G-7 Preparing for a Jump in Age-Related Spending

• Author: David Hauner, Daniel Leigh, and Michael Skaarup
• Position: IMF Fiscal Affairs Department
• Pages: 8-9

Page 8

Increased longevity, falling fertility rates, and the retirement of the baby-boom generation mean that governments in advanced economies will have to boost spending on the elderly in coming decades and should prepare by strengthening their fiscal positions in the near term.

By 2050, the populations of the seven major industrial countries-Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States (known as the Group of 7, or G-7, countries)-will be smaller and considerably older, with ratios of elderly people to the working-age population (the oldage dependency ratio) projected to double. These trends will put great added pressure on national fiscal balances.

General government age-related spending in these countries is expected to climb by an average of 4 percentage points of GDP over the next 45 years, although with substantial variation across countries.

Life expectancy

UN projections show that the old-age population in these seven countries will increase by an average of 80 percent between 2005 and 2050 (see Chart 1). According to Eurostat projections, life expectancy in the European Union countries will rise by about six years over the next five decades. Given the age structure of European populations, the oldage dependency ratio is expected to double to about 50 percent from 25 percent because of a small decline in the working-age population and a sharp rise in the elderly population.

Such developments imply a steep increase in the countries' age-related government spending by an average of 4 percentage points of GDP over the next 45 years. Estimates vary substantially across countries, with Canada at the high end (with growth estimated at 9 percentage points of GDP), and Italy and Japan at the low end (with growth rising by about 2 percentage points). The bulk of the spending increase is expected to cover additional health care costs, with long-term care and pension spending accounting for the rest.

Assessing the impact of these demographic changes on the sustainability of public finances is complicated by uncertainties about long-term technological, demographic, labor supply, and productivity growth forecasts-especially the strength of the link between aging and health care costs. Also, a comparison of age-related spending across countries is complicated by differences in...