Paying for the elderly
Supporting Aging Populations as Demographics Shift
IMF Survey online
June 10, 2011
- Massive demographic shift has far-reaching implications for global economy
- Countries need to rethink how to support growing elderly population
- Governments are at different levels of preparation to meet retirees’ needs
Demographic changes are threatening the ability of many countries to provide a decent standard of living for the old without imposing a crushing burden on the young, say Ronald Lee and Andrew Mason in Finance & Development (F&D) magazine.
According to their article, the world’s population is projected to rise from 7 billion this year to over 9 billion in 2050. But low fertility combined with the fact that people are living longer means that 1.25 billion elderly (ages 60+) and 1 billion working-age adults will be added to the global population by 2050, while the number of people younger than 25 will hold steady at 3 billion.
The dramatic aging of many countries’ populations has worrying implications for both policymakers and individuals, prompting a reevaluation of how countries will support the growing elderly cohort.
The June issue of F&D also covers a broad range of current topics, including Middle East unemployment, the economic repercussions of the earthquake and tsunami in Japan, the impact of U.S. financial sector lobbying on the financial industry, and banking in offshore financial centers.
Fewer people carrying the load
Most elderly people have left the labor force and and rely on private or public pensions, younger family members or savings for support. But as the proportion of elderly to working-age people rises, Lee and Mason point out, the first two options become more difficult, and savings are often just not enough.
The full economic consequences of the demographic shift faced by many countries depend on how a nation’s individuals, families, and governments plan for and respond to population aging. Societies can fund old-age consumption by postponing retirement, relying more on the family, increasing public transfers to the elderly, accumulating more assets, or investing more in human capital to increase productivity. For most countries, no single step is the solution.
For example, how long workers would need to postpone their retirement depends on how much a country’s population is aging. In emerging economies such as Mexico and Brazil, it would be enough to increase the retirement age by only 1 to 3 years. But in the countries that are aging most rapidly—Japan, Germany, Spain, and Korea—retirement would have to be postponed by nearly a decade. Such a drastic increase is not feasible and therefore cannot be the sole policy change.
Cover of the June 2011 F&D
According to another article by IMF staff, how and when countries implement pension reforms affects not only retirees but also national and global economies. And when countries coordinate reform, this can have major implications for global economic health.
The study examines the economic effects of three options for cutting pension costs: raising the retirement age, reducing pension benefits, and increasing workers’ contribution rates.
The authors conclude that postponing retirement has the most positive long-term economic effect because it increases the size of the active labor force and boosts consumer demand. A cut in pension benefits can lead to increased private savings, depressing domestic demand (though having a positive effect on investment), and raising contribution rates can discourage work. If countries take bold and coordinated action to cut age-related spending, preferably by raising the retirement age, the global economy would enjoy increased growth and lower debt.
Global aging casts an ominous shadow over countries’ ability to maintain a decent quality of life for their elderly citizens. A new index developed by researchers from the Center for Strategic and International Studies looks at how well countries are prepared to pay for the benefits they promised retirees and which countries offer the most adequate standard of living for pensioners.
The index covers 20 countries including most major developed economies and some emerging markets looking ahead to 2040. With few exceptions, the study finds that the countries best prepared to meet their promises to retirees are those that have promised the least. The results show that demography is not necessarily destiny; policy matters. Countries with similar aging profiles perform significantly differently on the index, because of different policies.
The authors conclude that extending working lives and increasing funded pension savings are the best ways to improve the living standards of the elderly without putting too much of a burden on the young. Despite-- or even because of--the pressures of the recent global economic crisis, the authors say timely action to address the long-term aging challenge is urgent. Maintaining confidence in governments’ fiscal future while protecting the elderly is a challenge that can’t be postponed.
Balancing the burden
Intergenerational equity is an important consideration when assessing the increased costs of aging. A study by IMF staff uses intergenerational accounting to figure out the financial burden that current generations are placing on future ones. The authors use the United States and Italy as examples because they are at similar levels of development but are facing different levels of aging. Italy is aging faster but intergenerational inequality is worse in the United States.
To put it starkly, Americans living today will pay less in taxes than they receive in benefits, but future citizens will pay the price. By contrast, because Italy has already begun to make related policy changes including reforming its entitlement programs, future Italians will pay less for current generations than will their U.S. counterparts. The difference is largely due to the higher health costs in the United States.
One unexpected effect of the rise in the number of older voters relative to younger ones could be a decline in the creditworthiness of borrowing countries—resulting in less external lending and more sovereign debt defaults. A country’s willingness to repay is as important as whether it has the resources to pay.
Older people have less time to benefit from their country’s access to international capital markets, and they depend more on public resources such as pension and health care benefits that might be cut of a country repays its debt. This means older voters are more likely to support default on current debt. A study by Ali Alichi finds that younger countries are less likely to default, and cautions that lenders may take this into account when lending to an aging country.
The most obvious effects of aging populations are on health care, jobs, and housing. But policymakers also need to focus on the broader impact of the demographic shift on national and international economies. Taking action today could prevent serious problems in the future.
■ Also in the June 2011 issue of Finance & Development, Carmen Reinhart and Jacob Kirkegaard look at how governments are manipulating markets to hold down the cost of financing huge public debts; Doug Irwin says the Fund and the World Trade Organization must pull together to sort out exchange rate policy disputes; Special Advisor to the Managing Director Min Zhu talks about the long-term challenges now facing emerging markets; and we profile Nobel Prize winner George Akerlof.