption over the life cycle (Figure 15). Researchers can use these estimates to account for transfers across generations, examine savings patterns, estimate spending on public programs, and assess the burden of family support for older people.
Source: Chawla, A. National Transfer Account Estimates for Thailand, as reported in Lee R, Mason A, eds. What Is the Demographic Dividend? Finance and Development. 2006:43(3). Available at: http://www.imf.org/external/pubs/ft/fandd/2006/09/basics.htm