Older and Smaller

• Author: Benedict Clements, Kamil Dybczak, and Mauricio Soto

Older and Smaller Finance & Development, March 2016, Vol. 53, No. 1

Benedict Clements, Kamil Dybczak, and Mauricio Soto

The fiscal consequences of shrinking and aging populations threaten advanced and emerging market economies alike

With fertility rates falling across the globe, population declines will become more widespread over the next few decades. According to the latest projections from the United Nations (2015), the world’s population will peak around 2100 and begin to shrink soon thereafter. Populations are already shrinking in several countries, and by the end of the century, nearly 70 percent of more-developed and 65 percent of less-developed countries will have shrinking populations (see Chart 1).

As a result there will be a gradual increase in the ratio of old individuals to young. The global old-age dependency ratio (the number of people ages 65 and older divided by the population ages 15 to 64) will triple over the next 85 years, driven by rapid aging in less-developed countries (see Chart 2). In China and Kenya, for example, the United Nations (UN) projects that the old-age dependency ratio will increase fivefold between 2015 and the end of the century. In more-developed countries, the ratio will double over this period, which is in line with the expected developments in the European Union, Japan, and the United States. The United Nations defines more-developed countries to include all of Europe, Australia, Canada, Japan, New Zealand, and the United States.

The combination of declining and aging populations portends large and growing fiscal burdens for both more- and less-developed countries. Unless steps are taken to deal with the issue, age-related spending as a percentage of GDP could rise to unmanageable levels—to a quarter of all economic output in more-developed countries. Less-developed countries would also experience a sharp rise in spending.

Unprecedented spending pressureTo assess the long-term implications of this shrinking and aging of the global population, we projected spending for age-related programs (pensions and health) for more than 100 countries between 2015 and 2100. Many studies have looked at long-term spending increases in selected countries through the middle of the century. We were one of the first to look at spending increases for such a large number of countries and extend the analysis to the end of the century. Such a long period is necessary to capture the full effects of the demographic transitions, including shrinking populations, expected in many countries.

Population aging increases government spending because it usually leads to a higher share of the population receiving public pensions and to more use of health care services. The methodology we use incorporates expected changes in the size and age structure of the populations based on recently updated UN demographic projections, the expected evolution of pension benefits under current law, health care spending patterns of various age groups, and growth projections for health care costs.

Our results suggest that countries around the world will face a tremendous fiscal challenge. Under current policies, age-related spending in more-developed countries will reach 25 percent of GDP by the end of the century, representing an increase of 8½ percentage points over...