Will Population Change be Good or Bad for the World s Economies?

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1 Will Population Change be Good or Bad for the World s Economies? Ronald Lee University of California Berkeley Andrew Mason University of Hawaii and East West Center Woodrow Wilson International Center for Scholars Washington, D.C., April 1, 2011

2 Acknowledgements National Transfer Accounts (NTA) research network Research teams in 35 high and low income economies Funding National Institutes of Health (NIA R37 AG and R01 AG025488) International Development Research Centre (IDRC) United Nations Population Fund (UNFPA) Draws on Lee and Mason 2011 forthcoming Population Aging and the Generational Economy Population data from UN World Population Prospects. Lee and Mason, April 1,

3 Key Ideas The Global Age Transition The First Dividend Economic lifecycles Swings in support ratios Potential Responses (part II) Lee and Mason, April 1,

4 Three Phases of the Global Age Transition Increase in the child share of the population Increase in the share in the working ages Increase in the share of the elderly population Lee and Mason, April 1,

5 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

6 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

7 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

8 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

9 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

10 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

11 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

12 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

13 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

14 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

15 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

16 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

17 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

18 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

19 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

20 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

21 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

22 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

23 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

24 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

25 The Global Age Transition Percentage 60 and older Percent over 50% Percentage under 25 Lee and Mason, April 1,

26 The Coming Dominance of Aging Number of countries classified by age group experiencing the largest absolute increase in population Population Population Population under Lee and Mason, April 1,

27 Phases of Global Age Transition Countries classified by age group (<25, 25-59, or 60+) with the largest absolute increase in population size. Source: Based on UN Population Prospects Lee and Mason, April 1,

28 The First Demographic Dividend Changes in population age structure are important because of the economic lifecycle Estimates of consumption and labor income by age based on National Transfer Account (NTA) methods First order effect: Changes in share of the working age population influence economic growth. Time series of support ratios constructed using NTA lifecycle profiles Lee and Mason, April 1,

29 NTA lifecycle estimates: Consumption and labor income Uses cross sectional data from existing surveys for a recent year. Averages across all population at a given age, combining males and females. Consumption includes Private expenditures, imputed to individuals within each household Public in kind transfers (e.g. education, health care) Labor income includes Wages, salaries, fringe benefits before tax 2/3 of self employment income Average includes 0 s. For comparisons age profiles are standardized by dividing by average labor income for ages Lee and Mason, April 1,

30 Economic Lifecycle Four high income countries Consumption Labor Income Note. Simple average of Japan, Germany, Sweden, and US. Yl and C normalized to 1.0 and 0.6 respectively for age range. Lee and Mason, April 1,

31 Economic Lifecycles Compared High and low income countries High HK spending in high income/low fertility countries. Consumption rises with age in high income countries Labor income more concentrated in high income countries Indonesia, Kenya, Nigeria, Philippines Lee and Mason, April 1,

32 Economic Lifecycle of India, 2004 Per capita consumption and labor income Lee and Mason, April 1,

33 Economic Lifecycles Compared 3 Asian countries Seniority wage system in Japan; inflexible labor markets (retirement age) in India. Very low consumption at all ages in China; high saving but low HK spending. Lee and Mason, April 1,

34 The Support Ratio Measures the number of workers relative to the number of consumers. Given worker productivity, a 1% increase in the support ratio leads to a 1% increase in per capita income. Support ratio constructed for each country using NTA profiles in base year to estimate: Age specific variation in labor productivity Age specific variation in consumption Multiply profile values by past or projected population by age to measure how the number of effective workers varies with respect to the number of effective consumers. Lee and Mason, April 1,

35 Support Ratio, China Lee and Mason, April 1,

36 Support Ratio, China Net swing of 1.2% per year in per capita income growth due to changes in population age structure Plus 0.8% per year Minus 0.4% per year Lee and Mason, April 1,

37 Support Ratios: Divergent Paths for China, India, and Japan India China Lee and Mason, April 1,

38 Support Ratios: Divergent Paths for China, India, and Japan India China Lee and Mason, April 1,

39 Five high income countries Spain Japan Germany Sweden US Lee and Mason, April 1,

40 Support Ratio, Annual Growth NTA Economies, Lee and Mason, April 1,

41 Possible responses to population aging and the declining support ratio Consume less in proportion to the decline. E.g. in US, consume 12.5% less in 2050, other things equal. Work more perhaps by retiring later? Show case of the US Similar result for Spain and S. Korea Ronald Lee and Andrew Mason, April 1,

42 Years of shift in labor income needed to keep the support ratio at its 2007 level. This takes 8 years by 2050 and 10 years by Years of Extension of YL Age Profile From Peak to Maintain 2007 Support Ratio 10 Years of YL Profile Extension Analysis uses 2007 age profiles to calculate the support ratio, called SR(2007), which has a peak at age 51. The population is based on SSA rates but estimated to have e0=84.5 years in Each year that the new population would generate a support ratio less than SR(2007), the age profile of labor income is extended from age 51 by repeating the peak value. This graph shows the cumulative 1 year extensions Year Source: US National Transfer Accounts, Lee and Donehower, 2011 Ronald Lee and Andrew Mason, April 1,

43 The shift in the labor income age schedule needed to hold support ratio constant at 2007 level YL Profiles ($2007) YL Age Profiles Extended to Maintain 2007 Support Ratio Analysis uses 2007 age profiles to calculate the support ratio, called SR(2007), which has a peak at age 51. The population is based on SSA rates but estimated to have e0=84.5 years in Each year that the new population would generate a support ratio less than SR(2007), the age profile of labor income is extended from age 51 by repeating the peak value. This graph shows the resulting age profiles of labor income Age Source: US National Transfer Accounts, Lee and Donehower, 2011 Ronald Lee and Andrew Mason, April 1,

44 Alternatives to reducing consumption and working longer: Increased investment The Second Demographic Dividends result from increased investment spurred by population itself. Investment in human capital Investment in assets, physical capital These second dividends raise labor productivity and reduce or reverse the decline in support ratio Ronald Lee and Andrew Mason, April 1,

45 Second Dividend: Investment in Human Capital Parents choose between number of children and amount to invest per child (Quantity quality tradeoff) As economies develop parents opt for fewer children and spend more per child (Becker; Becker and Lewis, Willis). Aging (low fertility) will be accompanied by more human capital, regardless of causal direction. The human capital response helps to offset the negative effect of population aging on the support ratio. Ronald Lee and Andrew Mason, April 1,

46 Investment in human capital NTA measures HK spending as sum of spending on health and education per child at ages 0 to 17 for health ages 0 to 26 for education Separately for public and private spending Express in years of labor income (30 49) Ronald Lee and Andrew Mason, April 1,

47 Human capital spending (% average annual income age 30 49) The trade-off between fertility and human-capital spending SL ES HU DE JP TW AT FI CN SE KR US BR CR MX TH UY CL ID IN PH KE NG Total fertility rate (children per woman) Human-capital spending on each child in low-fertility European countries and the US (light green) is about four times the average annual labor income of a prime-age adult. In high-fertility African countries Ronald (gray) Lee and spending Andrew Mason, is twice April 1, the average annual labor income

48 Time Series Relationship 7 Estimated elasticities Japan Taiwan United States Number of Observations Human capital spending Japan Taiwan US Japan 5 Taiwan 27 United States Total Fertility Rate Ronald Lee and Andrew Mason, April 1,

49 Conclude: Population aging is accompanied by increased investments in HK per child Raises productivity and earnings of future labor force Substitutes HK for number of workers Higher productivity offsets falling support ratios. Ronald Lee and Andrew Mason, April 1,

50 Second Dividend: Population aging and asset accumulation Assets generate income and if domestically invested they raise capital stocks and make labor more productive. Slower growth of population and labor force in an aging population mean that capital per capita or per worker can rise even if national saving rates fall. People accumulate assets over their adult lives so the elderly hold more assets than younger adults. In aging populations the proportion of wealth holding elderly is higher, so there is more asset income and higher capital labor ratios. But if people expect to be supported by public or private transfers when they are old, this effect is muted. Ronald Lee and Andrew Mason, April 1,

51 How net consumption is funded in Mexico and Brazil in both, the elderly make large net transfers to younger family members Mexican elders rely heavily on assets to fund their net consumption. Brazilian elders rely heavily on public pensions to fund their net consumption. 80,000 60,000 40,000 Asset income 8,000 6,000 4,000 Asset income 20,000 0 Public transfers 2,000 0 Public transfers -20,000-40,000 Net family transfers -2,000-4,000 Net family transfers -60,000-6,000-80, Age -8, Age Ronald Lee and Andrew Mason, April 1,

52 How is consumption by elderly financed? Elderly continue to work (not shown on previous chart) Elderly use asset income Elderly receive transfers from family from public sector Shares of labor income, asset income and transfers must add to 100%. Ronald Lee and Andrew Mason, April 1,

53 Funding consumption of the elderly in 17 economies around 2000: Labor income, Transfers (public and private combined), and Asset income (part not saved) 1) Main tradeoff is between transfers and asset income. Ass ets 2) In economies relying more on assets, people also have more labor income in old age. But this effect is not large. 2/3 ES US TH MX PH 1/3 ID SI 1/3 JP DE BR TW KR CR UY 2/3 Transfers AT SE HU CL 2/3 1/3 Labor income Ronald Lee and Andrew Mason, April 1,

54 Now look just at t he part of consumption that is not funded by labor income. That way we can show public and private transfers separately Ronald Lee and Andrew Mason, April 1,

55 Funding the share of consumption not covered by labor income: Family Transfers, Public Transfers and Asset income (part not saved) Assets PH MX TH KR JP US UY ES CRDE BR Private transfers TW CL SL AT HU SE Public transfers The elderly in European countries (light green) rely almost exclusively on public transfers for support. The elderly in the Philippines (PH), Mexico (MX), Thailand (TH), and the US rely heavily on assets. Few rely on private transfers. In countries to the right of the triangle, the elderly Ronald actually Lee and give Andrew more Mason, to April their 1, families than they receive

56 Funding the share of consumption not covered by labor income: Family Transfers, Public Transfers and Asset income (part not saved) Ass ets In countries to the right of the triangle, elderly make net private transfers to their children. 2/3 TH PH 1/3 US MX No Asian countries do this, but almost all other countries do. 1/3 KR JP UY ES CR DE 2/3 BR TW CL SI AT Family transfers 2/3 1/3 HU SE Public transfers Ronald Lee and Andrew Mason, April 1,

57 Funding consumption of the elderly in 17 economies around 2000: Family Transfers, Public Transfers and Asset income (part not saved) Asian economies: As sets Only Asian countries have important family support of the elderly. Preliminary estimates suggest China has the strongest family transfers of all. 1/3 2/3 TH PH KR 1/3 JP MX US UY ES CR DE 2/3 BR TW CL SI AT Family transfers 2/3 1/3 HU SE Public transfers Ronald Lee and Andrew Mason, April 1,

58 Implications for capital accumulation Population aging raises the need to fund the old age deficit. If need is met by asset accumulation, then population aging raises asset income and perhaps labor productivity. If met by public or private transfers, then population aging just raises the transfer burden on workers. Ronald Lee and Andrew Mason, April 1,

59 Conclusions: Demographic transition raises support ratios, at least temporarily The first demographic dividend can boost per capita income growth rate by.8% per year for a number of decades in the middle of the transition. Eventually rising support ratios turn to declining ones as the population ages. Based on theory and on our estimates, falling fertility is accompanied by rising investment in human capital of children. Ronald Lee and Andrew Mason, April 1,

60 Conclusions: Population aging will certainly cause problems Fiscal sustainability of public programs is a huge problem for many countries. We did not discuss this. Population aging will cause falling support ratios, which will reduce consumption, other things equal, by 1%/yr relative to earlier phase. Fiscal pressures of population aging may crowd out human capital investments in children. Ronald Lee and Andrew Mason, April 1,

61 But Population aging raises the demand for capital by raising the share of old age consumption in the economy Extent of increased capital/labor ratios depends on extent to which old age consumption is funded by public or private transfers rather than assets. The same low fertility that causes population aging also goes with increased HK investment per child. Higher physical capital and human capital per worker raise labor productivity, offsetting declining support ratios. Ronald Lee and Andrew Mason, April 1,

62 Thank you Lee and Mason, April 1,

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