Global Aging and the Future of Global Aging and the Future of Funded PensionsFunded Pensions

Richard JacksonRichard JacksonCenter for Strategic & International StudiesCenter for Strategic & International Studies

2009 FIAP International Seminar2009 FIAP International SeminarWarsawWarsaw

May 29, 2009May 29, 2009

Demographic IndicatorsDemographic Indicators

Fertility RateFertility Rate Life Ex.Life Ex. Median AgeMedian Age Elderly ShareElderly Share

Total Total Pop. Pop.

ChangeChange

19601960 20052005 19601960 20052005 20052005 20302030 20502050 20052005 20302030 20502050 2005-502005-50

EuropeEurope 2.62.6 1.41.4 69.869.8 74.674.6 38.938.9 46.146.1 49.649.6 16%16% 23%23% 29%29% -14%-14%

JapanJapan 2.02.0 1.31.3 69.069.0 82.682.6 42.942.9 52.352.3 56.256.2 20%20% 31%31% 39%39% -22%-22%

United StatesUnited States 3.33.3 2.02.0 70.070.0 78.278.2 36.036.0 38.638.6 39.639.6 12%12% 19%19% 20%20% +40%+40%

Sub-Saharan AfricaSub-Saharan Africa 6.86.8 5.55.5 42.142.1 50.450.4 18.018.0 20.220.2 24.124.1 3%3% 4%4% 5%5% +155%+155%

Islamic BeltIslamic Belt 6.56.5 3.13.1 46.446.4 67.767.7 23.223.2 28.728.7 32.132.1 4%4% 7%7% 12%12% +91%+91%

Developing East AsiaDeveloping East Asia 5.75.7 1.71.7 50.050.0 73.173.1 32.632.6 42.242.2 47.447.4 8%8% 17%17% 25%25% +0.8%+0.8%

South AsiaSouth Asia 6.06.0 3.03.0 45.145.1 65.865.8 24.124.1 29.829.8 33.933.9 5%5% 9%9% 13%13% +71%+71%

Latin AmericaLatin America 6.06.0 2.62.6 56.856.8 73.373.3 26.026.0 32.032.0 35.135.1 6%6% 11%11% 16%16% +66%+66%

Source: UN (2007)Source: UN (2007)

The world is being overtaken by an The world is being overtaken by an unprecedented demographic transformation.unprecedented demographic transformation.

The world is being overtaken by an The world is being overtaken by an unprecedented demographic transformation.unprecedented demographic transformation.

Part IPart I

The Economics of Global AgingThe Economics of Global Aging

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

Three Economic Challenges.Three Economic Challenges.Three Economic Challenges.Three Economic Challenges.

Falling fertility and rising longevity translate directly into a falling support ratio of workers to retirees.

A falling support ratio in turn translates into a rising cost rate for PAYGO retirement systems.

Fiscal Burden

Fiscal Burden

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.

CSIS “Current Deal Projection”*CSIS “Current Deal Projection”*

  Public Pension Public Pension Expenditures, Expenditures, as a % of GDPas a % of GDP

Retirement Retirement Age Hike Age Hike

Required to Required to Stabilize Stabilize

CostsCosts

Benefit Cut Benefit Cut Required to Required to

Stabilize Stabilize CostsCosts

   20052005 20502050 2005-502005-50 2005-502005-50

Canada**Canada** 4.4%4.4% 9.7%9.7% 1010 55%55%

FranceFrance 12.8%12.8% 22.1%22.1% 88 42%42%

GermanyGermany 11.7%11.7% 22.6%22.6% 99 48%48%

ItalyItaly 14.2%14.2% 27.6%27.6% 1010 49%49%

JapanJapan 8.7%8.7% 20.2%20.2% 1111 57%57%

UKUK 6.6%6.6% 11.2%11.2% 77 41%41%

USUS 6.1%6.1% 11.0%11.0% 77 44%44%

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.

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.

Economic Growth

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.

Savings Rates

Adults Aged 20 & Over by Age Group, as a Percent of All Adults

Source: UN (2007)Source: UN (2007)

20052005 20202020 20302030 20402040 20502050

EuropeEurope Age 20-34Age 20-34 28% 23% 20% 20% 18%

Age 35-59Age 35-59 46% 45% 43% 40% 38%

Age 60 & OverAge 60 & Over 27% 32% 37% 40% 44%

USUS Age 20-34Age 20-34 29% 28% 26% 26% 26%

Age 35-59Age 35-59 48% 42% 41% 41% 40%

Age 60 & OverAge 60 & Over 23% 30% 33% 33% 34%

JapanJapan Age 20-34Age 20-34 25% 18% 17% 16% 15%

Age 35-59Age 35-59 42% 41% 38% 34% 33%

Age 60 & OverAge 60 & Over 33% 41% 44% 50% 52%

Developing Developing East AsiaEast Asia

Age 20-34Age 20-34 35% 29% 23% 22% 20%

Age 35-59Age 35-59 49% 49% 46% 42% 39%

Age 60 & OverAge 60 & Over 16% 23% 31% 36% 40%

Latin Latin AmericaAmerica

Age 20-34Age 20-34 41% 35% 32% 31% 29%

Age 35-59Age 35-59 44% 46% 45% 43% 41%

Age 60 & OverAge 60 & Over 15% 19% 23% 27% 30%

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.

The economics of global aging gives funded The economics of global aging gives funded systems decisive advantages over PAYGO systems decisive advantages over PAYGO

systems. systems.

The economics of global aging gives funded The economics of global aging gives funded systems decisive advantages over PAYGO systems decisive advantages over PAYGO

systems. systems.

Part IIPart II

The Cost Advantage of Funded The Cost Advantage of Funded Systems in Aging SocietiesSystems in Aging Societies

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.

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.

CHILE: Stylized Replacement Rate Projections. CHILE: Stylized Replacement Rate Projections. CHILE: Stylized Replacement Rate Projections. CHILE: Stylized Replacement Rate Projections.

CHILE: Contribution Rate Illustration. CHILE: Contribution Rate Illustration. CHILE: Contribution Rate Illustration. CHILE: Contribution Rate Illustration.

Given Poland’s more extreme aging trend, personal accounts will far outperform a PAYGO system under virtually any set of assumptions.

POLAND: Stylized Replacement Rate Projections. POLAND: Stylized Replacement Rate Projections. POLAND: Stylized Replacement Rate Projections. POLAND: Stylized Replacement Rate Projections.

POLAND: Contribution Rate Illustration. POLAND: Contribution Rate Illustration. POLAND: Contribution Rate Illustration. POLAND: Contribution Rate Illustration.

Despite China’s rapid aging, high real wage growth reduces the cost advantage of a funded pension system.

Yet even in China, personal accounts are likely to outperform a PAYGO system as its economy develops and real wage growth slows.

CHINA: Stylized Replacement Rate Projections. CHINA: Stylized Replacement Rate Projections. CHINA: Stylized Replacement Rate Projections. CHINA: Stylized Replacement Rate Projections.

Part IIIPart III

New ChallengesNew Challengesfor Funded Pensionsfor Funded Pensions

Global aging poses significant challenges for Global aging poses significant challenges for personal account systems.personal account systems.

Global aging poses significant challenges for Global aging poses significant challenges for personal account systems.personal account systems.

Slower economic growth may lower long-term rates of return in fast-aging countries.

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.

Aging workforces may also be more risk-averse, putting downward pressure on returns.

Widening fiscal deficits in countries with PAYGO systems may increase inflation risk.

Rising longevity will gradually lower replacement rates.

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.

The implications of rising longevity. The implications of rising longevity. The implications of rising longevity. The implications of rising longevity.

UN Projections of Life Expectancy at UN Projections of Life Expectancy at Birth in 2045-2050 Birth in 2045-2050 

  1996 1996

RevisionRevision2006 2006

RevisionRevision

CanadaCanada 83.283.2 85.385.3

FranceFrance 83.183.1 85.185.1

GermanyGermany 81.681.6 84.184.1

ItalyItaly 83.583.5 85.085.0

JapanJapan 83.883.8 87.187.1

UKUK 82.082.0 84.184.1

USUS 81.781.7 83.183.1

We live in an era defined by many challenges, We live in an era defined by many challenges,

from global warming to global terrorism.from global warming to global terrorism.

None is as certain as global aging.None is as certain as global aging.

And none is likely to have such a large and And none is likely to have such a large and

enduring effect on the shape of economies, enduring effect on the shape of economies,

societies, and the world order.societies, and the world order.