Old world order

An ageing population will limit economic growth, unless governments take action soon, the IMF has warned


The populations of the Group of Seven (G7) leading economies are getting smaller and older. That is a long-term trend, and one that is widely believed to be irreversible. It sounds like good news – generally, it’s only rock-stars who want to live hard and die young; most people would rather live sensibly and die old – as old as possible. But the combination of increased longevity, falling fertility rates, and the retirement of the baby boom generation will mean that, by 2050, in most G7 countries the ratios of elderly people to the working-age population is likely to have doubled. That shifting balance causes potential problems.

A recent report from the International Monetary Fund warned that governments in advanced economies will have to step up their spending on the elderly in coming decades, and should prepare now by strengthening their fiscal positions in the near term. But few are.

Life expectancy
The report cited United Nations projections that show that the old-age population in the G7 countries will increase by an average of 80 percent between 2005 and 2050. Life expectancy in the European Union countries will rise by about six years over the next five decades. Given the age structure of European populations, the old-age dependency ratio is expected to double to about 50 percent from 25 percent, owing to a small decline in the working-age population and a sharp rise in the elderly population.

Those are expensive changes. “Such developments imply a steep increase in age-related government spending in G7 countries ­­– by an average of four percentage points of GDP over the next 45 years,” the IMF report said. Estimates vary substantially across countries, with Canada at the high end (with growth estimated at nine percentage points of GDP), and Italy and Japan at the low end (with growth rising by about two percentage points). The bulk of the spending increase will cover additional health care costs, with long-term care and pension spending accounting for the rest.

Making this sort of long-term prediction is increasingly necessary, but not easy, the IMF said. “Assessing the impact of demographic changes on the sustainability of public finances is complicated by uncertainties about long-term technological, demographic, labour supply, and productivity growth forecasts – especially the strength of the link between aging and health care costs.” Given the uncertainties, governments should plan to fund the worst-case scenarios, the IMF said.

Its report used two measures to assess the evolution of fiscal sustainability for each of the G7 countries and evaluated the impact of policy. Under either measure, the estimated fiscal adjustment needed to ensure long-run fiscal sustainability (i.e. stabilizing fiscal debt at a permanently sustainable level) is large for all G7 countries. It requires an average improvement of 4-4.5 percentage points of GDP in the primary fiscal balance, defined as revenues less non-interest spending, relative to 2005 positions.

Nearly two thirds of the fiscal adjustment reflects the expected rise in age-related spending, while the remaining one third owes to the interest on public debt. The largest primary gaps are in Japan, which had the largest primary deficit and a high debt level in 2005, and the United States, owing to a combination of a high primary deficit and large projected increases in age-related spending. The smallest primary gap was in for Canada, whose primary surplus of 5.5 percent of GDP helps offset the projected impact of the very large expected gains in age-related spending.

Fiscal positions
How well prepared are these countries for an age-related cost crunch? Not very, according to the IMF. It sends the trends leading up to 2005, when its analysis stopped, were ‘disturbing.’ The fiscal positions of all G7 countries except Japan worsened during 2001-05 by 2.7 percentage points of GDP. Even in Japan, whose fiscal sustainability improved over the five-year period, the end-2005 fiscal position was unsustainable.

The IMF said that the main cause of the deterioration in fiscal sustainability in the G7 countries was a worsening primary fiscal balance – which deteriorated by 2.8 percentage points of GDP. The countries showing the sharpest falls were the UK and the US, whose fiscal balances worsened by 5.5 percentage points of GDP.

These countries do seem to be waking up to the problem. The IMF said most G7 countries have recently adopted substantial reforms to contain the growth of age-related public spending, making more progress on pensions than on health care. Over the past five years, for example, France, Germany, Italy, and Japan have passed pension reforms that should bring about sizable savings. “But additional structural reforms or fiscal consolidation in other areas will be needed,” it said. New reforms are also planned, notably health care reforms in Germany and Japan.

Any delay in dealing with the issue will prove expensive, according to the IMF’s analysis. Its report looks at the difference in outcomes if the G7 act immediately, compared to further delay. If a country adjusts its fiscal policy within the next five years, the cost to economic activity would be substantially less and the country would experience gains in long-run output. The economy would grow faster by an average of 0.3 percentage points a year over the next 10 years, according to the IMF. If it delays for 10 years, public debt levels will increase substantially.

Delaying adjustment and allowing public debt to increase implies the need to run permanently larger primary surpluses to service the higher interest costs on the debt. On average, the primary balance required to stabilise public debt on a sustainable basis is 1.1 percentage points of GDP higher in the end than in the immediate adjustment scenario, the report said. Delayed adjustment also entails lower economic growth over the next 10 years, owing to increasing crowding out effects and a large rise in payroll taxes.

Fiscal adjustment
When those factors are added up, early fiscal adjustment can be expected to deliver a permanent economic output gain averaging about two percent of GDP, said the IMF, while “postponing adjustment increases the size of the fiscal adjustment ultimately required to restore sustainability.” Given the upside risk to fiscal spending pressures, early fiscal adjustment would also allow greater fiscal scope to absorb any higher-than-expected age-related spending needs. “The sooner G7 countries begin to adjust their fiscal positions the better, both for their own fiscal sustainability and for long-run growth,” it said.

An ageing population isn’t a problem solely for the G7 countries to worry about. In China, for example, the authorities have warned that an ageing population could erode its position as the world’s major supplier of low-cost labour. There are currently six workers for each retiree in China, but that could narrow to two-to-one between 2030 and 2050, the National Committee on Ageing says. Officials say the economy will suffer as there will be fewer people working and more older people to support. “We might encounter the heaviest burden especially after 2030, when the demographic dividend is set to end,” Yan Qingchun, deputy director of the office of the ageing committee, told China Daily. “With fewer people of working age and more pressure in supporting the elderly, the economy will suffer if productivity sees no major progress,” he added.

The change is partly because of improvements in healthcare and China’s one-child policy, but also because fewer couples are having children. Estimates say that by 2050, the number of over-60s in China will climb to 437 million – more than a quarter of the population. Zhang Kaidi, director of the China Research Centre on Ageing, told China Daily that the country is “not prepared” for the problems presented by an ageing population. He warned that the authorities need to “allocate more funds to build a comprehensive and efficient system of support for the elderly.”

Age proportions
Other countries face the same challenge. According to the United Nations, the proportions of older persons (60 years or older) are increasing at the same time as in the proportions of the young (under age 15) are declining. By 2050, the number of older persons in the world will exceed the number of young for the first time in history. Moreover, by 1998 this historic reversal in relative proportions of young and old had already taken place in the more developed regions.

The UN predicts that population ageing will have an impact on economic growth, savings, investment and consumption, labour markets, pensions, taxation and intergenerational transfers. In the social sphere, population ageing affects health and health care, family composition and living arrangements, housing and migration. In the political arena, population ageing can influence voting patterns and representation.

Population ageing is enduring, the UN says. During the twentieth century the proportion of older persons continued to rise, and this trend will continue into the twenty-first century. For example, the proportion of older persons was 8 percent in 1950 and 10 percent in 2000, and will to reach 21 percent in 2050.

It is also largely irreversible. The increase in the older population is the result of the demographic transition from high to low levels of fertility and mortality. As the twenty-first century began, the world population included approximately 600 million older persons, triple the number recorded fifty years earlier. By mid-century, there will be some two billion older persons–once again, a tripling of this age group in a span of 50 years. Globally the population of older persons is growing by two percent each year, considerably faster than the population as a whole. For at least the next twenty-five years, the older population will continue growing more rapidly than other age groups. The growth rate of those 60 or older will reach 2.8 percent annually in 2025-2030. Such rapid growth will require far-reaching economic and social adjustments in most countries, the UN says.

As the pace of population ageing is much faster in developing countries than in developed countries, developing countries will have less time to adjust to the consequences of population ageing. Moreover, population ageing in the developing countries is taking place at much lower levels of socio-economic development than was the case in the developed countries. The G7 might be slow to respond to the economic challenges laid down by an ageing population, but developing nations will not have that luxury.