It is a privilege to be invited to address this Future Economic Leaders think-tank,
which is focusing this year on the important subject of population ageing.
Nature and Dimensions of Population Ageing
The process of population ageing has been likened to the course of a glacier
– something that is extremely slow moving but has apparently irresistible
momentum. In most of our countries, the
challenges that population ageing poses will unfold over a period of perhaps
the next 50 years.
This is far beyond the events we would normally try to forecast, and yet in
some ways the effects of population ageing seem more predictable because of
their slow momentum.
The population transition that we are currently experiencing in fact began
in the industrialising world about 200 years ago. But it is really in the
post-War period that these changes have accelerated around the world.
In a mechanical sense the main features of this transition have involved three
things:
• declines in infant mortality;
• increases in adult life expectancy; and
• coming rather later than the other two, declining birth rates.
The reasons for the fi rst two of these developments are not hard to understand.
Falls in infant mortality, and rises in adult life expectancy, were driven
by improved hygiene, better medical care and better nutrition – all things
that accompany human progress. The third phenomenon, falling birth rates,
is more diffi cult to explain. But what we can say is that it does not seem
to be culture-specifi c. As countries get richer, birth rates fall – this
is a repeated pattern around the world. The only question is how far. This
is something that I will return to later.
The effect of these changes in the basic demographic parameters has been to
set up a period of transition that works in several stages. The fi rst stage,
after mortality rates start to fall, is a population boom. Later, as birth
rates decline, the effect is a population bulge that moves gradually through
the population structure into the older age groups. Later still, presumably,
there will be a transition to a new stable equilibrium with a stable age structure.
What we are concerned about now is the economic consequences of going through
the second of those stages – which, for the world as a whole, is what will
be happening over the next half century.
Virtually all countries around the world are going through this transition,
although they are at different stages and it is happening at different speeds.
The process is most advanced in countries like Japan, Italy and other parts
of continental Europe. In Japan, the crude birth rate will fall below the
crude death rate in the current decade, so that the ‘natural increase’ in
the population turns negative. This point has already been reached in Italy,
and the excess of deaths over births is even larger in parts of eastern Europe,
especially Russia. At the other end of the spectrum are the countries of sub-Saharan
Africa and south Asia, which still have very high birth rates. But even in
those countries, UN projections show an eventual ageing of the population
structure, though it comes much later than in the developed world.
In between those extremes, there are a large number of countries like the
US, the other English-speaking countries, China, other parts of east Asia,
and Latin America, where signifi cant population ageing is now under way,
even though it is not as far advanced as in Japan and continental Europe.
But, even though there are some big differences across countries, we should
be clear that this is a global phenomenon, and not something that is confi
ned to the developed world. One common way of summarising these trends is
to look at old-age dependency ratios – that is, the ratio of people aged 65
and over to those of working age. According to the Harvard demographers Bloom
and Canning, in a paper to a Federal Reserve conference last year, this ratio
is projected to roughly double, from about 12 per cent now to about 25 per
cent by 2050. And it will be signifi cantly higher than that in places like
Japan, Europe, the US and China.1 The corollary of that trend is that there
will be fewer workers available to support each person in retirement than
is the case today.
Economic Implications
What are the implications of all this for our economies? Before I try to answer
that, a preliminary point to consider is the question of what constitutes
old age. The conventional way of thinking is to use a fi xed cut-off – say,
age 65, and to defi ne everyone above that age as being old. But it is conceivable
that societies can defi ne old age more fl exibly. If population ageing is
being driven partly by improved longevity, which entails better health and
higher life expectancy at any given age, then it is reasonable to think that
what constitutes old age is itself shifting upwards. The average 70–year old
in Australia today is much fi tter and healthier, and can expect to live longer,
than was the case a generation ago. And I am sure the same is true in other
countries.
The reason I make this point is that many of the economic effects that stem
from population ageing are a result of structures that assume a fi xed cut-off
point for old age – particularly things like fi xed retirement ages and fi
xed ages for qualifying for pension benefi ts. But these things do not necessarily
have to be fi xed. Having made that point, let me outline what seem to me
the main economic consequences of population ageing, given the economic structures
we currently have. The fi rst one is likely to be slower economic growth.
When a large part of the population starts to move from the pre-retirement
to the postretirement age group, the effect of that is to slow down the ;
growth of the working-age population.
Other things equal (that is, assuming given participation rates and productivity
growth), this is going to mean lower growth in per capita incomes and lower
growth in the total economy. In Japan, for example, the working-age population
is already falling, and this is one reason, though not the only one, why potential
growth there is lower than it was two or three decades ago. Other countries
are experiencing the same transition, though it is not as far advanced. In
Australia, growth of the working-age population is still a healthy 1½ per
cent per annum, but it has already started to slow down and this in turn will
mean lower potential growth of the economy. The same will happen in China,
Korea and many other countries. This is the reverse of the process that countries
would have experienced in the previous phase of the population transition.
In that phase, working-age populations were generally growing more quickly
than the population as a whole. The resultant growth in labour supply is thought
by many economists to have been an important contributor to above-average
growth in per capita GDP, especially in east Asia. But what the demographic
projections are telling us is that this positive force will eventually turn
around and become a drag on growth, as it already is in large parts of the
developed world.
The second consequence will be to put strain on government budgets. One way
this will arise is through government pension commitments, especially where
governments run defi ned-benefi t systems that are effectively funded on a
pay-as-you-go basis. This is the norm in large parts of the developed world,
including the US, continental Europe and Japan. Work done at the OECD has
shown that these pension systems have very large negative net present values
to their respective governments.2 In other words, they represent a signifi
cant (but not formally recognised) net liability. This is borne out by offi
cial projections for the US social security pension system, for example, which
show that it will soon turn cash-fl ow negative and eventually will run out
of funds.
Another important source of fi scal strain is the impact of ageing on health
costs. A disproportionate amount of the lifetime health-care cost for an average
person is incurred in old age. This means that, as the population gets older,
health costs for the population as a whole will go up. Australian Treasury
projections suggest this will in fact be the main way that population ageing
affects the fi scal position in this country: in 40 years’ time, under ;
unchanged policies, rising health costs are projected to add an extra 4 per
cent of GDP to government spending.
A third set of possible consequences will be the effects on fi nancial markets.
Population ageing means we are entering a world where, in relative terms,
labour will become more scarce and capital more abundant. As a result of that,
economic modellers generally predict that real wages will rise and returns
to capital will fall. It is interesting to note that this change in relative
prices will actually make it harder to prepare for population ageing purely
by saving more, because the returns on saving will be lower. This means that
what will be needed is some combination of increased saving and greater workforce
participation, which is what higher real wages should help to bring about.
Another way that fi nancial markets may be affected is through the fi scal
strains I already mentioned. If governments around the world fail to prepare
adequately for these events it might undermine confi dence in the sustainability
of public fi nances, with effects on fi nancial markets in general. Most models
would predict that these and other fi nancial market effects would be slow
moving, because the demographic changes that drive them are themselves slow
moving. But we know in practice that fi nancial market adjustments are not
always achieved smoothly. Some commentators speculate that markets might be
disrupted if there were a pattern of delayed recognition followed by overreaction
to the implications of demographic change. Yet another way that fi nancial
markets might be affected is through the impact of differential rates of population
ageing on international capital fl ows. This is a major separate subject in
itself, so I mention it only in passing. Economic theory suggests that the
high-income countries that are ageing soonest should be preparing for that
by exporting capital to the countries that are further behind. In this way
they would build up assets that will yield a return fl ow of income when the
costs of ageing are eventually incurred. Whether or not this mechanism can
make a big difference in spreading the costs of ageing is an interesting question
for debate. Also interesting is the puzzle of why (in some instances) capital
seems to be fl owing in the opposite direction at the moment to what the theory
predicts.
A final point worth making here concerns what might be called the political
economy of fi nancial market regulation. The emphasis on saving for old age
could help lift the overall importance of fi nancial institutions and markets
in our national economies. This might well bring with it greater demands for
regulatory scrutiny of saving vehicles, particularly when people are encouraged
into those vehicles by government policies.
Policy Responses to Prepare for Population Ageing
What should governments do to prepare for population ageing? Answering this
question is the task set for delegates to this think-tank over the next couple
of days, so I am not going to attempt any defi nitive answers myself. What
I will do is to suggest a few of the areas that you might want to look at
in your discussions. You may well be able to come up with more.
The first area is fi scal policy. It is always important to run a sound fi
scal policy, but particularly so when you know you are entering a period where
there will be additional pressures on government budgets. So the question
here is, are our governments entering the population ageing period with suffi
ciently strong fi scal positions?
A second area is pension schemes. Governments obviously need to avoid entering
into unsustainable pension commitments, if they can. Where they have already
done so, which is broadly the case in Japan, Europe and North America, they
have the more diffi cult problem of trying to put these schemes on a sustainable
footing. How might this be done? On the face of it, the main options are either
to raise social security contribution rates, cut benefi ts in ; some way
(possibly by delaying entitlement) or else to face an ever-increasing subsidy
requirement from the general budget.
More creative options are to try to move to pre-funded pension systems, as
has been done, to a degree, in the UK and is being considered in the US. The
available models for pre-funded schemes around the world include Singapore’s
publicly sponsored central provident fund, and the mandated private saving
schemes operating in Australia and Chile. Where pre-funded schemes are put
in place, they should have the effect of lifting saving rates, and therefore
helping individuals (and society as a whole) to prepare for the fi nancial
needs of old age. But, for reasons I have already alluded to, this seems unlikely
to solve the problem on its own. Higher saving can be expected to force down
rates of return, while at the same time people are facing a longer period
of retirement that needs to be funded.
This suggests a further area that will need to be looked at, namely policies
to lengthen the average working life. With people staying healthier for longer,
it may be natural to expect people to continue working longer than was the
case in the past. We need to consider whether there are obstacles that might
prevent this from happening. Is there anything governments need to do to encourage
this, like raising offi cial retirement ages, or changing the incentive structures
that operate in the years around retirement?
It is possible, too, that people’s expectations need to be changed. In Australia,
a common aspiration is to retire at age 55 which, for many people, would mean
working for 30 years to fund a 30-year retirement. For the bulk of the population,
that is clearly not going to be feasible. Do governments need to take a more
active role in reshaping those expectations, or will market forces achieve
the needed result? Two other policy areas we should think about are those
that can directly affect the age structure of the population and possibly
reduce the pace of population ageing itself. The fi rst is immigration. Some
countries might be able to slow down population ageing by attracting more
immigrants. Presumably, migration would fl ow from poorer to richer countries,
so this is not an option that is going to be available to everyone. But it
is one option that countries will need to consider as they see their working-age
populations either slowing down or going into outright decline. The extreme
case here is Europe. It is commonly said that on current trends, Europe faces
a choice between large-scale immigration and depopulation. For some other
countries the prognosis might not be as extreme, but it will differ only in
degree.
The second area is policies to infl uence birth rates. I am not an expert
on this, and there are many people who would argue that it is not feasible
for governments to infl uence birth rates, or that it is not a proper role
for governments to actively encourage larger families. But we should at least
consider whether there are aspects of our societies that unnecessarily discourage
people from having children. Are families too heavily taxed? Are women excessively
penalised for having children? Are our societies ‘child-unfriendly’ in other
ways? Again, these are questions that participants in the think-tank might
want to consider during the course of the meeting.
Broader Social Implications
Economists don’t tend to talk a great deal about the wider social implications
of the phenomena that they study, but I want to fi nish up by making a brief
comment of that nature. We know it is a recurring pattern around the world
that, as countries get richer, their families have fewer children. But many
countries are still in the early stages of this process. What we do not yet
know is how low birth rates will go before they fi nally level out. Will most
countries be like the United States currently is, with a birth rate around
the replacement level of 2.1 children per woman? Or will they be more like
Italy, with a birth rate not much more than half that?
The answer will make a big difference, not just to population trends, but
to the nature of our societies. ; The American social commentator Nicholas
Eberstadt speculated on what societies would be like if something like the
current Italian birth rate were to prevail for more than a generation. ;
Writing in 1998, he said: At the moment, Italy’s total fertility rate is estimated
to be less than 1.2; the UN’s ‘low variant projection’ anticipates the continuation
of this pattern to the year 2050. If Italy’s current fertility regimen is
extended for two generations, the modal ‘family’ will be completely redefi
ned. For in that future world, under reasonable assumptions about the incidence
of childlessness and larger families, almost three fi fths of the nation’s
children will have no siblings, cousins, aunts or uncles – only parents, grandparents,
and perhaps great-grandparents. Under those same assumptions, conversely,
less than 5 percent of Italy’s children would have both siblings and cousins.
[…]
While it is possible to describe this new typology of the family, it is almost
impossible today to imagine what it would portend. Throughout the remembered
human experience, the family has been the primary and indispensable instrument
for socializing a people; families presented the individual with extended
bonds of obligation, and reciprocal resources – including emotional resources
– upon which he or she could draw. Under the demographic
projections considered here, all that would change momentously. For many people
– in some places, for most people – ‘family’ would be understood as a unit
that does not include any biological contemporaries or peers.4
He went on to talk about what he calls the ‘social atomisation’ that might
result from that. Obviously, this thought experiment is based on one extreme
of the demographic spectrum, but it makes the point that demographic changes
are likely to have social consequences as well as economic ones. I leave you
with that thought, and wish you well in your discussions over the next couple
of days.
Source : Reserve Bank of Australia (RBA)