The aging of a country’s population has the effect, at first glance, of dropping the savings rate in that country. The population over the age of 65 do not contribute to production, and are consumers on top of that. In short, they dissave. As a higher and higher percentage of the population reaches retirement age, the more savings of the younger workers are eaten either by consumption by the elderly or by providing for their care.
Two essays challenge this assertion, however, and provide data and evidence that shows that an aging population is nothing to fret about. The first, Age Structure Dynamics in Asia and Dependence of Foreign Capital by Matthew Higgins and Jeffrey Williamson, compare the growth and demographics of Asian countries. Higgins and Williamson assert that an aging population is actually good for the savings rate at the early stages of development. They also include net foreign capital investment as a signal of the healthiness of a particular country’s savings rate.
Michael D. Hurd’s 1993 essay, The Effects of Demographic Trends on Consumption, Saving and Government Expenditures in the United States, looks at the stability of America’s Social Security program over the next thirty years. Hurd claims there is no cause for alarm, that the Social Security fund will not be drained by the massive age cohort that will begin to retire in 2010. The government can easily handle the extra increase in retirees by small tax increases and more efficient spending.
Higgins and Williamson look at three regions of Asia. First, the highly developed East Asia, the middle tier of Southeast Asia, and less developed South Asia. Higgins and Williamson show that since 1965, the savings rates for East and Southeast Asia has risen substantially, despite the fact that these region’s populations have aged significantly. The savings rates have close to tripled in those two regions, while in South Asia, the savings rates have dropped. Yet the age of their populations have remained the same.
Why? For Higgins and Williamson, the Youth Dependency Rate is negatively linked to the savings rates. Higgins and Williamson introduce a formula, savings = investment + net foreign investment. A country like Japan has a positive foreign investment, meaning they have excess savings to export. Pakistan’s foreign investment is negative, meaning they need to import savings, though their population is much younger than Japan’s. Back to the Youth Dependency Rate. A country that is "young" has a high Youth Dependency Rate, which drains on the investment part of the above equation. This forces the country to import more savings, since theirs are being drained by the high number of youths.
Nearly 50 percent of Bangladesh’s population is under the age of fifteen, which is a severe drain on investment, and therefore stunts the country’s growth. This percentage was identical in 1975. Eight percent of Bangladesh’s GDP is imported foreign capital investment. Now look at Singapore, who in 1975 also had roughly 50 percent of its population as youth dependents. By 1992, that percentage had dropped to 23 percent. Their Elderly Dependency Rate rose from six percent to twelve, not a hindering increase. Net foreign capital investment was positive in 1992 for Singapore, a full nine percent of its GDP was exported. The growth of Singapore’s savings rate, investment, and GDP all rose, while its population aged. Bangladesh had no such development.
Higgins and Williamson say that "much of impressive rise in Asian savings rates since the 1960’s can be explained by the equally impressive decline in Youth Dependency Burdens." In short, the aging of these the East and Southeast Asian countries increased their savings and investment rates as a percentage of GDP (roughly 30 percent in 1992) and the export of foreign capital investment is a sign of a strong savings rate.
Higgins and Williamson, in an effort to further prove their findings, ran a model where they switched the demographic transitions of the East Asia and South Asia for the next thirty years. For example, Japan will have Pakistan’s demographic makeup and vice versa. The model concludes that the East Asian countries would have a much lower savings rate and a negative foreign investment percentage. Those countries of South Asia would have economic growth fueled by a higher savings rate an positive percentage of foreign investment. In conclusion, an older population is a result of, and a tool for, economic growth. As a population ages, it moves from a society where thirty percent are workers to one that is 50 or 60 percent, and so growth is possible.
Michael Hurd looks at the Social Security issue in the US for the next thirty years. Hurd does believes that an aging population will lower the savings rate, as more and more of the population becomes non-contributing consumers. And, as the baby-boomer generation reaches retirement, than the costs of Social Security will rise accordingly. There is also concern that Medicare, the health insurance for the elderly, will go bankrupt. Hurd debates whether this increase in the costs of the program (payments to elderly, Medicare, administration) will outpace the income of the fund (taxes), and if costs do outpace income, if a drop in the savings rate will occur in an effort to meet those costs. As of 1992, the Social Security fund was taking more than it was paying out, and the excess is loaned out to the Federal Government. Yet a fear is that by 2020 is that a huge increase in the beneficiaries of Social Security will necessitate a likewise increase in taxes, thus reducing the savings rate of the whole population. To test this, Hurd set up three scenarios over the next thirty years, from most optimistic to most pessimistic.
What Hurd found was that by 2020 the Social Security system will have little to worry about. Even under the most pessimistic models, the added costs of the retiring baby-boomers could be handled by a small tax increase. Under optimistic models, no adjustments in the program are needed. The strength of the Social Security program lies in the strength of the economy. Even without an increase in taxes, the working-age portion of the population could support the elderly in 2020 because of an increase in GDP. The tax rate will remain constant, but the program’s income will rise.
The main concern is the Medicare portion of the Social Security package. Hurd concludes that governments, both federal and local, will have to spend more on health care, and will reduce government spending. Yet Hurd states that a small decrease in defense spending would counter-balance the costs of health care. For households, Hurd admits that consumption of health care will be substantially increased, between twenty and thirty percent of income in 2020, up from fifteen percent in 1992. This is a rather large increase. That means the household savings rate will fall from 4.6 percent in 1992 to 3.8 percent in 2020. For businesses as well, the increase in health insurance and pension benefits could be heavy, but new approaches to insurance plans will protect businesses from excessive costs. Still, health care will take a larger portion of the company’s pie. For the economy as a whole, health care expenditures will increase from two percent of GNP in 1992 to nearly six percent in 2020. In that year, elderly will be consuming almost half of all health care services.
All these numbers seem to disprove Hurd’s earlier assumption that Social Security is fine and dandy. But he explains that the drop in household savings in insignificant, and the model did not take into account household readjustments in terms of non-essential consumption. Households have the ability to compensate for added expenditures. Businesses will not be affected severely by rising costs, and the economy as a whole will not go through a crisis in savings. A small increase in taxes will safely assure that the baby-boomers receive their checks without destroying the incomes of their children. And a small reduction in government spending and the increase in per capita income may negate the need for more taxation altogether.
Hurd also asserts that the absurd increase in the costs of health care services drives down the savings rate, not the rather small increase in the age of the US population. If the inflation in the health care industry curbs, then Medicare will be even less of a burden on the savings rate.
Higgins and Williamson showed that an aging population can provide economic growth and increase the saving rate dramatically. Their model using net foreign capital investment was used as an indicator of a country’s savings rates and dependency burdens. The less developed countries had high youth dependency burdens, while the more developed countries could easily handle the small increases in their elderly dependency burdens. Hurd looked at the US and its concern over the increase in the number of retirees in 2020. Though Hurd admitted that the savings rate will decrease, he followed that the decrease was small. And that the Social Security program was not in danger of collapsing. The main reason for the decline in the savings rate falls on the shoulders of the health care industry and their skyrocketing costs.
Higgins, Matthew and Williamson, Jeffrey D. "Age Structure Dynamics in Asia and Dependence on Foreign Capital." Population and Development Review 261-293. Vol. 23, no. 2. June, 1997.
Hurd, Michael. "The Effects of Demographic Trends on Consumption, Saving and Government Expenditures on the U.S." National Bureau of Economic Research. Cambridge, MA. 1993.