Transcript Challenge of Global Aging

Global Aging and the Future of
Funded Pensions
Richard Jackson
Center for Strategic & International Studies
2009 FIAP International Seminar
Warsaw
May 29, 2009
The world is being overtaken by an
unprecedented demographic transformation.
Demographic Indicators
Fertility Rate
1960
2005
Life Ex.
1960
2005
Median Age
2005
2030
Total
Pop.
Change
Elderly Share
2050
2005
2030
2050
2005-50
Europe
2.6
1.4
69.8
74.6
38.9
46.1
49.6
16%
23%
29%
-14%
Japan
2.0
1.3
69.0
82.6
42.9
52.3
56.2
20%
31%
39%
-22%
United States
3.3
2.0
70.0
78.2
36.0
38.6
39.6
12%
19%
20%
+40%
Sub-Saharan Africa
6.8
5.5
42.1
50.4
18.0
20.2
24.1
3%
4%
5%
+155%
Islamic Belt
6.5
3.1
46.4
67.7
23.2
28.7
32.1
4%
7%
12%
+91%
Developing East Asia
5.7
1.7
50.0
73.1
32.6
42.2
47.4
8%
17%
25%
+0.8%
South Asia
6.0
3.0
45.1
65.8
24.1
29.8
33.9
5%
9%
13%
+71%
Latin America
6.0
2.6
56.8
73.3
26.0
32.0
35.1
6%
11%
16%
+66%
Source: UN (2007)
Part I
The Economics of Global Aging
Three Economic Challenges.
 FISCAL BURDEN
— rising old-age dependency
ratios and benefit costs
 ECONOMIC GROWTH
— stagnant or contracting
workforces and more
slowly growing GDPs
 SAVINGS RATES
— declining savings and
threat of capital shortages
Fiscal Burden
 Falling fertility and rising
longevity translate directly
into a falling support ratio
of workers to retirees.
10.0
 A falling support ratio in
turn translates into a
rising cost rate for PAYGO
retirement systems.
7.0
9.0
Number of Working-Age Adults (Aged 20-64) per Elder
(Aged 65 & Over) in 2005, 2030, and 2050
8.7
8.0
8.0
2005
2030
2050
6.0
4.0
3.9
3.7
3.1
3.0
2.0
5.0
4.9
5.0
2.9
2.5
3.4
2.7
2.2
1.8
1.8
1.2
1.0
0.0
Europe
Source: UN (2007)
Japan
United States
Developing
East Asia
Latin America
Fiscal Burden
CSIS “Current Deal Projection”*
 Few countries will be able
to raise taxes enough to
cover more than a fraction
of the age wave’s cost.
 Balancing PAYGO systems
will require large benefit
adjustments—and is likely
to meet political resistance
from aging electorates.
 As countries reduce the
generosity of PAYGO
benefits, they must fill in
the retirement income gap
with funded savings.
 The alternatives to tax
hikes and benefit cuts:
cannibalize other public
spending or let fiscal
deficits grow.
Public Pension
Expenditures,
as a % of GDP
Retirement
Age Hike
Required to
Stabilize
Costs
Benefit Cut
Required to
Stabilize
Costs
2005
2050
2005-50
2005-50
4.4%
9.7%
10
55%
France
12.8%
22.1%
8
42%
Germany
11.7%
22.6%
9
48%
Italy
14.2%
27.6%
10
49%
Japan
8.7%
20.2%
11
57%
UK
6.6%
11.2%
7
41%
US
6.1%
11.0%
7
44%
Canada**
Source: The Graying of the Great Powers (CSIS, 2008)
*Projections assume retirement ages remain unchanged and benefits continue to replace the same share of
wages they do today. **Projection for Canada ignores current trust-fund build up.
Economic Growth
2.5%
 The slowdown in workforce
growth will translate into
slower growth in GDP and
workers’ taxable payroll.
 Productivity and real wages
may also grow more slowly
as societies age, further
reducing economic growth.
 Productivity growth may
depend on the level of
aggregate investment, which
in turn depends on growth
in the labor supply.
 Aging workforces may also
be less flexible, less mobile,
and less entrepreneurial.
2.0%
Annual Average Growth Rate
in the Working-Age Population
(Aged 20-64), 2005-2050
Percentage Point
Change in Growth Rate
from 2005 to 2050
Europe
Japan
United States
Developing East Asia
Latin America
1.5%
-1.5%
-0.8%
-0.6%
-2.2%
-1.4%
1.0%
0.5%
0.0%
Europe
-0.5%
Japan
-1.0%
United States
-1.5%
Developing
East Asia
Latin America
-2.0%
2005-10
2015-20
Source: UN (2007)
2025-30
2035-40
2045-50
Savings Rates
Adults Aged 20 & Over by Age Group, as a
Percent of All Adults
 The lifecycle consumption
hypothesis predicts that
savings rates will fall as
more of the population
enters its harvest years.
 Mounting fiscal deficits may
exacerbate the decline in
private savings rates.
 The specter of a “Great
Depreciation” in financial
markets as postwar baby
booms retire is overstated.
 Instead, fast-aging countries
are likely to become more
dependent on capital
imports from younger and
faster-growing countries.
2005
Europe
US
Japan
2030
2040
2050
Age 20-34
28%
23%
20%
20%
18%
Age 35-59
46%
45%
43%
40%
38%
Age 60 & Over
27%
32%
37%
40%
44%
Age 20-34
29%
28%
26%
26%
26%
Age 35-59
48%
42%
41%
41%
40%
Age 60 & Over
23%
30%
33%
33%
34%
Age 20-34
25%
18%
17%
16%
15%
Age 35-59
42%
41%
38%
34%
33%
Age 60 & Over
33%
41%
44%
50%
52%
35%
29%
23%
22%
20%
49%
49%
46%
42%
39%
Age 60 & Over
16%
23%
31%
36%
40%
Age 20-34
41%
35%
32%
31%
29%
Age 35-59
44%
46%
45%
43%
41%
Age 60 & Over
15%
19%
23%
27%
30%
Developing Age 20-34
East Asia
Age 35-59
Latin
America
2020
Source: UN (2007)
The economics of global aging gives funded
systems decisive advantages over PAYGO systems.
 In aging societies, funded systems:
— help take pressure off public
budgets
— will likely enjoy a widening cost
advantage over PAYGO systems
— can help maintain adequate rates of
savings and investment
 Caveat: The slowdown down in
potential GDP growth may also reduce
the long-term rate of return to capital.
 Nonetheless, countries with funded
systems can invest in younger and
faster growing societies with higher
rates of return; countries with PAYGO
systems cannot escape the tyranny of
their own demography.
Part II
The Cost Advantage of Funded
Systems in Aging Societies
CHILE: Stylized Replacement Rate Projections.
Real Wage Growth Rate
3.0%
2.5%
2.0%
1.5%
1.0%
3.0%
23%
25%
28%
31%
34%
3.5%
26%
29%
32%
36%
40%
4.0%
31%
34%
38%
42%
47%
4.5%
35%
39%
44%
49%
55%
5.0%
41%
46%
51%
57%
64%
5.5%
48%
53%
60%
67%
76%
6.0%
56%
62%
70%
79%
89%
PAYGO
31%
29%
28%
26%
25%
*PAYGO calculations assume universal coverage, a retirement age of 65, and
price indexation; personal account calculations assume a 40-year career, a
retirement age of 65, and administrative charges equal to 0.5 percent of assets.
Source: UN (2007) and CSIS calculations
Outperforms PAYGO
 Given Chile’s aging trend,
a personal accounts
system will deliver higher
benefits under almost any
reasonable set of real
wage growth and rate of
return assumptions.
Personal Account Replacement Rates in 2050 versus PAYGO Replacement
Rates Assuming the Same 10 Percent Contribution Rate*
Real Rate of Return
 The faster the aging trend
and the slower the rate of
real wage growth, the
greater the advantage of
funded pension systems
over PAYGO systems.
CHILE: Contribution Rate Illustration.
20%
18%
PAYGO Contribution Rate Required to Generate the Same (51 Percent)
Replacement Rate as a 10 Percent Personal Account Contribution Rate
with 2.0 Percent Real Wage Growth and a 5.0 Percent Real Rate of Return*
16%
14%
12%
10%
8%
PAYGO
6%
Funded
4%
2%
0%
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
*PAYGO calculations assume universal coverage, a retirement age of 65, and price indexation; personal account calculations
assume a 40-year career, a retirement age of 65, and administrative charges equal to 0.5 percent of assets.
Source: UN (2007) and CSIS calculations
POLAND: Stylized Replacement Rate Projections.
Personal Account Replacement Rates in 2050 versus PAYGO Replacement
Rates Assuming the Same 10 Percent Contribution Rate*
3.0%
2.5%
2.0%
1.5%
1.0%
3.0%
24%
26%
29%
32%
36%
3.5%
28%
31%
34%
37%
42%
4.0%
32%
35%
39%
44%
49%
4.5%
37%
41%
46%
51%
57%
5.0%
43%
48%
53%
60%
67%
5.5%
50%
55%
62%
70%
78%
6.0%
58%
65%
72%
82%
92%
PAYGO
20%
19%
18%
17%
16%
*PAYGO calculations assume universal coverage, a retirement age of 65, and
price indexation; personal account calculations assume a 40-year career, a
retirement age of 65, and administrative charges equal to 0.5 percent of assets.
Source: UN (2007) and CSIS calculations
Outperforms PAYGO
Real Wage Growth Rate
Real Rate of Return
 Given Poland’s more
extreme aging trend,
personal accounts will far
outperform a PAYGO
system under virtually any
set of assumptions.
POLAND: Contribution Rate Illustration.
35%
30%
PAYGO Contribution Rate Required to Generate the Same (53 Percent)
Replacement Rate as a 10 Percent Personal Account Contribution Rate with
2.0 Percent Real Wage Growth and a 5.0 Percent Real Rate of Return*
25%
PAYGO
20%
Funded
15%
10%
5%
0%
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
*PAYGO calculations assume universal coverage, a retirement age of 65, and price indexation; personal account
calculations assume a 40-year career, a retirement age of 65, and administrative charges equal to 0.5 percent of assets.
Source: UN (2007) and CSIS calculations
CHINA: Stylized Replacement Rate Projections.
Real Wage Growth Rate
6.0%
5.0%
4.0%
3.0%
2.0%
3.0%
15%
18%
21%
25%
30%
3.5%
17%
20%
24%
29%
35%
4.0%
20%
23%
27%
33%
41%
4.5%
22%
26%
31%
38%
47%
5.0%
25%
30%
36%
44%
55%
5.5%
29%
34%
42%
51%
64%
6.0%
33%
39%
48%
59%
74%
PAYGO
35%
32%
29%
27%
24%
*PAYGO calculations assume universal coverage, a retirement age of 65, and
price indexation; personal account calculations assume a 40-year career, a
retirement age of 65, and administrative charges equal to 0.5 percent of assets.
Source: UN (2007) and CSIS calculations
Outperforms PAYGO
 Yet even in China,
personal accounts are
likely to outperform a
PAYGO system as its
economy develops and
real wage growth slows.
Personal Account Replacement Rates in 2050 versus PAYGO Replacement
Rates Assuming the Same 10 Percent Contribution Rate*
Real Rate of Return
 Despite China’s rapid
aging, high real wage
growth reduces the cost
advantage of a funded
pension system.
Part III
New Challenges
for Funded Pensions
Global aging poses significant challenges for
personal account systems.
 Slower economic growth may
lower long-term rates of return
in fast-aging countries.
30%
 Although pension funds can
offset lower returns by investing
in younger and faster growing
countries, the room to do so will
steadily diminish as the “second
wave” of global aging sweeps
the developing world.
25%
 Aging workforces may also
be more risk-averse, putting
downward pressure on returns.
10%
 Widening fiscal deficits in
countries with PAYGO systems
may increase inflation risk.
 Rising longevity will gradually
lower replacement rates.
Elderly (Aged 65 & Over), as
a Percent of the Population,
1970-2050
20%
15%
Developed
World
5%
China & East
Asia*
0%
1970 1980 1990 2000 2010 2020 2030 2040 2050
* Excludes Japan.
Source: UN (2007)
The implications of rising longevity.
 Official projections have repeatedly
underestimated the potential for
future gains in life expectancy.
 Actuaries tend to be longevity
pessimists, while demographers
tend to be longevity optimists.
 Longevity risk is an equally serious
problem in all pension systems.
The question is who should bear
the risk: workers or retirees?
 PAYGO systems are increasingly
shifting longevity risk to retirees
through various types of indexing
(Sweden, Germany, and Japan).
 In aging societies, higher
retirement ages are not just
inevitable, but desirable.
UN Projections of Life Expectancy
at Birth in 2045-2050
1996
Revision
2006
Revision
Canada
83.2
85.3
France
83.1
85.1
Germany
81.6
84.1
Italy
83.5
85.0
Japan
83.8
87.1
UK
82.0
84.1
US
81.7
83.1
We live in an era defined by many challenges,
from global warming to global terrorism.
None is as certain as global aging.
And none is likely to have such a large and
enduring effect on the shape of economies,
societies, and the world order.