Special Blog: The Macroeconomic Implications of Population Ageing

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Key points

  • Population ageing is a worldwide phenomenon and should be celebrated.
  • It will dramatically reshape the developing world in particular.
  • Has big implications for economic growth and debt sustainability.
  • Dependency ratio remains relevant from a public spending perspective.
  • UK has relatively favourable demographics relative to other developed countries but remains exposed to these headwinds.
  • Boosting fertility, migration and working longer could all have positive effects on economic output over the long run.
  • But raising productivity growth of the labour market and specific public services such as health care will also be key.

Background

The 1st of October is the UN’s official International Day for Older Persons. According to the UN’s medium population projections, the number of people aged over 65 could rise from just over 600 million today to close to 2.5 billion by 2100. Indeed in the next 20 years, the older population is expected to almost double in size. Clearly the fact that populations are growing older is cause for celebration, with unprecedented gains in life expectancy the result of continued economic development and advances in healthcare and technology. But population ageing will also pose an economic and fiscal challenge. This special extended blog therefore discusses what ageing might mean for future economic growth and the sustainability of government debt.


Population ageing around the world

Population ageing is a global phenomenon. The rate of growth in older people (people aged over 65) is expected to far outpace the rise of the working age population (people age 15-64). The chart below implies that the old age population will grow by over 300% over the course of this century by comparison to the working age population which will grow by less than 50%.

Cumlutive change in working age and old ageDeveloping countries will age most rapidly of all seeing a dramatic increase in the numbers of older people. Less developed countries will, for instance, see their older populations rise by nearly 4.5 times by the end of this century.

Cumulative change in old age and working age populations: Less developed countriesBy contrast, developed countries are likely to see more subdued growth in their older age populations, rising by around 70%. And in contrast with the developing world where its working age population is expected to continue rising, the developed world is expected to experience of fall in the working age population of over 10%.

Cumulative change in working age population and old age population: Developed countries
What does all this mean for dependency ratios?

Rapid population ageing in developing countries will result in sharp changes in the old age dependency ratio – which, in this context, is taken as the numbers of working age people for every older person (technically this an “inverse dependency ratio” but it is arguably easier to interpret). According to our calculations based on UN population projections, the world’s least developed countries will go from having around 16 working age people for every older person to around 4 by the end of this century. The developed world by contrast, will not experience such significant change. The developed world currently has 3.7 people of working age for every older person and this is expected to fall to 1.9 by the end of the period. The UK is expected to be broadly in line with the developed world – though it should be noted that its working age population is expected to continue rising well into this century.

Old age dependency rations
…demographic challenges in Southern Europe

Southern Europe is projected to endure a substantial decline in its working population – by 40% over the course of this century. After 2050 Southern Europe is also expected to experience declines in its old age population. This contrasts with Northern Europe which is expected to experience continued population growth over the period (both old age and working age populations).

Cumulative population change (N and S Europe)
Why should we still care about dependency ratios?

While recent developments in terms of extending working lives, and delayed entry into the labour market for younger workers should not be taken for granted, the crude dependency ratio is still relevant from a public spending perspective. In the OBR’s recent Fiscal Sustainability Outlook, there is a chart outlining representative tax revenues and government spending for people of different ages in the UK today. It shows a clear bulge in taxation for those of working age, alongside peaks in government spending at younger and older ages.

Representative spending and tax profiles by age

Representative spending and tax profiles by age
…population ageing implies greater age-related public spending relative to tax revenues

For the purposes of this blog, we have calculated what could happen to tax revenues and public spending if we assume age-related tax and spending remains the same and there is no growth in spending or tax revenues per capita up to 2037. Based on these simplifying assumptions, we project that tax revenues could rise by around £40bn up to 2037, while age-related spending could rise by up to £100bn.

Cumulative change in public spending vs tax receipts
Responding to population ageing

There are a number of ways in which to mitigate the potential economic and fiscal impacts of population ageing. Here we look at the potential of three plausible strategies in a UK context 1) boosting migration 2) raising productivity in the health sector and 3) encouraging longer working lives. There are, of course, more elements to consider including, and perhaps most importantly, the productivity of the labour force and we covered this in great detail in our analysis of the demographic challenges facing the Eurozone.


1)   
Migration

Migrant workers are typically of working age which means they help to boost the labour supply and contribute to economic growth and tax revenues. As a consequence, migrant labour can help to boost economic output and support lower levels of government indebtedness. The below chart from the OBR plots three different trajectories for debt as a proportion of GDP based on whether the UK experiences, high, low or central migration over the next 50 years. Based on the assumptions used, by the mid-2060s, the OBR projects that low migration could result in debts rising to over 100% of GDP by comparison to around 70% if we have high migration.

OBR debt to GDP projections
2. Health productivity

The OBR’s projections are most sensitive to changes in the rate of productivity in health care. The central projection assumes that productivity in health care rises by 2.2% per annum, but in reality health productivity has only risen by 1.1% per annum since the 1970s. If the historic trend rate of growth in health care were to continue, debt to GDP would be 100 percentage points greater than if health care productivity rose in line with the OBR’s central assumption. Delivering productivity increases in the health sector should therefore be a key public policy priority in responding to the challenges of population ageing.

Debt to GDP projections (various OBR)

Debt to GDP projections (various OBR)  Source: OBR and Michael O’Connor


3)   
Longer working lives

The ILC-UK has been at the forefront of the longer working lives debate and has estimated the potential economic benefit of supporting the “missing million” of older workers who are involuntarily forced out of the labour market back into work. In addition, in 2014 we used ONS data to show how small increases in the proportion of people working beyond the age of 65 allied to increased migration can make a real difference, at the margin, to economic growth rates over future decades.

Growth rates over future decades across various scenarios

Growth rates over future decades across various scenariosSource: ONS and own calculations

In truth, there is no silver bullet that will ensure we can secure rising prosperity in the face of population ageing. Ultimately it will take a concerted effort on many fronts, be that longer working lives, supporting productivity growth in health care and the wider economy and strategies to support migration where there are skills shortages in order to respond to the challenge of ageing. There may even be further attempts to boost the fertility rates of populations, though where this has already been tried in Japan it was relatively ineffective.

But as we stop to celebrate UN Older Persons day, perhaps it is now time to reflect on how as a global society we can develop appropriate and tailored long strategies to cope with the demographic revolution which is already in full swing.


Key links

United Nations (UN) (2015), World Population Prospects: The 2015 Revision. Available at: http://esa.un.org/unpd/wpp/Publications/Files/Key_Findings_WPP_2015.pdf

OBR (2015), Fiscal sustainability report. Available at: http://budgetresponsibility.org.uk/fiscal-sustainability-report-june-2015/

Japan Times (2015) ‘Fertility rate dips again’. Available at: http://www.japantimes.co.jp/opinion/2015/06/21/editorials/fertility-rate-dips/#.Vgv8QctVhBc
Authors: Ben Franklin and Matthew Jones

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