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Shrinking Populations, Rising Fiscal Challenges

Author(s): Benedict Clements, Kamil Dybczak, and Mauricio Soto

From iMFdirect:

Populations are getting older around the world—that’s no surprise in light of declining fertility and improvements in health care. But in many countries, something more dramatic is going on—the population is actually shrinking. These demographic developments portend stark fiscal challenges. What should countries—whatever their degree of economic development—do to respond to these challenges?

 

Large increases in spending are likely outcomes

By the end of this century, according to recently released UN projections, populations will be shrinking in about two-thirds of the world’s countries: nearly 70 percent of more-developed countries and about 65 percent of less-developed ones (Figure 1).

SDN-Shrinking Pops.chart1

They will also be aging. For the world as a whole, the share of the population older than age 65 is expected to increase from 12 percent today to 38 percent by 2100 (Figure 2, which shows the old-age dependency ratio: the 65-and-older population as a percentage of the population aged 15 to 64).

SDN-Shrinking Pops.chart2

These two factors—shrinking and aging populations—will exert pressure on public finances. With current policies unchanged, spending on age-related programs (pensions and health) will rise, and the increase in outlays for these programs will be staggering. In more-developed countries, spending will reach 25 percent of GDP by the end of the century; in less-developed countries, to 16 percent of GDP (Figure 3). The fiscal consequences are potentially dire: such spending increases could lead to unsustainable public debt, require sharp cuts in other spending, or necessitate large tax increases that stifle economic growth.

SDN-Shrinking Pops.chart3

Population projections pose additional risks

In the past, demographers have often underestimated declines in both fertility and mortality rates. If fertility and mortality turn out to be lower than forecast, the impact on fiscal variables will be even larger. For example, lower fertility on its own could (by increasing the ratio of older individuals to younger) raise age-related spending by another 8 percentage points of GDP in more-developed countries and another 4½ percentage points in less-developed countries by the end of the century. The fiscal impact of any larger-than-forecast increases in longevity would be on top of this.

But policy changes now can make a big difference later

The stark magnitude of the challenge necessitates a multi-pronged approach that could encompass the following:

  • Entitlement reform—starting now, but at a gradual pace. This would spread the burden across generations and decrease the risk of policy reversals.

One of the most urgent priorities is to contain the growth of health care spending, which has yet to be reformed to the same degree as pension spending. For example, if growth in health care costs per capita were kept in line with growth in GDP per capita, we estimate that this would lower public health care spending by 4½ percentage points of GDP by 2100 in more-developed countries and 3 percentage points of GDP in less-developed countries. Countries could pursue this in a number of ways: by increasing competition among insurers and service providers, improving the provider payment system to control costs, paying more attention to primary and preventive health, and making more effective use of health information technology.

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