Demographic transition and the demographic deficit: rethinking intergenerational equity

Sarah Harper, 20 Jan 2011

A concurrent increase in longevity and a decrease in fertility are causing a negative change in the dependency ratio of the economically active to the economically inactive throughout developed countries. Under current models of retirement the dependency ratio will continue to increase significantly into coming decades. The current expedient to prevent further deterioration is largely confined to migration; but this may not be a viable indefinite solution. Only a substantial restructuring and rethinking of current life patterns, while maintaining intergenerational equity, will allow a smooth transition to more mature societies.

As 2010 drew to a close, the UK government released figures forecasting that one fifth of the current UK population could become centenarians. There have always been individuals who have lived to 100 but very few. Increases in life expectancy from birth have been a constant feature of all developed countries for the past two centuries. There has been a rapid fall in mortality in younger years. This has been achieved through the reduction in infant, child and maternal mortality, driven primarily by public health initiatives, and the fall in deaths from infectious diseases, through vaccination and medication programmes. The result has been more and more people living to early old age. What is new, however, is the rapid and currently continuous fall in late life mortality rates among those over 65 and more recently over 85. The rise of geriatric medicine and the considerable influence of pharmaceuticals on these age groups have been significant here. Life expectancies at birth are predicted to rise across the globe reaching 84 years for developed regions and 77 years for less developed ones by the middle of the century. Already 65 year old men in the UK have on average a life expectancy of 82, rising to 88 for healthy individuals in high socio-economic groups, while 65 year old women have a life expectancy of 85 on average, rising to 88.5 by 2050.

What is also of significance is that this longevity is occurring in the context of ageing populations, driven as well by falling fertility rates. Most countries of the developed world are now in the late stages of the demographic transition, resulting in the decrease in both mortality and fertility rates, which typically is associated with economic development. Mortality rates fall first, including infant mortality, enabling the survival of large birth cohorts into adulthood. Falls in fertility arise both through economic development leading to family planning, education and employment opportunities for women; but also appear directly linked to a response to falling infant mortality rates themselves. Population growth levels off and the profile of the population ages as late life mortality rates fall and individuals survive to increasingly older ages. The steady increase in life expectancy is thus occurring in the context of population ageing, whereby falling fertility rates have led to increasing percentages of older dependents, and falling percentages of economically active workers. The fact that increasing longevity is occurring within populations, which are themselves ageing, has clear implications for providing for this longevity.

The latter half of the 20th century thus saw the more developed countries, and in particular Europe, experience population ageing to a degree unprecedented in demographic history. If we take the proportion of the population aged 65 and over in the world's oldest countries with the exception of Japan, the top 20 all are European. Europe reached maturity at the turn of the millennium, with more people over 60 than under 15. It is predicted that Asia will become mature by 2040 and the Americas shortly after. It is predicted that by 2050 the number of the world’s older people will outnumber the young and the percentage over 60 will have reached more than a fifth of the total global population (21%). The total number of individuals 60 and over will have reached 2 billion. The numbers of those aged 80 and above will show an even greater increase, rising from 69 million to 379 million by 2050.

Deteriorating dependency ratios

A more sophisticated approach is to move from considering the total number or percentage of older people, to understanding the proportion of old and younger dependents within a population and the relationship of this to non-dependents. Taking an age-structural transition perspective allows us to consider the cohort composition and how this will alter over time. Three broad groupings may be identified: youth dependents aged under 15; working age population aged 15-64; and elderly dependents aged 65 and over. The combination of these within a population will to an extent influence the productivity and economic growth of that population. The UK will thus move from 60% of its population of working age, to 55% by 2050, a smaller fall then the rest of the current EU27 who will experience a fall from 62% to 51% over the same time period.

Taking an age-structural change perspective also allows us to view population change in terms of a shift between providers and dependents – the dependency ratio - and how this will typically move from a large percentage of young to large percentage of old dependents during the demographic transition. These ratios comprise Elderly Dependency Ratios (EDR), the number of persons of working age (aged 15 to 64) per person aged 65 or over; Youth Dependency Ratios (YDR), the number of persons of working age (aged 15 to 64) per person aged 15 or under; and Total Dependency Ratios, number of those 15-64 with those outside this age range. The shift in TDR from YDR to EDR may be useful in determine when a population reached demographic maturity. Europe, including the UK, became mature by this measure in 2000, Asia is predicted to reach maturity by 2045.

The next decade will thus see a rapid shift towards increased EDRs in most industrialised countries. The EU25 EDR is set to double as the working-age population (15-64 years) decreases by 48 million between now and 2050. The EU25 will change from having four to only two persons of working age for each citizen aged 65 and above. Italy, for example, will see its EDR double between now and 2050 to reach 70:100 workers. In contrast the UK will increase only slightly, reaching 67:100. By 2050, the EDR will also exceed 70:100 in Spain and Japan, while remaining below 40:100 in Denmark, Iceland, Luxembourg, Mexico, Turkey and the United States.

Demographic deficit?

There is a widespread assumption that this structural ageing of the European population, will lead to a demographic deficit, whereby the population of working age is insufficient to support the increasing proportion of older dependents. This is seen to herald negative implications for both nations and regions. There are a series of assumptions behind this view which coalesce around two broad themes: demographic decline leads to decline in economic activity; and demographic ageing leads to economic burden due to increased requirement for pensions and health care.

The view that demographic decline leads to decline in economic activity is based on the assumption that declining populations are equated with declining demand for goods and services. This, in turn, has a negative effect on economic growth and employment. However, this is contested by those who argue that in a modern, industrial economy aggregate demand depends on aggregate incomes rather than on the number of people, and that in a modern, open economy the extent of the markets does not depend on the number of domestic consumers.

The belief that demographic ageing leads to economic burden due to increased requirement for pensions and health care is based on increased demand for such services and reduced capacity to fund them. In terms of increased demand, it is projected that for EU25, age-related public spending such as pensions, health and services for older adults, will rise by 3 to 4 GDP points between 2004 and 2050, representing an increase of 10% in public spending. This will be particularly pronounced between 2020 and 2040. However, it is recognised that public spending will to an extent be protected by the general move within the EU to transfer responsibilities from governments and companies to individuals.

The other side is the potential reduced capacity of ageing populations to finance pensions and long term health and social care. This is seen to depend both on the growth of labour productivity and on the employment rate. Average annual GDP growth in the EU between 2004 and 2010 was 2.4%, projected to fall to 1.2% by 2030 due to the reduction in the working age population.

Strategies to cope with an ageing population

While the impact of population ageing and the associated “demographic deficit” are still contested, it is now accepted by most governments that some remedial measures will be needed across the EU27. These measures may be approached by altering the age composition of the population, through encouraging changes in fertility and migration rates to increase the proportion of young people.

These age structural changes have been fuelled by a fall in Total Fertility Rates (TFR), that is the number of children per reproductive women – requiring 2.1 for replacement – and low fertility is now a global phenomenon. Yet while research does indicate that increasing fertility can have a strong influence on altering old age dependency ratios. With the exception of France, no EU country is currently pursuing an active fertility promotion policy. In Western Europe, all countries, again bar France, are now below replacement level, and southern Mediterranean countries are at 1.2 and 1.3. In Asia, Singapore and Korea have now fallen to below 1.2, while Hong Kong, at below 1, now has the lowest TRF in the world. Indeed, some demographers have expressed concern that due to demographic inertia, a very low fertility rate could become irreversible.

The impact of migration on the demographic deficit is more complex than simply introducing numbers of young people. Migration has a potentially strong and long-lasting impact on population growth and structure through the interaction between the number of migrants, their relatively young age structure and their higher fertility. Immigration thus has the ability to prevent population decline, maintain the size of the labour force and thus the support ratio, and slow down structural population ageing. There is general consensus that immigration to Europe will in the short term achieve immediate increases in total fertility rates, population growth and labour market contribution. However, these are unlikely to achieve full replacement level, to be unsustainable over the longer term, and indeed may eventually contribute to a worsening of the demographic deficit, as the total fertility rates of the immigrant population falls and they age in place. It may also affect the economy via a positive impact on innovation, economic growth, employment in general, and welfare, though these are more complex and contested.

Given the complexities of altering the demographic composition most governments are thus looking at alternative policy options, including increasing the productivity of the population by encouraging higher labour force participation rates and extending working lives by altering entry and exit ages. Increasing the economic contribution of older workers is thus an important measure for governments to consider, given the potential higher levels of educational and health status of successive future cohorts. This is particularly the case in those Europe countries where early retirement rates are high.

Clearly, however, population ageing is taking place within existing institutional structures, including those providing social security and health care. Crucial here will be the capacity of individuals and households to make the relevant adjustments, and of institutions to both make and enable such adjustments. This must also occur to savings behaviour, labour supply, private intergenerational transfers and investment in human capital. In particular, while the essential frameworks for tackling future challenges may be established in most developed counties, these are framed by the collective social goals – such as increasing general prosperity, intra and inter generational fairness, and social cohesion – developed in the previous century. These may need to be adapted for the future. As societies attempt to successfully adjust to population ageing, a key public policy question is thus how national collective goals will influence these necessary societal adjustments, and how such required adjustments will be facilitated or restricted by existing social goals. More specific is the question of the appropriateness of financial and health institutions and programmes, designed for the population of the 20th century, for the individual life courses, familial and societal structures of the 21st century.

Intergenerational equity

The traditional contract between the generations, for example, is based on a system of intergenerational reciprocity. Adults provide for young dependents (children) and in return, when those young dependents become adults, they provide for older dependents. This is maintained in most societies both at the familial level (parents providing for young children, children providing for elderly parents). It is also maintained at a societal level, with adults within the labour market providing via public transfers for both older and younger dependents, to provide health care and education, and health care and income support respectively. The question for an ageing population is whether successful cohorts (in terms of both fertility and mortality reduction) pass the cost of such success onto future cohorts via the traditional intergenerational contract, or bear the cost of their success via an adapted intergenerational contract. This latter contract would require older cohorts to bear the costs of their longer lives through, for example, higher post-retirement contributions to their own welfare and/or a longer working life.

Demographic challenges will also require the integration of public and private transfers into future systems. This includes understanding the complementary relationship between private and public intergenerational transfers and the relationship between upward and downward transfers. A global survey of 44,000 people over 40 in 24 countries undertaken at the University of Oxford by Leeson and Harper reveals, for example, that while public transfers reduces private upward transfers from adult children to older parents, it has far less effect on private downward transfers from older parents to adult children and grandchildren.

There must also be a consideration of intergenerational fairness through sharing out the proceeds of growth between workers and dependents. This, for example, may occur through maintaining a link between pensions and wages so pensioners receive some share of a nation’s economic growth. It may be implemented through linking pensions to increases in prices so pensioners do not see absolute living standards fall as a results of inflation. It could be ensured through pensions being tied to the capacity of the system defined by the growth in total wage bill. Or it may be maintained by a system which integrates several indices.

The new challenges also require consideration of new frameworks which support and encourage individual responsibility. It may be argued that population ageing necessitates a division between government responsibility to keep population out of poverty and individual responsibility to raise personal standards of living.

These general ideas may be developed in line with specific provision, for example those of social security and health care. Economists David Bloom and Rodney McKinnon have, for example, questioned the ability of societies to adequately finance existing social security programmes through a combination of: risk-pooling social insurance contributions; sufficient allocation by governments of tax revenues and mandated savings for individuals; and to finance new social security programmes which may address the new income protection required by ageing populations. Philosopher Kenneth Howse highlights three main challenges that population ageing holds for the provision of health and social care. These are that: (i) population ageing will have a large and independent effect on the total amount of ill-health and disability in the population and as a result will exert pressure to increase total health care spending; (ii) ageing will change the kinds of health problem that people bring to the system, and as a result will exert pressure for a major shift in the allocation of health care resources and the configuration of services; and (iii) changing dependency ratios will make it harder for ageing societies to provide for the care of their older members.

Conclusion

In conclusion, it can be argued that the 20th century approach of many ageing societies to rely on migrant workers from the younger poorer South to prop up their economies will no longer be a viable option in the coming decades. Dramatic falls in TRF which are now occurring in both Asia and Latin America reduce the number of scarce skilled workers. While substitution by new technologies may reduce the need for labour market growth, many countries now recognise the need to retain older workers in the labour market, not only to reduce pension burden, but also to retain valuable skills and experience in the light of an upcoming global skills shortage. New policy approaches in the light of population ageing must thus include the development of broad, coherent and integrated multi-pillar approaches to labour markets, health and social security. These should enable and promote longer working lives through life long training, education and skills updating, and the provision of appropriate working environments for older workers. They should further ensure that private family/household transfers are integrated into old age security systems where possible; promote well-being and enable healthy active living to reduce chronic illness and health care costs and support active contributory life for as long as possible; provide access to education across the life course to ensure that all individuals are prepared physically, mentally, socially and financially to cope with increasing individual responsibility for old age.

Understanding this reality is vital for individuals who need to reassess their life courses in the light of the new longevity probabilities. Moreover, it is also of highest importance for governments charged with planning and developing appropriate policy frameworks to address the forthcoming demographic changes, challenges and opportunities. There are, indeed, a number of immediate policy implications which must be tackled. For example, pay-as-you-go social security schemes face the challenge of a low or even potentially negative rate of return when workforce ceases to grow. A sustainable rate of return equals the rate of growth in total wage bill; and capital reserve schemes face the effect of change in population age structure on asset prices. However, it should be recognised that the major concerns - public spending on pensions; high dependency ratios between workers and non-workers; increases in health care costs; declining availability of family based care; and a slowdown in consumption due to an increase in older people and a decrease in younger people - are dynamics of current cohorts and current behaviours, they are not fixed. In additional, they are all phenomena which can be addressed by policy, given the political and economic will.

This is a version of "Europe’s 21st Century demography: framing the challenge which lies ahead " which will be published in Current History, March 2011.


Download full article (PDF 667 KB)

Author

Sarah Harper

Sarah Harper is Professor of Gerontology at Oxford University and Director of the Oxford Institute of Ageing, a multi-disciplinary research unit concerned with the implications of population ageing.  Her research concerns globalization and the global ageing, and the impact of population change, in particular the implications at the global, societal and individual level of the age-structural shift from predominantly young to predominantly older societies.

Related articles

The longevity revolution: challenge or opportunity?

Colin Milner, 20 Jan 2011

If we are to redesign policies and environments that respond effectively to the challenges of population ageing, we need to reorient ourselves to the opportunities that ageing represents.

Financing longer lives: Longevity funding issues and potential solutions

20 Jan 2011

As highlighted by other articles in this newsletter, longevity is increasing. Individuals in developed economies are living longer; while fertility rates are dropping, causing a worsening dependency ratio. Pension and long-term health care costs are set to rise considerably which will be a burden both for the public sector as well as pension funds. Governments and private sector pension providers will need to study means of reducing their financial exposure to longevity increases. One way is to look to insurance products to mitigate this risk.

The demographic risks to China’s long-term economic outlook

Nicholas Eberstadt, 20 Jan 2011

Emerging markets are widely regarded as key to the future growth of the world economy - and in this regard, no emerging market is deemed to be more important than China. Over the past three decades, China has grown at a more rapid tempo than any country in history - and expectations are high, both in China and internationally, for a continuation of extremely rapid Chinese economic growth over the coming decades. Such assessments do not take China’s dramatically changing demographic outlook into account. Over the past generation, China’s demographics abetted the country’s remarkable economic rise. In the generation ahead, by contrast, China’s economic performance will be constrained by a multiplicity of demographic factors, including declining manpower availability, rapid population ageing, and dramatic changes in family structure. These demographic pressures do not preclude continuing economic progress for China in the years ahead. Attention to demographic risk, however, suggests that China’s future pace of growth may be considerably slower than Beijing’s leadership (and many international investors) currently assume.