Changes in fertility rates over the last century have led to demographic changes in industrialized countries. This paper will address some of the economic implications of ageing populations and the expected effects on the US economy. This paper will draw upon information from two papers, first Johnson and Falking address this issue in their paper Ageing and the Macroeconomy 1992, and Demographics Effects on Personal Saving in the Future by Pryor in 2003. These two authors focus mainly on potential changes in consumption, productivity in the labor force, and the impact on savings rates in the future. What, if any will the impact be of ageing population on the US economy? What are the relevant issues in terms of savings, pensions, labor markets, capital accumulation, productivity, and changes in per capita income? Pryor goes into considerable detail in addressing long-term growth in the US economy and the rate of technological change and innovation. Because savings are presumed to play a large role in technological change and investment, this paper addresses possible effects of population ageing on the saving rate and impact on US economic growth in the future. Johnson and Falking focus in much greater detail on the composition of the workforce and how this may change in the future, while briefly addressing additional impacts such as consumption and at the same time addressing potential effects on savings and investment.
Industrialized countries are faced with a similar problem, ageing populations.
This is a phenomenon in which changes in fertility rates have long term
impacts on the future of an economy in terms of income growth, per capita
income, and productivity. This is coupled with increased life-expectancy
and changes in family size. The most basic concern is that the 'baby-boom'
followed by a subsequent 'baby-bust' will create a situation in which the
number non working individuals (retired, unemployed both voluntarily and
unvoluntary, and children) will far exceed the number of individuals in
the working population. This poses a particular problem given the structure
of the western retirement system of social security and pension plans. While
this is by far the most publicized issue, it may be more important to address
the possible long-term effects of population aging as they change the structure
and dynamics of the economy.
Ageing Populations and Consumption - The effects of ageing on consumption: use three terms which apply to consumption patterns: age, cohort, and period. "Age alone has very little impact on the overall structure of consumer demand." (Joohnson and Falking 1999) The authors note that post-retirement consumption may be more a product of savings and the opportunity during one's lifetime rather then a trend with ageing. There are however two sectors of the economy which may be highly influenced by changes in consumption specifically the housing and healthcare. Changes in family size and structure will have an impact on consumer demand in the housing sector. This becomes more relevant because different age groups have different geographical preferences for their homes, an example of this would be Florida. Older age groups tend to settle in small villages and retirement communities particularly in warmer climates, while younger age groups prefer areas of high employment growth. Secondly, rising costs of medical care and increased life expectancy will significantly affect demand for health care. Currently the elderly spend approximately 35% of all consumption on medical care.
Production in the Economy - One of the greatest concerns brought about by population ageing is the impact this will have on the workforce, as there will be a larger number of retired people than in previous decades. If wage is a proxy for productivity, than it would appear that the elderly age more productive because of the experience acquired over one's lifetime. This is called renumeration, and ideally a higher ratio of older workers to younger workers would result in a higher level of labor productivity and stimulate the macroeconomy. Johnson and Falking mention in their 1992 paper "Older workers were as efficient as younger workers in tasks which require skill, experience, self-motivation, but were less efficient at work carried out at an externally set pace…" (Clark and Dunne 1955) Except for assembly line type production, the change should not be a problem and in fact may be a benefit. Johnson and Falking do find that marginal productivity is decreasing, and younger generations may be better adapted to new technologies and have more modern education and training. This is particularly important given the massive amount of technological change and innovation over the last few decades and is changing exponentially. This may not be a problem however, because older workers can be retrained just as easily as younger workers, and because of this rapid technological innovation in services and manufacturing suggest that it is better to retrain older workers. This is because job-specific skills depreciate rapidly, so mush so that investment in retraining could be seen on par with investment in physical capital.
More retraining and opportunities for older people can only exist if rigidities
in the labor market are removed. Structurally pensions are based on the
last year of employment, so were an older worker to receive a lower wage
this would be reflected not just for that year but would also be reflected
in their pension which dictates future income. Secondly, because the baby-boom
is such a large cohort, they will also have substantial political power
so adjustments to the retirement age or a reduction in social security benefits
is highly unlikely because it is politically infeasible. Secondly, the older
age groups vote in record numbers and are an essential political group,
their large size will shift towards preserving or improving pension plans
for the elderly.
Savings and Investment - There are strong argments which suggest that population ageing will lead to an overall reduction in the savings rate which will affect future innovation and investment. Neo-classical growth theory suggests that as the savings rate declines, so to will investment, leading to slower per-capita income growth in the future.
It has been theorized that savings rates will change with changes in the
age structure of the economy. Rightly so, as baby-boomers reach retirement
they will not need to save as much, which raises fears that the average
savings rate could fall below the optimal level. The problem is two-fold,
this will not only reduce the current capital stock as depreciation sets
in, but future investment and improvements in technology and productivity
are necessary given a smaller workforce but equal population size. Some
economists would argue that technology and innovation are strongest when
population growth is slow and labor is scarce. Conversely, smaller workforce
reduces economies of scale both in production and adoption of technology,
and that ageing leads to a loss of economic dynamism and innovative spirit.
Johnson and Falking show however that while current age groups may save
less once they reach retirement, this may not take into account cohort specific
preferences for savings and consumption, ie. Baby-boomers will not react
the same way as previous or subsequent generations in terms of their savings
or consumption during retirement. Secondly, savings may not decrease with
the life cycle, that their consumption decreases with retirement and that
they may continue to save from social security and pensions. Secondly, even
if the elderly do save less, reduced savings will lead to higher interest
rates which attract foreign capital. They argue that even if savings rates
decline, highly mobile capital will seek the best rate of return and may
flow into the US. This is however based on two assumptions, first that the
US economy will continue to grow steadily and secondly that capital will
flow into the US, perhaps from other rich countries. They fail to address
the fact that almost all industrialized nations are facing a similar situation,
so it is doubtful that Western Countries would be able to supply this scarce
capital.
Cites Heller and expects savings to decline by 5 to 12 percent by 2025.
Because of this, the savings rate needs to increase dramatically to cope
with ageing populations, others argue that demographic changes increase
wealth, reduce the rate of return of saving in the short-run, and attract
foreign capital: all of which would lead to a reduction in the optimal savings
rate. Increasing labor costs at home may continue promote further the process
of globalization as highly mobile capital seeks higher returns and cheap
labor.
If retirement remains the same, than future cohorts will have to save more
to finance longer retirement periods, conversely shifting or shortening
retirement will lower savings rate as income is spread over longer time.
Average consumption of retirees is a fraction of current workers, (60-70%)
and increases as the gap between income of current workers as compared to
retirees is greater (when they were working) Current workers have impressive
savings rates which are however offset by dissaving of retirees, net savings
down 3.8 % from 1990's to 2000 (Pryor 2003) Pryor gives four factors and
scenarios which would have a dramatic impact on the savings rate in the
present and it the future. First, a fast growing population reduces elderly
dependency ratio, and thus reduces aggregate dissaving and the decline in
net. Second, higher income growth rates are associated with low dissavings
rates proportionally, or increase of workers income of 1.8% and 1.5% decline
in net savings. Wages for workers are expected to rise significantly in
the future, which might offset the reduction in net savings by the elderly
in the future. Third, a higher consumption replacement ratio results in
greater savings rates in the present but lower savings rates in the future.
And forth, changing retirement age lowers savings rate because savings may
occur over a longer period and have less time to spend this in retirement.
These are all significant because as discussed earlier, a change in the
savings rate will clearly affect investment and innovation in the future.
The optimal savings rate may change in the future for a number of reasons,
so ageing populations may not be as detrimental as previously predicted.
Secondly, there are many aspects which could exacerbate or offset changes
in the savings rate because of retirement, so these avenues must be explored
to resolve this issue. Pryor suggests that a decline in private savings
rates by 5.1% or more will mean that investment will not cover depreciation
and net capital stock will decrease, which will then cause economic growth
to be considerably slower by 2050.
Conclusions - Ageing populations will certainly have a dramatic impact on
the US economy in the future, it is still uncertain however what the impacts
will be. One would expect some changes in consumption patters particularly
in the housing market, which may be reflected in the current housing bubble.
Perhaps the biggest impact will be on the level of human capital in the
economy as many experienced members of the workforce leave for retirement.
One the one hand, younger generations may be better adapted to new technologies
but their relative cost of labor will be significantly higher. One solution
is more hiring or retraining of the elderly, however labor market inflexibility
will most likely prevent this. Lastly, savings and investment may change
dramatically in the future, there is still not certainty as to their effects.
The elderly may continue to save and bequeath, on the other savings could
decrease dramatically in the future which will most certainly affect the
US capacity for investment and innovation in the future. The only thing
for certain is uncertainty, but a greater understanding of the dynamics
involved will make it much easier to come up with viable solutions in the
future.
Johnson, Paul and Falking Jane "Ageing and the Macroeconomy" Ageing and Economic Welfare Sagr Publications 1992
Pryor Frederic L. "Demographic Effects on Personal Saving in the Future" Southern Economic Journal No. 69.3 January 2003