The Impact of Aging Worldwide on Pensions and Public Policy

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The Impact of Aging Worldwide on Pensions and Public Policy

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• Authors: DAVID AMAGLOBELI, VITOR GASPAR, ERA DABLA-NORRIS
• Published: March 1, 2020

Overview and key findings

• Today there are, on average, 3.4 working-age people to support the retirement of every person 65 and older; by 2050 that number is projected to dwindle to just 2.
• Japan is already nearly at that point; by 2050 more than 35 other countries (about 7 percent of the world population) will join Japan.
• Aging is driven by two main factors: people are living longer and having fewer children.
• Demographic stages differ across regions: many Northern Hemisphere countries, particularly Japan, are in a more advanced stage; many African countries are in the early stage.
• Countries in advanced stages face a shrinking labor force and higher burdens on pay-as-you-go pension systems; countries in early stages need to create a large number of new jobs every year to absorb a rapidly growing working-age population.
• By 2050 there will be stark contrasts between regions (for example, Europe and sub-Saharan Africa).

Impact on savings

• Life-cycle saving behavior implies societies at more advanced stages of aging are likely to see lower aggregate savings.
• Recent IMF research (Amaglobeli and others 2019) shows that in advanced economies both private and public savings (effectively the government fiscal balance) are projected to decline as a result of more pension spending during the next 30 years (all else equal).
• Younger cohorts will need to save significantly more and postpone retirement by a number of years to maintain pension benefits similar to today’s retirees.
• In emerging market economies and low-income developing countries collectively, relatively young populations will lead to higher private saving; this increase is expected to outweigh an expected decline in public savings due to rising public pension spending.
• Pension-system design features materially affect saving outcomes:
  • Overly generous public pensions lower both public and private savings, all else equal.
  • Less generous public pensions can drive up private saving as individuals self-fund more of their retirement.
  • Defined-contribution plans (dedicated pension savings accounts) are associated on average with increased private savings compared with countries without them (example cited: individual retirement accounts in the United States).

Pension reforms and system design

• Recent reforms aim to contain growth in the number of pensioners by changing key parameters (increase statutory retirement age, tighten eligibility).
• Examples cited:
  • Proposed reform in France aims to raise the full-pension retirement age to 64.
  • Reform adopted in Brazil in October 2019 increases retirement ages to 65 for men and 62 for women from 56 and 53, respectively.
  • Cyprus, Denmark, the Netherlands, and Portugal legislate increases in statutory retirement age in line with rising life expectancy.
• Reforms have also reduced benefit generosity via:
  • Modifying benefit calculation formulas (for example, inflation indexation components).
  • Rewriting valorization rules.
  • Changing accrual rates in defined-benefit plans.
• Trade-offs and distributional consequences:
  • Reducing generosity and delaying retirement attenuate long-term fiscal vulnerabilities and moderate the decline in aggregate saving but have distributional consequences and require careful calibration.
  • Linking retirement-age increases to improvements in life spans can slow inflow of new retirees and encourage older workers to remain in the labor force.
  • Effective provisions to prevent old-age poverty are important when tightening pensions.

New models and broader policy responses

• Rethink pension system architecture; one option is public defined-contribution programs (assuming necessary preconditions).
• Stimulate voluntary retirement saving through financial-sector instruments; priority differs by financial sector development:
  • Less developed financial systems should first increase financial inclusion (globally, 31 percent of adults still do not have bank accounts; the majority of the unbanked population lives in sub-Saharan Africa).
  • Financial literacy can foster a culture of saving and better retirement planning.
  • Countries with developed financial sectors could use tax-preferred retirement saving vehicles (example cited: 401(k) plans in the United States) or tax-preferred general or education savings accounts.
  • Participation of middle-income households is essential to generate additional saving rather than displacement of existing saving.

Labor-market and social policies to offset demographic pressures

• Policies to counteract expected declines in the labor force include:
  • Closing gender gaps in labor force participation (example cited: Italy and Spain have enacted such reforms).
  • Globally, only 50 percent of women participate in the labor force, compared with 80 percent of men (Dabla-Norris and Kochhar 2019).
  • Promoting access to high-quality, affordable childcare to increase labor-force participation of young mothers.
  • Encouraging older workers to keep working by reconsidering taxes and benefits that favor early retirement.
• In countries with inadequate retirement systems, policy priorities include:
  • Expanding coverage of social security systems.
  • Raising social pensions (pure cash transfers to the elderly).
  • Enhancing targeted social assistance transfers to reduce old-age poverty and household precautionary saving (examples: China and the Republic of Korea cited as having high saving rates and social security systems with low coverage and generosity).

Combined policy implications

• Pension system, financial, and labor-market policies together can:
  • Damp projected declines in national saving.
  • Improve sustainability of pension systems.
  • Ensure decent living standards in retirement.

David Amaglobeli, Era Dabla‑Norris, and Vitor Gaspar; F&D Magazine, March 2020.

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