Global Ageing: What is at stake? - by Börsch-Supan - Oxford Institute ...

Copyright 2006 by theOxford Institute of AgeingAGEING HORIZONSIssue No. 4, 3–5Global Ageing: What is at Stake?Axel Börsch-Supan, University of Mannheim, GermanyAbstractA central question for economists and politicians alike ishow demographic change will affect the wealth of nations.Which countries will gain, which countries will lose in theinternational pecking order? Equally important is thequestion how these gains and losses can be influenced bypublic policy. With these two core questions in mind, thisbrief paper reviews the most important economic challengesand opportunities due to global ageing for Europe.IntroductionThe expected change in the age structure in virtually allindustrialized countries – but also in many developingcountries – is dramatic and will lead to a substantiallyhigher proportion of older people in the world. The ageingprocess deeply affects future labour, financial andcommodity markets. On a macroeconomic level, labour isbecoming relatively scarce in the ageing countries whilecapital becomes relatively more abundant. This precipitateschanges in the relative price of labour, will lead to highercapital intensity, and might generate large internationalflows of labour, capital and goods from the faster to theslower ageing countries. On a microeconomic level, theage composition of the labour force will change, whichmight affect labour productivity. Consumption and savingspatterns are likely to alter when the elderly become a largerproportion of consumers and savers, with widespreadimplications for capital and goods markets.While ageing is global, there are marked internationaldifferences in the speed and the extent of the ageingprocesses. Even within the industrialized countries, differencesare large. Europe and Japan have already a mucholder population than North-America. Italy and Germanyare ageing faster than France and Great Britain. In Asia,some countries start from a relatively young population,but ageing is very quick. A particular dramatic example isChina. Due to the globalisation of our economies, no studyof ageing can disregard these differential changes.International flows of capital, goods and services, andlabour – in descending order of mobility – will be importantmechanisms moderating the effects of populationageing in each individual country.Labour marketsUnderstanding the development of the labour force duringthe next decades is crucial for any analysis of global ageingbecause the long run macroeconomic development is dominatedby fundamentals such as the relative scarcity oflabour and the relative abundance of capital. The essentialmacroeconomic effects of population ageing are a changingbalance between capital and labour, and between laboursupply and demand for consumption. An ageing society hasrelatively few workers for the existing capital stock thatproduces consumption goods for a still relatively largenumber of consumers. The fundamental parameter foreconomic performance during the ageing process is thereforethe ratio between workers and consumers.It is very unlikely that the decline in this ratio can becompensated by an equiproportional increase in productivityand/or capital accumulation. GDP in most Europeancountries will therefore almost surely decline, and thesecountries are likely to become members with a decliningweight among the G8/G20 countries.From a domestic consumer’s point of view, total GDPmight be less relevant than GDP per capita. However, totalpopulation sizes will stay relatively constant for mostEuropean countries until about 2035, maybe slightly decliningor increasing. Once the baby boom generationdeceases, however, many European countries will face asignificantly declining population. Labour force as a shareof the adult population – the so called support ratio – willtherefore decline slower than total labour force. Forexample, the German support ratio is projected to declinefrom 56% in the year 2000 to 49% in the year 2035, a15%-decline in 25 years.This figure is useful because it demonstrates the force ofageing in an understandable metric. A decline of 15% inthe 25 year period between 2010 and 2035 translates in anegative growth rate of around 0.45 percentage points perannum from 2010 to 2035. The long-term real productivitygrowth of a typical European economy is about 1.5%per annum. In other words, the negative economic force ofageing, simply by reducing the number of workers availableto produce goods and services, corresponds to betweena quarter and a third of the average annual productivitygrowth. To compensate for the lack of workers by higherproductivity of the existing workers, total factor produc-AGEING HORIZONS Issue No 4OXFORD INSTITUTE OF AGEING3

tivity would need increase by 40%, probably an unrealisticfigure.The variability range for this forecast is large and almostentirely depends on future labour force participation of theyoung, the elderly and the female. In most pessimisticscenarios of unchanging labour force participation, theimpact of the declining support ratio is huge. On the otherhand, in an optimistic scenario of Denmark-style labourmarket reforms, the shift in the age structure is compensatedfor almost entirely by the increase in participationrates.This example bears several lessons for policy in times ofglobal ageing. First, the huge variability of the projectionsand the leverage of employment on GDP make clear thatit is important to better understand how public policy caninfluence labour force participation rates. Structuralreforms such as education reform and pension reform havepotentially huge “side-effects” on GDP growth throughtheir impact on employment, over and above the oftenmore prominently discussed impacts on social budgets.Second, the above example shows how strongly the differentialforce of global ageing depends on to the extent towhich an increasing quality of labour will compensate forthe decreasing quantity of labour. “Side effects” of structuralreforms on productivity may in the long-run dominateany direct but static effects, because they change thegrowth path of the economy.Not only the size but also the age structure of the workingpopulation will change radically in the coming decades.We again use Germany as an example for how dramaticthe change will be. The modal age of the German workforce in the year 2000 was around age 36; in 2010, thispeak age will increase to 46 years; and a further 10 yearslater it will be 54 years. The baby boomers then retire –the age distribution curve flattens out and changes verylittle in the following decades.This fundamental change in the age structure of theworking population will have profound effects on themicroeconomics and the sociology of the labour market.The most important – and most controversial – aspect isthe potential effect on labour productivity. If labourproductivity is age dependent, a shift in the age structurewill also bring about a change in aggregate productivity,even if age-specific productivity were to remain constant.We know little about the size of these effects. Rather, moreresearch on age-specific productivity is needed to betterunderstand whether ageing economies will suffer from aproductivity decline, amplifying the effects of a shrinkingquantity of labour. At the very least, however, we understandthat further education increases productivity – andherein lies an important policy message: prevent all actionsthat make further education less attractive, and strengthenall steps that increase the investment value of further education– such as a later retirement age.Interactions between labour, product andcapital marketsThe labour market is not insulated from other markets. Itis not only directly affected by population ageing, but alsoindirectly by ageing-induced changes in product and capitalmarkets.Product demand will change, since an older population ofconsumers has different preferences and needs than ayounger population. Consumption demand may also declinefor at least two reasons. First, because GDP per capita willdecline in the face of a shrinking labour force unless thisis offset by higher capital input and productivity. Secondand more subtly, it is likely that more retirement incomecomes from asset income which fluctuates more than annuitizedpension and labour income. This will increaseprecautionary savings and depress consumption, given afixed level of income.Consumption behavior changes with increasing age. Forexample, spending on goods in the group “transport andcommunication” falls over the life cycle, while goods inthe “health and hygiene” group, as well as costs of shelter,account for a growing share of older households’ budgets.Hence, if the age distribution of an economy is changing,the composition of consumption will change accordingly.Most notably the aggregated expenditure on health willincrease during the ageing process while the correspondingspending on transport will decline.Changing product demand will then precipitate shifts insectoral labour demand. Employment in the health sectorwill increase; it will decline in the transport sector. Someestimates suggest that more than a sixth of all workers willneed to change their jobs due to population ageing.Labour supply is also affected by capital market fluctuations.The more retirement income is provided throughfunded pension income (e.g., 401k plans or other individualaccounts invested in the stock market), stock marketperformance will, at the margin, affect the retirement decisionof workers as well as their consumption demand.Understanding this mechanism is important for analyses ofglobal ageing since it may substantially amplify capitalmarket disturbances. Stock markets have exhibited hugeswings, and we do not fully understand how bubblesemerge and even less how to predict and prevent them.This topic has a clear political dimension since the flexibilityof choosing the retirement age is a core transmissionmechanism for these interactions between the capitalmarket on one side and labour and product markets on theother side.Capital marketsCapital markets play a crucial role in global ageing sincecapital is the factor which moves with the least frictionsAGEING HORIZONS Issue No 4OXFORD INSTITUTE OF AGEING4