Thankfully, we enjoy longer lives than any generation before us. We also have fewer siblings, on average. All of these things add to our quality of life – we have more time to have fun, and we get more attention from mom. But are these changes, which are good for each of us, also good for all of us?
When people live longer and have fewer babies, the average age of the population increases. According to UN calculations, the world’s median age – currently about 29 – is 7 years higher than it was in 1970.
In fact, we are getting older faster. The median age is expected to increase by almost 8 years between now and 2050. And population growth will slow. In that time, the world will gain only 40 percent more people. By contrast, in the last four decades, the earth’s population doubled.
What does that trend mean for prosperity? Common sense tells us that if there are fewer young people (workers) and more old people (retirees), the economy will suffer. In new World Bank research, “Is Aging Bad for the Economy? Maybe,” we take nuanced look at this idea and finds that the pattern of economic growth in a country depends on how the population is aging: Is it driven by people who are living longer or by people who are having fewer babies? These characteristics affect the way people save and spend money, which in turn affects investment and economic growth. How a country grows also depends on policy – different social security systems provide different incentives for saving.
Here’s what becomes clear: fewer babies plus a certain type of retirement system might boost growth. We will walk through the steps.
Demographics and growth
First let’s just look at how demographic trends affect growth in a model that – stay with us – decomposes growth rates of gross domestic product (GDP) into labor productivity growth, population growth, and growth in labor force participation. The graph below is hypothetical or, as economists say, counterfactual. It shows how growth trends between 1970 and now would have behaved at the faster rate of aging expected between now and 2050.
Figure 1. What Demographic Dynamics from 2010-2050 Imply for Growth Rates in 1970-2010
Source: Onder and Pestieau (2014)
The results show that GDP growth is slower – by 1.2 percentage points annually, or nearly a 40 percent decrease over 40 years. Each worker is producing the same amount, but there are fewer workers. The growth of GDP per capita is only slower by 0.4 percentage points annually because total production is shared by fewer people.
Also notable: all high-income countries (HIC) except Estonia see slower growth. But many low-income countries (LIC) and some middle-income countries (MIC) benefit – they are not aging as quickly.
The growth-and-aging hypothetical does not tell the whole story. We also have to think about how people behave. Let’s look at behavior under different types of aging: longer lives or fewer babies.
When people live longer, they tend to save more so they can smooth their consumption across a longer lifespan. Higher savings, in turn, increase the productivity of labor by increasing the capital available per worker. When people live longer, they also work longer. So the labor force may not shrink as much as in the scenario above, which holds retirement age and labor productivity constant.
When people have fewer babies, capital per worker increases – savings do not change, but the number of workers decreases. Viola: both demographic trends increase economic growth per capita.
And add policy…
But policy could throw this off. (Here’s where it gets complicated.) Let’s consider two different retirement systems. One is known as a defined contribution system. Under this scheme, a worker sets aside a defined amount of money each year into a common pool. That pool is used to fund pensions on an ongoing basis. Here’s the catch: there is no way of guaranteeing how much the contributor will get upon retirement – it depends how big the resource pool is at that time.
When there are fewer babies, the number of people contributing to the system decreases. This reduces retirement benefits. In response, people save more. With lower fertility, the number of workers also decreases. So, between the increased savings and shrinking workforce, this boosts capital per worker and, therefore, growth.
In contrast, increased longevity has no clear effect on capital per worker. If people live longer, they save more but also work longer, keeping more people in the workforce. These two forces place opposite pressures on the amount of capital per worker, so the net effect is ambiguous.
The second policy option is the defined benefit system, in which workers are guaranteed a certain income in retirement, usually based on their final salary. The most common example of this is a pension system seen in many European countries. Under this system, when people have fewer babies, there are fewer workers to contribute to the system, so each individual has to contribute more. This leads to a decrease in savings. But the overall impact on capital per worker is ambiguous: negative impact from lower savings and positive impact from fewer workers.
Longevity is also ambiguous: People might save more but also work longer, with opposing effects on capital per worker.
Table 1. Impact of Aging on Capital Per Worker Under Different Unfunded Pension Systems
Source: Dedry, Onder, and Pestieau (2014)
So, what does this all mean? What’s a policy-maker to do? It seems that demographic trends alone will put downward pressure on economic growth in aging societies, but there is hope for remedial action. Policy-makers would do well to consider the nuances in demographics and social security systems. By paying attention to savings and retirement incentives in the workforce, they can craft policies that foster strong economic growth despite these demographic pressures.