The economic consequences of population aging

The world is greying. An aging population is affecting many aspects of the economy, especially in developed countries. Japan, for example, has 22.7% of population aged over 65 in 2009 and this percentage is forecast to increase to nearly 40% by 2050. (fig. 1)

Japan's changes in population pyramid

Figure 1 shows the shift of Japanese population towards an elderly direction. In 1950, the bulk of the population (nearly 60%) is of working age, and the elderly composed of a mere 5% of the total population. This allowed for more resouces to be directed to investment and hence contributed to the fast growth of Japan during the 1960s. There was a moderate proportion of youth (35%).

Over time, however, the babyboomers get older but they tend not to have as many children. The Total Fertility Rate, which measures the number of children on average a woman aged 15-49 has, has steadily fallen down. (Figure 2. Author’s plot. Data acquired at Japanese Statistical Bureau).

The reduction in fertility rate is only one of the reasons of population aging. Better health conditions enable people to live longer.

An aging population impacts the economy by several channels.

Firstly, an increasing elderly population needs more social transfers, whether done by government or individuals. This has a crowding out effect towards investment for younger generations and lowers capital per worker, which will slow economic growth. The flip side, however, is that lower fertility brings an aging population as well as an working population that is growing slower, so the amount new workers need will decrease. We should also notice that if the old were forward-looking and saved intentionally for their retirement, they wouldn’t need as many social transfer payments. But the individual’s motivation to save is always limited, therefore some governments have enforced mandatory schemes to ask for savings in the youth for post-retirement use. Hong Kong’s Mandatory Provident Fund (MPF) is an example.

Secondly, population aging will urge the government to seek diversified and cost-effective ways to provide elderly care. Tax transfers to the dependents (both the young and the elderly) requires a large tax base which is mainly the working age population. They will face increasing burden as the tax base shrinks.

Lastly, population aging affects the fertility rate. The working age population, faced with increasing pressure to feed the youth and support the elderly, are likely to have fewer children, lowering the new population and increases the problem of population aging even further. Instead of simply funding the retirees with taxpayers’ money, the government of developed countries should consider designing some effective individual saving scheme to fit the intertemporal consumption and savings of a typical individual. It is better to be self-contained.

Reference:

Weil, David N. 2006. “Population Aging”, nber working paper 12147.

Statistical Handbook of Japan 2010.

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