Group of Ten - The macroeconomic and financial implications of ageing populations

April 1998


In response to an initiative at the Denver Summit in June 1997, representatives from the central banks and the ministries of finance of the Group of Ten countries have carried out an assessment of the macroeconomic and financial implications of ageing populations. The initiative was prompted by the recognition that the prospective increase in the share of the elderly in the population could have significant repercussions for economies and financial markets across the world.

The purpose of this work is to distil the principal conclusions from the extensive factual and analytical material provided by national authorities and international organisations such as the OECD and the IMF. The major conclusions of this study are the following:

    • Although many G-10 countries have instituted reforms to address some of the issues raised by ageing populations, demographic developments will have adverse effects on material living standards and will significantly widen budget deficits unless further action is taken.

    • The need for early action is urgent because the burden of adjustment for governments and individuals increases the longer action is delayed.

    • To ease the burden of adjustment and to offset the expected negative effects of ageing on living standards and fiscal balances, reforms should encourage economic growth and the efficient use of resources. Thus reforms should pursue measures that would:
        • increase national saving and investment. Important in this regard will be further reduction of fiscal deficits and debt, including addressing the problems of funding public retirement and health benefits;

        • increase the supply and efficient utilisation of labour. Ensuring greater efficiency in labour markets and eliminating disincentives to continued labour force participation by older workers will help to achieve this;

      • ensure the efficient allocation of savings both within and across borders. Important actions in this area include strengthening the financial infrastructure, encouraging financial transparency, enhancing financial supervision and eliminating barriers to international capital flows.

  • An immediate increase in the funding of private and public pensions would help to alleviate the potentially severe demographic pressures on existing pay-as-you-go (PAYG) and underfunded systems. The choice of how retirement income is provided will depend on national circumstances, but a mixed approach based on all three "pillars" of retirement income - public retirement benefits, private pensions and household saving - has many advantages.

Demographic trends

Because of declining birth rates and increasing longevity, the share of the elderly in the populations of the G-10 countries has been growing for the past 150 years. Although demographic projections are not entirely certain, it is probable that this trend will accelerate sharply as the post-World War II baby boom generation begins to reach retirement age late in the next decade. Currently, there are about two people aged 65 and older for every ten people aged 15-64 in the G-10 countries. By 2040, this ratio is projected to reach four to ten on average and more than five to ten in some countries. The ratio of retirees to workers could rise even faster if recent trends towards earlier retirement continue. Actions to reduce structural unemployment and make labour markets more efficient will help to alleviate these pressures.

Implications for standards of living

As ageing raises the number of consumers relative to producers, the growth of material living standards (i.e. consumption per capita) will fall unless relative declines in the workforce are offset by increases in labour productivity and the effective supply and utilisation of labour. Decreases in labour force participation rates associated with projected demographic trends alone would depress the growth of GDP by as much as ½ to 1 percentage point per year in many of the G-10 countries between 2010 and 2030. Although the recent trend growth in labour productivity generally has been in excess of 1% per year, its future growth will depend on trends in technical progress and capital accumulation, which could be adversely affected by a decline in saving prompted by the retirement of the baby boom generation.

Fiscal consequences

The ageing of populations could have dramatic effects on government finances. Under current policies, government spending in the G-10 countries is projected to rise sharply over the next several decades for several reasons. Per capita expenditure for the elderly is high in the areas of public retirement benefits and, in some countries, welfare support. Public expenditure on medical and health support for the elderly is also high and has been rising. If advances in medical technology come at ever-increasing cost and if the incidence of health expenditure on the elderly continues to rise, the fiscal burden could become substantial in some countries. Projections in this area are, however, quite uncertain.

At the same time, government revenues will be adversely affected as the baby boom generation moves from its high-income-generating years to retirement. Countries whose revenues are tied more to consumption or value added taxes will tend to experience less of a deterioration in revenues than those that depend more heavily on income or payroll taxes. Although most countries have improved their fiscal balances in recent years, longer-term projections suggest that budget deficits would still reach unsustainable levels under recent policies. This would create a severe drag on national saving at a time when saving will be crucial to fostering the growth of labour productivity.

Population ageing will also raise important distributional questions for fiscal authorities. Governments will face the challenge of distributing the burden of supporting their growing dependent populations both efficiently and equitably. Reform of public pension systems requires a sufficiently long lead time to allow workers to compensate by adjusting their working and saving decisions. Even though the fiscal crunch will not occur for a number of years, reforms should be enacted soon.

Financial market effects

Population ageing can be expected to increase the flow of savings into private retirement accounts. Private pension fund assets have grown in many G-10 countries in recent years, although the size of such assets relative to GDP differs widely across countries. Continued growth of retirement savings, depending on how they are invested, could reduce rates of return and equity premiums. At the same time, greater capital flows should promote the increased breadth and depth of financial markets, allowing greater diversification. Once the baby boom generation retires and its saving rate declines, some of these effects may be reversed unless saving rates of younger people rise above historical levels.

Implications for current accounts

Demographic trends may have implications for current account positions to the extent that these trends differ across countries and to the extent that their effects on saving and investment differ within countries. Among the G-10 countries, those that are currently more advanced in ageing (e.g. Japan and Italy) are running current account surpluses. Looking ahead, the more rapid ageing of the G-10 countries on average relative to the non-G-10 countries could contribute to an improvement in the aggregate current account position of the G-10 countries for at least the next decade. Thereafter, such influences on current accounts might well be reversed if saving rates in the G-10 countries decline as ageing progresses further. Of course, actual outcomes for current accounts will also depend on a variety of other factors influencing both saving and investment across countries.

Higher rates of net and gross investment from industrial countries into faster-growing developing countries should benefit not only the recipient countries but also the investor countries, although the magnitude of these effects is uncertain. Nevertheless, an increased flow of savings to countries where the ageing trend is not as pronounced is one way to raise productivity and the total supply of goods and services available to consumers in countries where ageing is rapid.

Policy considerations

The best mix of policy reforms in response to population ageing is often country-specific. However, based on the analysis presented in this study, some general guidelines can help determine the shape that successful reforms are likely to take.

One component of a successful policy will be the encouragement of more growth to offset the negative effects of ageing on living standards. This will entail more saving and investment now. The most effective action that governments can take to raise national saving and thereby stimulate investment may be to cut their budget deficits or, even better, to reduce their national debts, in a manner that does not decrease private saving. Pension reform, including increased funding or prefunding of PAYG systems and reversing the trend towards shorter working lives as longevity increases, will play an important part in this process. Governments will also need to consider how best to implement other measures to spur investment and private saving.

It is also important to encourage the efficient allocation of labour. Incentives to retire early or disincentives to working longer should be removed or adjusted to ensure that the decision to retire is actuarially neutral at the official retirement age. Also, steps should be taken to enhance the efficiency of labour markets where needed to better utilise the existing supply of labour.

In view of the important role that financial markets play in coordinating the supply of savings with investment demand, governments should help to ensure that their financial markets function efficiently. Rules that unnecessarily inhibit portfolio diversification and risk management by retirement funds and other similar investors should be eliminated. G-10 countries also have an interest in other countries' financial markets being well developed and well run. The relaxation of investment restrictions, including controls on international capital flows, should be accompanied by measures to enhance the stability of the international financial system, including sound macro-economic policies, effective prudential supervision and regulation, and policies to promote financial transparency and disclosure. Finally, it is essential for governments to recognise that shifts in current and capital account positions may be a natural and transitory consequence of population ageing. The temptation to curtail trade and capital flows should be resisted.