Demographic Change and Economic Well-being: The Role of Fiscal Policy, By Christine Lagarde, Managing Director, International Monetary Fund
IMF News, March 4, 2016
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Bibliographic details
- Authors: Christine Lagarde
- Published: March 4, 2016
Overview
- Speech delivered as prepared for delivery, Massachusetts Institute of Technology, Cambridge, March 4, 2016.
- Central thesis: demographic change (population growth in some regions, ageing and shrinking in many advanced and emerging economies) has profound implications for growth, financial markets, and fiscal sustainability; fiscal policy and technological innovation are crucial policy levers.
Key demographic trends and economic implications
- Population scale and trajectory:
- "The world’s population is at about 7½ billion people today. Forty years from now, it will be an estimated 10 billion inhabitants.1"
- Two contrasting regional patterns: continued rapid growth in South Asia and Sub-Saharan Africa; ageing and shrinking populations in most advanced and many emerging market economies (about two-thirds of all countries expected to have declining populations by end of this century).
- Life expectancy and fertility:
- "Average life expectancy around the world has jumped from 47 years in 1950 to 71 years2 today."
- Regional variation: "from a low of 61 years in Africa to a high beyond 80 years in northern America, Japan, and many European countries."
- Fertility: "in 1950 the average woman bore 5 children; today she has 2.5 children (these are global averages)."
- Global literacy: "the global literacy rate jumped from 36 percent to 83 percent today."
- Income, poverty, and inequality:
- Global income per capita has "nearly quadrupled since the end of the Second World War."
- Poverty: "People living at or below the poverty line of $1.90 per day account for 13 percent of the world’s population, down from 44 percent in 1981."
- China: "China alone has lifted more than 750 million people out of poverty over the past three decades."
- Economic and fiscal challenges of ageing and shrinking:
- Growth effects: "combination of aging and shrinking will reduce potential growth in advanced economies by about 0.2 percentage points in the medium term—and by twice as much in emerging economies.4"
- Longevity risk and fiscal cost: "if everyone lived three years longer than expected, pension-related costs could increase by 50 percent in both advanced and emerging economies.5"
- Age-related spending trajectory: "in advanced economies alone, age-related spending is projected to jump from 16½ percent of GDP to 25 percent by the end of this century—unless policy action is taken.6"
- Fiscal financing scenarios (hypothetical example):
- Borrowing to finance the entire increase: public debt rises "from an average of 100 percent of GDP now to 400 percent by the end of the century."
- Higher taxes: "lifting VAT rates by roughly 20 percentage points, or increasing social security taxes by about 25 percentage points."
- Entitlement cuts: "slashing pensions and health benefits on average by about a third."
- Country-specific projections: "China’s spending on pensions and health care is projected to increase by 13 percentage points of GDP by the end of this century, compared to 15 percentage points in the United States."
Fiscal policy: first line of defense — findings and policy recommendations
- General approach: multi-pronged response; fiscal policy that supports demand while ensuring sufficient savings for pensions and health care.
- Game changer 1 — Entitlement and health care reforms:
- Increase competition among insurers and service providers.
- Target spending to primary and preventive health care; promote healthier lifestyles.
- Make more effective use of information technology (e.g., greater use of health data history, unique health identifiers).
- Lift retirement ages to match longevity gains while providing safety nets for those unable to work longer.
- Make pension systems flexible and automatic (examples: Japan, Germany, Finland, Portugal link benefits to life expectancy).
- Game changer 2 — Tax systems and public expenditure efficiency:
- Tax measures: broaden VAT bases; improve taxation of multinational corporations; strengthen tax compliance.
- Spending measures: better management of public investment; "the most efficient public investors get twice the growth 'bang' for their 'buck' than the least efficient."
- Energy pricing: reduce subsidies and increase energy taxation—estimate: "global energy subsidies amounted to $5.3 trillion last year, or 6.5 percent of GDP."
- Timing: reform energy subsidies now, "when energy prices are low."
- Game changer 3 — Lift potential growth (the larger pie):
- Boost labor force participation of women:
- Policies: affordable childcare, fairer tax and legal systems, promote equal pay.
- IMF estimate: "raising female labor participation rates to those of men could increase GDP by 5 percent in the United States."
- Immigration: can boost labor force, investment, and growth if integration is effective.
- Productivity gains via technology are essential.
Technological innovation: role, uncertainties, and policy
- Technologies highlighted: artificial intelligence, robotics, genetic engineering, 3-D printing, quantum computing.
- Two contrasting views:
- Optimists (e.g., Brynjolfsson and McAfee): technical advances lead to accelerating productivity and prosperity.
- Pessimists (e.g., Robert Gordon): the major productivity-transforming inventions occurred between 1870 and 1970; recent technical progress may be less visible in productivity growth.
- Conclusion: "Nobody knows" which view will prevail; nevertheless "we need more innovation, not less."
- Policy to foster innovation:
- Governments should remove barriers to competition, cut red tape, and invest more in education and Research and Development (R&D).
- Support for universities, research networks, and subsidies for private-sector R&D.
- New IMF research: "if advanced economies were able to ramp up private R&D by 40 percent, on average, they could increase their GDP by 5 percent in the long term.7"
- Encourage technology sharing between advanced and emerging economies via foreign direct investment, trade reforms, education, and better enforcement of intellectual property rights.
- Note: China is "today’s number one in the world in terms patent applications"; multinationals increasingly outsource R&D to countries like Brazil and India.
Concluding points
- Moral framing: responsibility to future generations — "Leave every campground better than you found it."
- Core message: demographic challenges are solvable with the right mix of entitlement reform, efficient and fair taxation and spending, policies to raise labor supply and productivity, and a strong push for technological innovation.
- Urgency and political economy: reforms require political resolve and leadership; earlier reforms allow fairer adjustments.
Source: Demographic Change and Economic Well-being: The Role of Fiscal Policy, By Christine Lagarde, Managing Director, International Monetary Fund (Speech, March 4, 2016).