The economic implications of changing age structures

The economic The economic implications of changing implications of changing

age structuresage structures

Ronald LeeRonald LeeUniversity of California at University of California at

BerkeleyBerkeley

Based on research supported by Based on research supported by National Institute of AgingNational Institute of Aging

The demographic transitionThe demographic transition

During the demographic transition, During the demographic transition, typically mortality begins to fall typically mortality begins to fall decades before fertility declines.decades before fertility declines.

Initially, families find themselves with Initially, families find themselves with more surviving children to feed and more surviving children to feed and educate than before. educate than before.

Likewise, there are more surviving Likewise, there are more surviving children in need of public education children in need of public education and health care.and health care.

Once fertility begins to decline, this Once fertility begins to decline, this process is reversed. Families and process is reversed. Families and governments have fewer children to governments have fewer children to provide for, and consumption pressures provide for, and consumption pressures ease. ease.

This leads to the first demographic This leads to the first demographic dividend, a period of declining numbers of dividend, a period of declining numbers of consumers per producer. This alone tends consumers per producer. This alone tends to boost the growth of income per capita.to boost the growth of income per capita.

The transition continues…The transition continues…

At some point, the number of children per At some point, the number of children per working age person stops declining, and working age person stops declining, and the first dividend, in the sense of a boost to the first dividend, in the sense of a boost to the rate of increase in per capita income, the rate of increase in per capita income, comes to an end.comes to an end.

Around this time, lower fertility also leads Around this time, lower fertility also leads to slower growth of working age population to slower growth of working age population while the number of elderly keeps growing while the number of elderly keeps growing rapidly, and speeds up due to falling rapidly, and speeds up due to falling mortality: Population aging.mortality: Population aging.

Population aging raises the number of Population aging raises the number of elderly dependents just as the number of elderly dependents just as the number of child dependents has fallen. child dependents has fallen.

This puts renewed pressure on This puts renewed pressure on consumption and slows the growth of per consumption and slows the growth of per capita income. But it also may lead to capita income. But it also may lead to increased accumulation of wealth per increased accumulation of wealth per capita which generates non-labor income capita which generates non-labor income and raises labor productivity. This is the and raises labor productivity. This is the second demographic dividend.second demographic dividend.

The dividendsThe dividends The first dividend occurs quite The first dividend occurs quite

mechanically, regardless of institutional mechanically, regardless of institutional setting. Independent variations in setting. Independent variations in productivity growth may reinforce or offset productivity growth may reinforce or offset its effects. its effects.

The second dividend depends on policies The second dividend depends on policies and institutions. and institutions. • If consumption in old age is provided through If consumption in old age is provided through

transfer programs, the second dividend is transfer programs, the second dividend is weakened or absent. weakened or absent.

• If old age consumption is funded through asset If old age consumption is funded through asset accumulation, the second dividend does occur. accumulation, the second dividend does occur.

Crucially,Crucially,

the economic effects of the economic effects of population aging depend on population aging depend on

institutions and policiesinstitutions and policies..

Questions about the dividendsQuestions about the dividends

Does consumption of an elderly person Does consumption of an elderly person cost more or less than that of a child?cost more or less than that of a child?

How long does the population share of How long does the population share of dependent children continue to decline? dependent children continue to decline?

How much does the ratio of workers to How much does the ratio of workers to consumers rise in total and per year? consumers rise in total and per year?

Are increased resources per consumer Are increased resources per consumer used to raise consumption, invest in used to raise consumption, invest in education of children, or saved for education of children, or saved for retirement?retirement?

To answer these questionsTo answer these questions

We will consider a typical We will consider a typical demographic transition.demographic transition.

We will also examine the way We will also examine the way consumption and labor income vary consumption and labor income vary with age in different settings.with age in different settings.

We will see how old age consumption We will see how old age consumption is paid for in different countries.is paid for in different countries.

THE CASE OF INDIATHE CASE OF INDIA

Indian life expectancy began to rise around Indian life expectancy began to rise around

1900, here simulated to go from 24 to 80 years.1900, here simulated to go from 24 to 80 years. Life expectancy in years

Actual data (*)

Earlier UN projections

Simulations based on smooth mathematical trajectories for fertility and mortality

Actual data (*)

Indian fertility began to fall around 1960, Indian fertility began to fall around 1960, here simulated to go from 6 to 2.1 birthshere simulated to go from 6 to 2.1 births..

Children per woman

Changes in the child dependency ratioChanges in the child dependency ratio

Once fertility begins Once fertility begins to decline, the to decline, the child dependency child dependency ratio falls.ratio falls.

Child dependency

ratio (<15/15-64)

Increasing survival of children initially raises the ratio

Then declining fertility reduces the ratio.

Changes in the old-age dependency ratioChanges in the old-age dependency ratio

Serious Serious population aging population aging begins more begins more than a century than a century after the after the transition starts.transition starts.

The old-age The old-age dependency dependency ratio rises ratio rises rapidly, by a rapidly, by a factor of six.factor of six.

Old-age dependency ratio (65+/15-64)

Onset of serious population aging is late in the transition

Rising dependency as mortality falls

Population aging


The “first dividend”: Dependency falls

Dependency ends where it began. Transitory effect.

Variation in the total dependency ratioVariation in the total dependency ratio

Population aging


The “first dividend”: dependency falls

At start: Many children and few elderly.

At end: Many elderly and few children.

This generates the “second dividend”.

Variation in the total dependency ratioVariation in the total dependency ratio

How Dependency Ratios Change Over A Classic Demographic Transition:How Dependency Ratios Change Over A Classic Demographic Transition:Actual and Projected for India and Simulated, 1900-2100Actual and Projected for India and Simulated, 1900-2100

USA

Least developed countries

China

Europe

There is great variation in projected There is great variation in projected old age dependency ratios for 2050old age dependency ratios for 2050

Southern Europe

Ratio in Japan Ratio in Japan projected to be 6 projected to be 6 times as high as times as high as in the least in the least developed developed countries.countries.

Differences are Differences are due to position in due to position in transition, baby transition, baby booms and busts, booms and busts, and fertility and fertility below below replacement.replacement.

Japan

II. How labor income and II. How labor income and consumption vary by ageconsumption vary by age

To understand economic implications To understand economic implications of age structures, we need to know of age structures, we need to know how labor income and consumption how labor income and consumption vary with age. vary with age.

The National Transfer Accounts The National Transfer Accounts project (NTA) is estimating these for project (NTA) is estimating these for many countries.many countries.

NTA measures labor income as NTA measures labor income as average income at each age, average income at each age, whether the individual is working or whether the individual is working or not. not.

It includes fringe benefits and self It includes fringe benefits and self employment income.employment income.

Source: Sang-Hyop Lee, report on NTA labSource: Sang-Hyop Lee, report on NTA labor income dataor income data










Consumption by ageConsumption by age

NTA includes private household NTA includes private household consumption and also publicly consumption and also publicly provided education, health care, and provided education, health care, and other items.other items.

A typical LDC example: Thailand, A typical LDC example: Thailand, 19981998

Thailand's Economic Lifecycle, 1998Per capita labor income and consumption per year (baht)

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

0 10 20 30 40 50 60 70 80 90+

Consumption

Labor income

Source: Chawla 2005.

Some MDCs have higher consumption in old age Some MDCs have higher consumption in old age (US, 2003); Public health care is important(US, 2003); Public health care is important

0

10000

20000

30000

40000

50000

60000

0 20 40 60 80

Dol

lars

(US

, 200

0)

Labor Income

Consumption

-20000

-10000

0

10000

20000

30000

40000

50000

0 20 40 60 80

Dol

lars

(US

, 200

0)

Source: National Transfer Account data.

III. Economic Consequences of III. Economic Consequences of Age Distribution: Support ratiosAge Distribution: Support ratios

The balance of workers and The balance of workers and consumers for the whole population consumers for the whole population is summarized by the support ratiois summarized by the support ratio• Add up population times labor income at Add up population times labor income at

each ageeach age• Add up population times consumption at Add up population times consumption at

each ageeach age• Ratio of labor to consumers is the Ratio of labor to consumers is the

“support ratio”. “support ratio”.

A high support ratio is favorable. A high support ratio is favorable. The increase in the support ratio in The increase in the support ratio in

the middle of the demographic the middle of the demographic transition is the “demographic transition is the “demographic dividend”. dividend”.

Here are examples for some LDCs at Here are examples for some LDCs at different stages of their transitions.different stages of their transitions.

Support Ratios for Five Less Developed Countries, 1950-2100, Based on UN population projections and average LDC age profiles from NTA

India

Brazil Niger

ChinaS. Korea

0.5

0.6

0.7

0.8

0.9

1

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ect

ive

Pro

du

cer

s P

er

Co

nsu

mer


India

Brazil Niger

ChinaS. Korea

0.5

0.6

0.7

0.8

0.9

1

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ect

ive

Pro

du

cer

s P

er

Co

nsu

mer

Niger first dividend:

2014-2090, 76 years,

increase of 52%

.55%/yr


India

Brazil Niger

ChinaS. Korea

0.5

0.6

0.7

0.8

0.9

1

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ect

ive

Pro

du

cer

s P

er

Co

nsu

mer

First dividend for China and S. Korea are about finished.

China: 1971-2013, 42 years,

increase of 35% or .7%/yr

2007


India

Brazil Niger

ChinaS. Korea

0.5

0.6

0.7

0.8

0.9

1

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ect

ive

Pro

du

cer

s P

er

Co

nsu

mer

India is in middle of first dividend phase.

Brazil is near the end.2007

Spain

Italy

US

Japan

Germany

Spain, Low Fert.

Italy, Low Fert.

0.5

0.6

0.7

0.8

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ecti

ve P

rod

uce

rs P

er C

on

sum

erSupport Ratios for Five More Developed Countries, 1950-2100, based on UN long term population projections and the NTA age profile for the US.

Spain

Italy

US

Japan

Germany

Spain, Low Fert.

Italy, Low Fert.

0.5

0.6

0.7

0.8

1950 1970 1990 2010 2030 2050 2070 2090

Year

Eff

ecti

ve P

rod

uce

rs P

er C

on

sum

erSupport Ratios for Five More Developed Countries, 1950-2100, based on UN long term population projections and the NTA age profile for the US.

For Japan, Spain, Italy, and Germany, the support ratios drop

substantially by 2050.

For US, less so.

For Japan, Spain, Italy, and Germany, the support ratios drop

substantially by 2050.

For US, less so.

Proportionate Changes in the Support Ratio from 2007 to 2050 for Selected Countries

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

US Spain Italy Japan Germany S. Korea China Brazil India Niger

Country

Pro

po

rtio

nal

Ch

ang

e in

Su

pp

ort

LDCs from lowest to highest current fertility.

MDCs

Proportionate Changes in the Support Ratio from 2007 to 2050 for Selected Countries

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

US Spain Italy Japan Germany S. Korea China Brazil India Niger

Country

Pro

po

rtio

nal

Ch

ang

e in

Su

pp

ort

LDCs from lowest to highest current fertility.

MDCs

For MDCs other than the US, this is an annual decline of .5 to .8%.

Compared to expected productivity growth of perhaps 1 to 2% per year, this is significant.

IV. Population change, saving, and IV. Population change, saving, and capitalcapital

The first demographic dividend is The first demographic dividend is transitory.transitory.

Given the right policies, age Given the right policies, age structure changes can produce a structure changes can produce a second demographic dividend which second demographic dividend which is permanent.is permanent.

The second demographic dividendThe second demographic dividend

Typically, adults accumulate assets over Typically, adults accumulate assets over their life cycles.their life cycles.

Thus elderly hold more assets than others. Thus elderly hold more assets than others. Population aging raises the population Population aging raises the population

share of elderly, and therefore raises the share of elderly, and therefore raises the average amount of wealth and asset average amount of wealth and asset income.income.

More capital per worker also raises labor More capital per worker also raises labor productivity. productivity.

This is the second dividend.This is the second dividend.

The second dividend may be The second dividend may be reinforced by demographic changereinforced by demographic change

Longer life requires increased saving Longer life requires increased saving for retirement.for retirement.

Lower fertility may mean higher Lower fertility may mean higher saving by parents with fewer saving by parents with fewer children. children.

For these reasons, elderly may For these reasons, elderly may accumulate even more wealth.accumulate even more wealth.

The second dividend may be larger.The second dividend may be larger.

This does not mean the aggregate This does not mean the aggregate saving rate will rise with agingsaving rate will rise with aging

Actually, aggregate saving may well Actually, aggregate saving may well fall.fall.

The second dividend still occurs, The second dividend still occurs, because with slower labor force because with slower labor force growth, even lower saving can raise growth, even lower saving can raise capital per worker. capital per worker.

However, the second dividend However, the second dividend depends on institutions.depends on institutions.

If If elderly are supported by their adult elderly are supported by their adult children, then they save less and children, then they save less and hold less wealth.hold less wealth.

If elderly are supported by unfunded If elderly are supported by unfunded public pensions, then they save less public pensions, then they save less and hold less wealth.and hold less wealth.

Then second dividend is reduced.Then second dividend is reduced.

How old age consumption is financed in three countries

0%10%

20%30%

40%50%60%

70%80%

90%100%

US 2000 Japan 1999 Thailand1998

Work

Asset-basedReallocations

Familial Transfers

Public Transfers

Source: National Transfer Accounts.

41%43%

13%

44%67%

35%

Important differences across these Important differences across these four countriesfour countries

Assets account for more than 40% in Assets account for more than 40% in Thailand and the US, but only 13% in Thailand and the US, but only 13% in Japan. Japan.

With these arrangements, the second With these arrangements, the second dividend will be substantial in dividend will be substantial in Thailand and the US.Thailand and the US.

In Japan, population aging will just In Japan, population aging will just raise the transfer burden on the raise the transfer burden on the working age population.working age population.

ConclusionsConclusions

The transition leads to a first The transition leads to a first dividenddividend

Low fertility, longer life and slower Low fertility, longer life and slower population growth or decline are the population growth or decline are the destiny of all countries.destiny of all countries.

The transition to low fertility The transition to low fertility

produces increasing support ratios produces increasing support ratios for a period and generates a first for a period and generates a first dividend.dividend.

The first dividend is transitoryThe first dividend is transitory

These same processes later cause These same processes later cause population aging, reducing the population aging, reducing the support ratios.support ratios.

Institutions and programs focused on Institutions and programs focused on the elderly such as familial support, the elderly such as familial support, public pensions and long term care public pensions and long term care will come under severe stress. will come under severe stress.

The second dividend will helpThe second dividend will help

Yet, even as the population ages, Yet, even as the population ages, the second demographic the second demographic dividend raises capital per dividend raises capital per worker, boosting productivity worker, boosting productivity and asset income.and asset income.

The second dividend is not The second dividend is not automaticautomatic

BUT, the second dividend depends BUT, the second dividend depends on the specific institutional context on the specific institutional context of each country and the balance of each country and the balance between transfers and asset between transfers and asset accumulation for old age support. accumulation for old age support.

Transfers also have many good Transfers also have many good points.points.

expressing social solidarityexpressing social solidarity strengthening familial tiesstrengthening familial ties improving social equityimproving social equity Providing a safety net. Providing a safety net.

Policy makers should weigh carefully Policy makers should weigh carefully their costs and benefits.their costs and benefits.

These dividends are only two These dividends are only two among many factorsamong many factors

These demographic dividends are among These demographic dividends are among many other factors that influence the pace many other factors that influence the pace of per capita income growth. of per capita income growth.

Their size is moderate and other factors Their size is moderate and other factors may predominate.may predominate.

Nonetheless, they deserve careful Nonetheless, they deserve careful attention because they are relatively attention because they are relatively predictable and because policy shapes predictable and because policy shapes them.them.

It is important to act early.It is important to act early.

Countries early in the aging process have Countries early in the aging process have the option to encourage asset the option to encourage asset accumulation rather than transfers for old accumulation rather than transfers for old age support, and to harness the power of age support, and to harness the power of population aging to increase wealth.population aging to increase wealth.

Later, after aging has already occurred, Later, after aging has already occurred,

massive implicit debt in transfer programs massive implicit debt in transfer programs makes it very difficult to change – as in makes it very difficult to change – as in MDCs today. Flexibility is reduced.MDCs today. Flexibility is reduced.

Final thoughtsFinal thoughts

Population aging is not a cause for Population aging is not a cause for alarm, but it will require adjustments alarm, but it will require adjustments in many institutions and programs, in many institutions and programs, and these should be addressed early and these should be addressed early while options are open. while options are open.

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The economic implications of changing age structures