Elderly people have always depended on younger people to support them when they are no longer able to work. In primitive societies, parents provide for children, who, in their turn, provide for elderly parents. In more advanced societies, working-age adults provide for both children and elderly.
This is known as the ‘social contract’.
The social contract works well when the proportion of young and old in the population is relatively stable. Over the generations, the cost to workers of supporting the young and the old remains approximately the same: no one loses out relative to older people, and although those born later benefit from the march of progress, people accept this because they want their children to have better lives than they did themselves.
But now, the proportion of elderly people in the population is rising. More people are living well into old age than ever before, and birth rates have fallen below the population-replacement rate of approximately 2.1 children per woman.
Currently, according to Organisation for Economic Co-operation and Development (OECD) figures, Japan is the ‘oldest’ country.
In 2015, there were about 47 over-65s for every 100 working-age adults; by 2075, the ratio of over-65s to working-age adults (the ‘old-age dependency ratio’) will be 77%.
European countries are not far behind: by 2075, the old-age dependency ratio will be 76% in Portugal, 66% in Germany and over 50% in the UK.
Many developing nations are ageing fast, too. South Korea has one of the fastest-ageing populations on Earth: according to the OECD, by 2075, there will be 80 over-65s for every 100 working-age adults. Its birth rate has fallen so low it has become a matter of national concern.
In an ageing society, low growth and low inflation could become the norm
And China’s one-child family policy backfired spectacularly, turning a nation with a fast-growing population into a nation with a fast-ageing population in a single generation.
Latin America is ageing fast, too: by 2075, the ratio of over-65s to working-age adults is projected to rise to 60% in Brazil and 47% in Argentina. Chile and Mexico, currently the youngest countries in the OECD, will also see the proportion of the elderly in their populations rise to about 60% of working-age adults by 2075.
Australia, Canada, New Zealand and the US have slightly younger populations because of immigration, but here, too, the trend is upwards: by 2075, the OECD predicts that the dependency ratio in these countries will have risen to about 50%.
Only India, South Africa, and sub-Saharan Africa will still have predominantly young populations.
The world is becoming middle-aged. And the consequences will be profound.
Traditional models of the economy assume a predominantly young population, which prefers spending to saving, and will borrow for consumption on the rational assumption that they can repay the borrowing in the future.
Inflation is the principal risk in such an economy.
The entry of the young ‘baby boomers’ into the workforce in the 1970s is thought to have contributed to the high inflation at that time.
But people near the end of their working lives are credit constrained, since they cannot earn enough to repay new borrowing. Their spending, therefore, is limited by their current income.
People near the end of their working lives also tend to have accumulated wealth, which provides them with income in retirement. However, since they don’t know when they will die, they tend to be reluctant to draw on their capital. They would rather restrict spending.
Thus, persistent demand deficiency resulting in stubbornly low inflation is likely to be characteristic of an ageing economy. This is already Japan’s experience.
There may also be persistently low growth. Investment in risky enterprises is essential for a vibrant economy, but it is a young person’s game, since early losses can be more than compensated by later successes.
Older people tend to be risk-averse, since they have little time left to recover from losses. Investment portfolios could, therefore, become increasingly skewed towards low-risk assets and passive investing as the population ages.
Additionally, productivity could decline, since people tend to become less productive as they grow older.
In an ageing society, therefore, low growth and low inflation could become the norm. Persistently low growth and inflation imply persistently low interest rates.
But this presupposes a population that borrows to consume and takes risk in investment. When large numbers of people are saving like crazy, unwilling to borrow and relying on investment income, low interest rates are deflationary.
Maintaining demand in an ageing population could therefore mean higher, not lower, interest rates.
An ageing population has serious implications for fiscal finances. Currently, governments rely mainly on income taxes to fund the pensions and healthcare needed by the old. This makes sense in a predominantly young population, where workers far outnumber the elderly.
But as the proportion of elderly in relation to workers grows, funding public services at current levels would mean ever larger deductions from labour income. This would make it increasingly difficult for workers to establish homes and families or save for their own retirements.
Cutting government spending to keep income taxes at politically acceptable levels could be very difficult. Rationing critical services, such as healthcare, has unpleasant welfare consequences.
And, as The Economist noted, many older people wrongly believe they have ‘paid for’ the benefits and healthcare they expect to receive in old age, and fiercely oppose any attempt to cut them back.
In a democracy where the population is weighted towards the old, therefore, policies to make the benefits of the old affordable for the young could simply be voted down.
Raising indirect taxes is problematic, too, since people are likely to cut back spending in response. When Japan raised its sales tax in 2014, demand slumped.
One solution might be to tax wealth, since an ageing population has abundant capital, but is income-poor at all ages. However, this could be politically difficult. The Conservative party’s plan to claw back the cost of social care from property wealth is widely believed to have cost it the 2017 general election.
Whatever form of taxation is adopted, it seems likely that the combination of rising spending on pensions and healthcare, coupled with poor GDP growth, will raise debt-to-GDP ratios in most countries significantly, raising the prospect of a buyer’s strike or unsustainably high borrowing costs.
To mitigate this risk, some economists say that countries with ageing populations should monetise fiscal debt and deficits (see, for example, Between Debt and the Devil by Lord Adair Turner).
Monetisation is widely feared, because it can cause very high inflation. But monetisation of deficits in a demand-deficient economy is unlikely to cause inflation to spiral out of control; indeed, it could enable the higher interest rates that older people need.
There may be other options, too. But one thing seems clear: maintaining the social contract in a middle-aged world will require policymakers to cast aside cherished beliefs, rethink traditional models and slaughter sacred cows.
Frances Coppola writes and speaks about banking, finance and economics.
This article was taken from the Sep/Oct 2017 issue of The Treasurer magazine. For more great insights, log in to view the full issue or sign up for eAffiliate membership