SPECIAL REPORT / DEMOGRAPHY
The ageing paradox
Elderly populations mean more government spending. They also mean low interest rates
AT THE PEAK of concerns over public debt and deficits in 2010, President Barack Obama created a bipartisan commission charged with putting American fiscal policy on a sound footing. Crucial to this was containing growing spending on health care and pensions as America’s population aged. By 2020 the resultant “Simpson-Bowles” plan aimed to bring America’s debt-toGDP ratio down to about 66%. Gloomy officials at the Congressional Budget Office (CBO) wrote up an “alternative fiscal scenario” that showed a “clear threat” of a fiscal crisis if corrective actions were not taken. In it, the debt would rise to 95% of GDP in 2022.
The actual figure for this year will be about 98%. That nobody worries much about it any more shows how far economists have rethought the limits on government borrowing in an era of low interest rates. Over the past decade they and many politicians have come to see the panic over debt and deficits of the early 2010s as a mistake. The director of the CBO at the time later admitted that rushing to reduce borrowing was “the biggest error” of the eco nomic cycle. Worrying about public debt is now deeply unfashionable.
But so, until not long ago, was worrying about inflation. Now that interest rates are rising again, might the fiscal rethink also be reversed? Long-term pressures on budgets from health-care and pension spending continue to mount. The share of the world’s population that is over 50 years old has grown from 15% to 25% since the 1950s, and it is projected to rise to 40% by the end of the 21st century. The IMF reckons that by 2030 annual pension and health-care spending in the G20 will have risen by an average of 2.8% of GDP in advanced economies and 2.6% of GDP in emerging markets.
Britain’s budget watchdog forecasts that stabilising debts at 75% of GDP would require cutting spending or raising taxes by 1.5 percentage points of GDP at the start of every decade for 50 years, a fiscal consolidation that seems almost unimaginable given that the tax burden is even now at its highest since the early 1980s.
History shows that controlling pension spending in ageing societies is hard. It means taking on “grey power” at the ballot box. In his book “Making Social Spending Work”, Peter Lindert studies 36 countries and finds only five that have contained pension spending as a share of GDP since 1990: Chile, Latvia, New Zealand, the Netherlands and Peru. In no Mediterranean country did public-pension benefits grow more slowly than output per working-age person from 1990 to 2013. Many countries have raised the retirement age as ageing has started to bite, but not by enough to stop the length of time that workers live in retirement creeping up—an expensive luxury.
f051-01f051-02
In Japanese footsteps
Much of the West is thus likely to walk the path already trodden by Japan, whose rapid ageing began in the 1990s. Its generosity to pensioners, benchmarked to incomes, is comparable to that of America, says Mr Lindert. Around 2011 Japan reached the dependency ratio of 2.5 people aged 20-64 for every person aged over 64 that is forecast in America for 2050. That year Japan spent about 10% of GDP on the elderly, about a quarter more than America spends today. Rising spending on the elderly has helped propel Japan’s gross public debts to a vertiginous 266% of GDP.
Other Asian economies are also ageing rapidly, though their pension systems are not as generous as Japan’s. By 2035 there will be 420m Chinese aged over 65. The Chinese government has rolled out pension coverage with remarkable speed over the past decade, yet the basic pension on offer outside cities is beneath the poverty line. South Korea’s fertility rate (the number of births per woman) is just 0.81, the lowest in the world; by 2075 it will have three over-65s for every four people of working age. Its pension provision is in the lamentable position of being both stingy and creating a black hole in the budget. The logical path forward is to increase pension contributions—which is almost as hard as cutting benefits.
Everywhere debt will continue to offer a tempting short-term fix. And although ageing populations are a drag on government budgets, they also limit how high interest rates are likely to rise. As workers approach retirement they build up savings. Today those savings compete for a dwindling set of profitable investment opportunities, because retirements also slow economic growth. In recent decades the scramble for returns has pushed down the so-called “natural” rate of interest, which equilibrates saving and investment globally. The public has lapped up government debt even at the low interest rates on offer.
Several studies have found that ageing populations and rising longevity have contributed half to three-quarters of the roughly two-percentage-point fall in the natural rate of interest since the 1980s. Even the slump in bond markets in 2022 has not fundamentally altered the long-term picture. As this special report was being completed, the governments of America, Germany and Japan could still borrow at rates ranging from 0.25% to 3.7%.
Central banks can raise real interest rates temporarily to fight inflation. But the only way real rates can stay persistently high is if the savings-investment balance shifts. Some economists have suggested that this may indeed happen as ageing proceeds. Don’t workers saving furiously on the cusp of retirement become pensioners keen to splurge on cruises and cabernet?
In “The Great Demographic Reversal”, an influential book, Charles Goodhart, a former official at the Bank of England, and Manoj Pradhan, a forecaster, argue that the crucial factor for interest rates is the world’s ratio of workers to pensioners. As this ratio falls in the 21st century, global savings will dry up, the authors argue, contributing to a rise in inflation and interest rates.
Yet most economic models reject this view. Elderly households tend to hoard wealth in retirement, rather than running it down quickly. They may limit their spending because they do not know how long they will live, or wish to pass money on to their children. Increasing longevity encourages workers to stash away money for a longer retirement. Using UN population projections and today’s behaviour to project forward rates of saving and investment for 25 countries, Adrien Auclert, Hannes Malmberg, Frédéric Martenet and Matthew Rognlie, four economists, predict that global rates will fall by another 1.2 percentage points between 2015 and the end of the 21st century. Three other economists, Noemie Lisack, Rana Sajedi and Gregory Thwaites, believe there will be a half-a-percentage-point fall in rates by 2050.
The paradox of ageing is thus that it both pushes up government spending and makes possible cheap financing of that spending. In fact, without governments readily running up debts the downward pressure on interest rates in recent decades might have been greater. The tripling in rich-world public debts between 1971 and 2017—from about 20% of combined GDP to about 70%—left rich-world interest rates 1.5-2 percentage points above where they would otherwise have been, according to Larry Summers and Lukasz Rachel, two economists. Had the natural rate of interest been determined only by the behaviour of the private sector, it might have fallen by fully seven percentage points, into deeply negative territory. That would have created big problems for central banks, whose policy rates must follow the natural rate downwards to avoid recessions, but which run into a hard floor near zero.
Over time it is possible that some governments might spend forcefully enough and persistently enough to overcome the impact of ageing. But mobility of capital across borders means that what matters is the balance between savings and investment at a global level. In 2005 Ben Bernanke, then chairman of the Federal Reserve, hypothesised that a “global saving glut” was holding down long-term interest rates in America. Mr Bernanke was particularly struck by the accumulation of dollar reserves by governments of Asian countries including China and South Korea. They and oil exporters, which were accumulating vast sovereign-wealth funds, appeared to be financing America’s growing current-account deficit.
Today, reserve accumulation has slowed and the saving glut is less visible in current-accounts. But Mr Auclert and his co-authors predict that so-called “global imbalances” are likely to return over time, as capital flows from countries that are ageing faster to those ageing more slowly. Because America’s transition is mild relative to the rest of the world’s, it will absorb foreign capital, particularly from China, Japan and Germany. Around the middle of the century, just as those countries cease ageing and start drawing down their savings, India’s vast population will start ageing, meaning that it will become the dominant global creditor.
Governments should be careful how they use the fiscal space that the saving glut creates
How much would governments need to borrow to sop up the savings tsunami? Mr Summers and Mr Rachel suggest a rule of thumb that a one-percentage-point rise in the aggregate debt-toGDP ratio for all advanced economies raises the natural rate of interest by 3.5 hundredths of a percentage point. The rule implies that the rise in debts during the pandemic, about 12% of rich-world GDP, would have increased the natural rate of interest by about 0.4 percentage points. Indebtedness would need to rise by three times as much again just to offset the downward pressure on rates forecast for the rest of the century, let alone to reverse the downward trend of the past 30 years.
The low natural rate of interest will continue to allow many rich countries to maintain high debts. But that does not mean it would be wise for them to go on a Japanese-style borrowing binge. To begin with, the gross figures are misleading: Japan’s net debt, which accounts for the government’s financial assets, is only 172% of GDP. If every advanced economy borrowed to the same extent, then the Summers/Rachel rule of thumb suggests that the natural rate of interest would rise by about 3.3 percentage points, undoing both the 20th-century decline in rates and the forecast 21st-century fall. A more instructive comparison is with Italy, whose net debts are almost 140% of GDP, enough for markets to worry at today’s interest rates (and even with the European Central Bank prepared to buy government bonds).
Governments should, therefore, be careful how they use the fiscal space that the saving glut creates—especially when unexpected crises like the pandemic or the war in Ukraine can strike at any time. Borrowing maximally to postpone pension reform or higher taxes is risky and wasteful. And there is an even more pressing project for which the money may be needed: reaching net-zero carbon emissions. Decarbonisation will also weigh on budgets for decades. ■