Should we fear population aging?

A farmer walks through a mustard field at Ghaduwan village in the northern Indian state of Punjab December 16, 2009.  REUTERS/Ajay Verma (INDIA - Tags: BUSINESS POLITICS AGRICULTURE SOCIETY) - GM1E5CG1GI901

Longer and more productive lives should be celebrated as an achievement of mankind rather than considered a problem. Longevity, however, does require personal and societal adjustments. In many advanced and developing economies, individuals are already adjusting to aging by working longer and upgrading their skills throughout their lifetimes. Companies are also making a change by accommodating older workers and redefining their roles. Will governments raise their game and make the necessary adjustments to support healthier and productive aging?

The global population is aging. The U.N. projects that the median age of the world’s population will increase from 23.6 years in 1950 to nearly 42 years by 2100. The pace of aging has risen substantially: It took 115 years for the 65+ year population to double in France (in 1984) and it will likely take 20 years for that doubling to happen in most countries in East Asia by 2030.

Population aging has wide-ranging implications for growth. The “traditional view” assumes no changes to the structure of production, technology, productivity, or labor force participation, and concludes, reasonably under such restrictive assumptions, that aging will exert downward pressure on total output and returns to capital—keeping real GDP growth low. Some economists even argue that population aging might put downward pressure on real interest rates, limiting the policy space for central banks and negatively impacting the financial sector.

Many of the assumptions of the traditional view are extreme. Consider living standards that, in general, depend on four main factors: the state of technology, the dependency rate (in this case, the ratio of older people to people of working age), the share of the working population, and labor productivity.

Production and technology have changed rapidly during the last century and will likely continue to change for decades. In fact, technology’s rapid change has given rise to worries that automation will replace predictable and routine jobs—or even put most of us out of work.

With dependency rates, the concern has been that with unchanged technology and a shrinking workforce, per capita output will go down. Dependency rates are not predetermined, however, and neither must the workforce shrink. Younger people, women, and older people are helping the labor force participation rise in many parts of the world. In Cambodia, Indonesia, and South Korea, for example, more than 40 percent of men in rural areas are working at the age of 75. In Japan, female labor force participation rose from 55 percent in 1981 to 78 percent by 2016. A recent study looking at Europe and Central Asia estimated that, while without policy and behavioral changes the dependency rate across the region would increase substantially by 2050, increased female labor force participation to male levels plus longer working lives by 10 years will keep it unchanged.

With productivity, if older workers are less productive, output per worker will go down. For example, a recent study estimates that an increase in the share of older workers by 1 percent is associated with a reduction in annual productivity by 0.2-0.6 percent in Europe and the U.S. However, empirical studies of teams of younger and older workers demonstrate that productivity need not decline with age. Moreover, “teams of young people make fewer mistakes than teams of older people [in automotive production]. But when the former team makes a mistake, it takes longer to fix it than the latter.” In other words, older people leverage their experience: They know the shortcuts, even if younger people “run faster.”

Individuals and firms are already adapting to population aging. Many workers remain active past what was considered retirement age a few decades ago. It is up to governments to make changes to support longer, healthier, and productive lives. What will governments do?

The most pressing risks from aging are fiscal and require urgent reforms of pensions, health care, and their financing. Traditional pensions have had substantial challenges in advanced economies and many more problems in developing countries: The low replacement rates of defined benefit schemes and the low coverage of defined contribution ones are well known. In developing countries, persistent informality in the economy limits the coverage of publicly funded pensions, exacerbating and inequality. As a result, governments need to start the financing of pensions and health from payroll taxes or general revenues, with coverage independent of employment status. A recent study suggests that many countries are moving in that direction. Many countries in Latin America and South Korea, to name a few, are shifting to non-contributory pensions: the road taken by New Zealand in the late 19th century rather than by Germany, which spearheaded the pay-as-you-go pension system.

In the meantime, the current pay-as-you-go systems must be adjusted to achieve fiscal sustainability and pension adequacy. Reforms of the parameters of pension systems are happening across the world, with higher retirement ages, longer contribution periods, and more modest replacement rates. Governments may be under pressure to supplement inadequate benefits which will be a substantial fiscal burden.

Besides the fiscal reforms, additional policies to manage aging are needed. These policies—to help reap the benefits of increasing labor force participation and stronger productivity—are not just about old people. Labor market reforms need to expand the opportunities for women, the young, and the elderly. Education opportunities need to be captured by people across all generations to keep their skills sharp through their lifetimes.