Abstract
As stressed in section one, the next 50 years will witness a significant increase in ageing in the EU, the US, Japan and the fast ageing group of countries, with the number of people aged 65 and over likely to grow significantly according to the most plausible scenarios. Such an unprecedented phenomenon raises serious questions as to its implications for the public finances, and in particular for the sustainability of the present old age PAYG (Pay-as-you-go) pension system, for private savings behaviour, for the evolution of labour productivity and for the outlook for potential growth and living standards in general. In addition, the effects of ageing are not confined to the respective domestic economies, with the international dimension being crucial. Consequently, as well as the domestic changes in savings / investment balances, the regional and global effects must also be considered, as differences in the intensity and timing of the ageing phenomenon will provoke changes in interest rates, exchange rates and international capital movements.
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For the simulations carried out in sections 4 and 5, since any increases in age-related public expenditure are fully financed via tax increases, Ricardian equivalence effects do not play a role, although an assumption of debt financing can be adopted in the model for sensitivity analysis purposes.
These models suggest that an important component in determining the aggregate savings rate is a population’s demographic profile, with savings propensities and the over-all dependency ratio expected to be negatively correlated. Inter-temporal considerations provide the intrinsic analytical underpinning of such models, with the objective of the average consumer being to even out consumption over a lifetime in which income fluctuates substantially depending on age, i.e. the notion of consumption smoothing. Under this view of the world, the savings rate would be expected to be high when a large proportion of the population is employed, with savings being built up to finance post-retirement consumption. Likewise, the savings rate should be lower when a large percentage of the population is very young or is over the retirement age.
The life cycle hypothesis is similar to the permanent income hypothesis in that consumption in both cases is a constant proportion of income.
In addition to the general theoretical considerations which have been laid out above, it is necessary to look at the issue of the specific mechanisms through which ageing will impact on savings. In this regard, the dominant indicator that is used to assess the impact of ageing on savings is the old age dependency ratio. In order to understand better the complex interactions between savings and ageing it is best to distinguish between the two fundamental variables which determine the trend of the old age dependency ratio, namely changes in the birth rate and changes in life expectancy (or more precisely changes in retirement duration). Both factors have fundamentally different effects on savings under the different hypotheses described earlier.
With a change in dependency ratios of 20–30 points, even a low private savings rate effect would result in a fall in the savings ratio of a few percentage points.
Concerning public savings, the model is used in the central scenario to estimate the effect of ageing pressures on public expenditure but it is assumed that increased expenditure is financed by increased levels of taxation. For example, in the case of public pensions, any increase in expenditure is financed by increases in social security contributions which normally are assumed to have the same effect in ECFIN’s ageing model as an increase in direct taxation but this assumption can be relaxed to allow for the savings element of social security contributions. This tax financing rule firstly, and most importantly, ensures that the public finances stay on a sustainable path over the simulation period and secondly it avoids having to adjust private savings rates for Ricardian equivalence effects, although such adjustments could be made if necessary.
Meredith (1995) concluded in relation to these household data studies “By using more recent and detailed information on the income and consumption of retired households, the analysis has shown that the savings rates for the elderly calculated in some house-hold level studies may be misleading. It appears that the elderly do dissave, and that the rate of dissaving is very similar to that predicted by a life-cycle model of household behaviour”. Meredith’s skepticism on the results of household survey data is supported by Miles (1999) who stresses the role played by PAYG pension systems in the results obtained. Miles states “What the numerical examples and the empirical studies suggest is that failure to measure pension wealth correctly can have a major impact on estimates of saving, especially for the elderly...... in principle, mis-measurement of pension income could account for the striking discrepancy between what life cycle models imply about the age/saving relation and estimates of savings rates by age that are derived from looking solely at household data in isolation from information on the value of funds that back pensions. The reason is that for those contributing to a funded scheme, pension wealth conforms exactly to the simple life cycle pattern; it is steadily built up during the working life and is run down in retirement”.
These broad numbers are backed up by the calculations included in the UN Population Division’s 2000 publication “Replacement Migration: Is it a Solution to Declining and Ageing Population” where the migration assumptions underlying the 1998 “mediumvariant” population projections was used as a reference for a number of migration scenarios. For example, if the objective of the EU is to keep either its total population constant or its working age population constant then migration rates would need to be respectively 31/2 and 6 times greater than those of the medium-variant scenario. If on the other hand the EU wanted to be even more ambitious and keep its old age dependency ratio constant then migration would need to be 50 times greater than that of the medium variant scenario or alternatively the effective retirement age would need to rise to 75.
It is important to stress that while the EU utilises a much smaller fraction of its labour potential compared with other areas around the world this is partially compensated for by relatively high rates of productivity per person employed and productivity per hour worked. For example in the year 2000, output per hour worked in the EU was roughly 29 dollars (in PPP terms) compared with 4 and 5 dollars in the slow and fast ageing groups of countries respectively and 31 and 23 in the US and Japan. In fact in terms of productivity per hour worked the EU is presently at 92% of the US average but because EU workers work substantially less hours the average standard of living is only 72% of the US average. In an ageing world the EU will have to seriously consider increasing their average labour input per person, through participation rate and effective retirement age increases in order to compensate for the lower numbers of entrants into the EU’s labour force.
The future evolution of the capital to labour ratio depends crucially on real interest rates. Two offsetting factors are at work in terms of ageing — declining labour forces require less investment but the savings rate of an ageing population is going down. Which effect dominates is controversial. The majority of models predict a slight decline in real interest rates. However, work by Kotlikoff et al (2001) suggests the opposite conclusion of an increase in interest rates.
This is a trend which was particularly evident in the 1990’s, when a high proportion of the total expenditure of the various “stimulus” packages over this period went on public works projects, with questionable benefits in terms of rates of return.
Given the uncertainties involved it is difficult to speculate as to the underlying factors driving trends in the US and EU capital-output ratios. However, a secular shift to the less capital intensive services sector is likely to be playing a role in the US, with the slight upward tendency for the EU partly related to capital / labour substitution and changes in relative factor prices. In more general terms, the underlying factors driving future investment / capital stock changes will of course continue to be GDP growth, capital intensity and depreciation rates.
Jones takes the view that TFP is negatively affected by the ageing process and estimates that a 1% point decline in the OECD’s population growth rate lowers the growth rate of TFP by .05 to .3% points.
In terms of the split of national savings between the public and private sectors, even allowing for the fact that the data for the fast and slow ageing countries is based on simple calculations using aggregated World Bank datasets, in general terms one can say that over the period 1960–1995 that private savings developments have been reasonably stable in all of the five areas with changes in overall national savings being driven mainly by public sector savings behaviour. However, for the most recent period 1995–2000, it would appear that the general pattern across all areas, with the notable exception of Japan, has been towards a substantial decline in private savings and with this being offset by a shift to positive savings by the government sector.
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© 2004 Springer-Verlag Berlin Heidelberg
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Mc Morrow, K., Roeger, W. (2004). How is Ageing Likely to Impact Economically over the Next 50 Years: What are the Main Transmission Mechanisms?. In: Welfens, P.J.J. (eds) The Economic and Financial Market Consequences of Global Ageing. European and Transatlantic Studies. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-540-24821-7_2
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DOI: https://doi.org/10.1007/978-3-540-24821-7_2
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