Aging gracefully: the population balancing act

Achieving population stability – higher growth in some countries, lower in others – is a more important global challenge than longer lives or the mechanics of pension system reform.

The “problem” of an ageing population is now discussed not just in rich countries but across the world. But increasing life expectancy is a wonderful development and is neither the major demographic challenge the world faces nor even a significant problem at all. By far the more important demographic change is the transition to low birth rates. But that too is welcome, provided it does not go too far. The ideal outcome for the world would be broad population stability combined with ever-increasing longevity. Provided we achieve that outcome, pension system challenges are manageable. But achieving it will require deliberate policy choices.

Ripe old age

Increasing life expectancy is not an inherent problem if ageing means more years of active, healthy life rather than more years of frail, dependent life; and the balance of the evidence is that ageing can be healthy if people make sensible lifestyle choices and if health-care systems are well designed. Increases in retirement ages are, therefore, a logical and feasible response to pension system challenges. And if the only demographic challenge a country faced were increasing life expectancy, a proportionate rise in retirement ages – the rise needed to keep stable the proportion of life spent working – would be a sufficient response to keep the pension system in balance. In such a situation there would be no need for tax rises, increases in savings, or reductions in relative pensioner income. Political courage is required to convince people of the need for and possibility of later retirement. Higher retirement ages will also require new approaches to the retraining of older workers, an end to age discrimination and changes to age-related pay scales. But a longer-lived society is not an inherent problem: the longer we live, the better.

Low birth rates pose a far more fundamental challenge to pension systems. And very low birth rates – Italy’s 1.2 children per woman, Russia’s 1.1, Japan’s 1.3 – would, in the long run, create major economic and social problems. But it is also important to recognize the huge long-term benefits of population stabilization and the huge disadvantages that would follow if Europe or China reverted to perpetual population growth. If the United Nations (UN) “medium scenario” is correct in projecting that world population will stabilize in about 2075, that is a good thing. The optimal birth rate for countries, and for the whole world, is probably at around replacement level and neither significantly below nor significantly above it.

The present predominant pattern, however, is that birth rates fall well below the replacement rate of two children per woman wherever economic success is achieved. At present Europe (east and west combined) has a birth rate of around 1.4, but low fertility is not specifically an “Old Europe” phenomenon. America has a fertility rate around the replacement level only because Hispanic immigrants maintain a high birth rate in the first generation after arrival. But with Latin American birth rates now falling fast, America’s rate is almost certain to fall back below replacement level. The developed east Asian economies – Japan, Korea, Hong Kong and Singapore – all have birth rates in the 1.0 to 1.4 range: China’s is 1.8. The UN’s medium projection meanwhile suggests that Brazil, Turkey and Iran will all have below-replacement birth rates within 15 years.

Who will pay for our pensions?

Low birth rates pose huge challenges to pension systems because the fundamental economics of pensions are determined by the ratio of workers to retirees. This is true irrespective of whether pensions are provided through a pay-as-you-go tax system or funded through capital market investments. In the past, the worker-to-retiree ratio was swollen by the fact that each successive generation was larger than the one before. The pension systems of the 20th century have all, to a degree, been pyramid schemes, chain letters or Ponzi schemes, where the relationship of benefits to contributions is vitally dependent on there being more people in the next generation, in the next link of the chain. But the base of the pyramid is now shrinking. When that happens one of four things must occur: pensioners become poorer relative to the rest of society; taxes must rise; savings must rise; or average retirement ages must rise more than proportionately to life expectancy, decreasing the proportion of life spent in retirement.

This is the challenge that the whole world will face before the end of the 21st century if the UN’s medium scenario population projection is correct. But the timing and the pace of the transition will vary hugely, with enormous consequences for the relative size of different populations. Russia’s population could well fall from 145 million today to 100 million by 2050, and Pakistan’s rise from 145 million to 350 million (see chart 1). Africa’s population, currently two-thirds of China’s, might by 2050 be 30% larger and still rising. China’s will probably be in gradual decline after about 2030 (see chart 2). America’s population might well grow via immigration by 40% between now and 2050. The European Union, unless it also accepts mass immigration, will have a slightly declining population. These changes carry consequences for economic growth rates and for countries’ financial and geopolitical weight. Even if European productivity rises as fast as that in America, the US economy will grow by around 1% faster per annum thanks to higher immigration, as it has done for the past 25 years. And Europe’s share of world population and of world income will shrink.

Higher immigration in the short term and a higher birth rate in the long term are therefore seen by some people in Europe as essential, not only to avoid a pension crisis but also to maintain economic growth and to minimize the loss of economic and geopolitical status. And, it is true that significant immigration into Europe is simply unavoidable, and that immigrants ought to be welcomed and integrated as effectively as possible. But immigration and high birth rates can only make a major difference to pension systems if large enough to produce significant population growth.

The limits to growth

In the very long run such population growth could only be achieved by a higher birth rate: once the whole world’s population stabilizes, the whole world cannot solve its pension crisis through immigration from the moon. But, however achieved, population growth on that scale, into already densely populated parts of the world like much of Europe, would have huge adverse economic and quality-of-life consequences. The benefits to pension-system sustainability would, therefore, be offset by the costs of transport congestion, countryside destruction and rising property prices as people compete for a limited supply of spacious and pleasantly located housing. And perpetual population growth on that scale at a global level would mean an ever-growing human impact on the world’s ecology and would undermine attempts to solve the pressing challenge of climate change. The shift towards lower birth rates might well be a naturally arising human response to both the opportunities and the environmental pressures created by rising prosperity: to seek to reverse it by deliberate policy, simply because generous pension systems are under strain, would be undesirable.

As for concerns about shifts in economic and geopolitical weight, similar mathematics apply. The biggest driver of such shifts will arise not from changing population sizes but from the developing world catching up to the prosperity of the developed, a catch-up that anybody with any moral sense should welcome. If China achieves in the coming half-century what Japan and Korea achieved in the past one, Europe’s economy will be significantly smaller than China’s. Only explosive European population growth – multiplying the population three-fold or four-fold – could prevent that. But although Europe’s share of world income will fall, and Europe’s total income will grow significantly more slowly than America’s, there is no reason why prosperity – per capita income – should not grow as fast. For countries to follow population growth strategies in pursuit of relative economic or geopolitical weight would be environmental folly. In the long term, when the immigration option is exhausted, it will also, almost certainly, be impossible. The chances that women will revert to high birth rates to serve the status ambitions of national elites is close to nil.

Stability – not decline – is desirable

But if strategies of population growth to earn geopolitical standing are both undesirable and, almost certainly, infeasible, there are good arguments for developed rich countries, and for low-income countries like China that already have rich-country birth rates, to encourage birth rates close to replacement levels rather than dramatically below them. Pension system challenges are manageable provided populations are about stable. If Britain’s population remains roughly stable at around 60 million over the next 50 years, the combination of an increase in tax equal to 1.5% of national income, a one-third increase in the pension savings rate, and a rise in the average retirement age from 63 to 66 (which would still allow a rise in the number of years spent in retirement) would be a sufficient response to the pension challenge. But when populations fall significantly, as they are forecast to do in Russia, Italy and Japan, pension system sustainability becomes impossible. Significantly poorer pensioners or a very big rise in the burden on the working population become unavoidable. And although there are good ecological reasons for desiring population stability, global environmental balance does not require perpetual and significant human population decline.

The optimal birth rate, for the whole world and for individual countries, is therefore likely to be close to the replacement level of two children per woman and neither significantly below nor significantly above this. The challenge in much of western Asia, the Middle East and Africa remains to get birth rates down to replacement level. For all the talk of a demographic slowdown and an ageing population, we should not forget that in Pakistan, Saudi Arabia, Somalia and Yemen, it is rapid population growth that still threatens economic and political stability. The challenge in rich developed countries, however, will be to avoid a lengthy or permanent period of birth rates well below replacement levels.

The good news is that both the decline (where desirable) and the increase (where desirable) are most likely to be achieved by empowering women to make their own decisions. Economic prosperity, education for women and open access to contraception seem to be sufficient to bring birth rates down towards replacement levels, irrespective of cultural and religious differences. And in countries with birth rates well below two there is survey evidence that many woman would have chosen a higher birth rate if it had been easier to combine work and family lives. The European evidence suggests that the best way to encourage birth rates at least close to two rather than far below (the 1.8 achieved in Norway rather than the 1.15 in Spain, for example) is via policies on working hours, child-care provision, gender equality and maternity and paternity leave.

The natural consequence of certain good things – prosperity and freedom for people, particularly women, to make their own choices – might well be population stability as well as ever-lengthening lives. We should welcome that stability and design policies to make it more likely, managing the significant but clearly surmountable problems that population stability and longer lives create for pension systems.

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