the aging population

The world’s population is ageing at such a rate that the over 60s now make up over 10%, and by 2050 this is likely to rise to over 20%. Increased longevity is one of the clear successes of economic development, with life expectancy an accepted and central indicator of development. However, an ageing population does not come without significant costs and raises many issues that policy makers need to address. Of increasing concern is the issue of ‘healthy life’ expectancy - living longer but without significant disability.

The causes of an ageing population in Europe, the US and across the rest of the developed world are well-established and effectively explained in the Demographic Transition Theory model.

The age structure of the developed world’s population has been subject to several significant changes occurring in the Post-War period. Firstly, sustained increases in life expectancy, which have been brought about by a steady decline in death rates since the late 18th Century, with continuous improvements in sanitation, disease control, diet, education and technological advancements. Wars apart, the underlying downward trend in death rates and upward trend in life expectancy continued throughout the 20th and 21st centuries. For example, in the US, UK and most of Europe, in every decade since 1930 life expectancy has increased by around 2.5 years. Life expectancy in these regions averaged 60 years for someone born in 1930, and this rose to around 80 by 2010. Of course, there is some inequality of life expectancy, with women living around 3.2 years longer than men, and those of higher educational levels and non-manual occupational status living around 3.1 years longer than those with lower educational levels and undertaking manual work. These differences vary considerably between different countries in similar geographical areas. For example, in Europe, life expectancy in former ‘Western Europe’ is higher than Central and Eastern Europe. Some differences are extreme. In the Czech Republic, those with higher educational levels lived on average 7 years longer than those with low educational achievement. (OECD)

In addition to improvements in healthcare and a declining death rate, the population has ‘aged’ because of changes in the birth rate (births per 1000 people). Immediately after 1945, the birth rate in most developed economies increased significantly. For example, in the US, between 1945 and 1950 births per 1000 increased from 20.4 to 24.1, peaking at 25 in 1955. The birth rate then started to fall from 1960, and by 1975 it had fallen to under 14.8. Improvements in contraception, increased female participation in the labour market, later marriage, and declining fertility (births per female) all contributed to this decline. Similar patterns can be found in most developed economies. This Post-War ‘baby boomer’ generation created a bulge in the age structure of most, if not all developed countries, and it is this that ‘aged’ the population more quickly than healthcare improvements alone would have done. The ageing of the populations of developed countries shows no signs of stopping, although it is likely to slow down. In the UK, by 2015 there were approximately 10 million over 65’s, and this is predicted to double by 2050, so that over-65’s will comprise 25% of the population. In terms of over-80s (defined as the ‘very’ old) there are currently 3 million in the UK, and this is likely to rise to 6 million by 2030 and 8 million by 2050.

Government or market success?

Increases in life expectancy are one of the pillars of economic development. The extent to which improvements are the result of government intervention or the effectiveness of free markets is hard to establish. For example, in terms of improved diet, free trade and reductions in barriers to trade, including tariffs, have increased imports of food from different countries – increasing food diversity, and lowering real food prices. However, specific agricultural policies have protected farmers and growers and increased food security. In terms of public health, it is clear that health care is a merit good, where the socially efficient level of provision is greater than the free market alone would be likely to generate. Without significant input from government, both in terms of healthcare legislation and publicly funded provision, life expectancy across the developed world would not have increased in the same way. The Post-War ‘Welfare State’, with universal provision free at the point of need and funded out of general taxation, is generally regarded as playing a significant role in continued improvements in life expectancy since its introduction. Supporters of a smaller State would, of course, argue that many of these improvements would have occurred anyway, and that the Welfare State has slowly created a dependency culture, and, with the state acting as insurer, moral hazard has increased. The truth is that increased life expectancy does not fit neatly into the free market-vs-public intervention debate.  

Increased dependency

Whatever the cause, the ageing population has resulted in the problem of dependency. In 2008, there were 3.2 people of working age for every pensioner, and this is projected to fall to by 12.5% to 2.8 by 2030, creating an increasing dependency ratio. The dependency ratio is, in its simplest form, the ratio of those in a population who do not work (are dependent, and inactive) to those who do work (are active). The framework for measurement varies between countries given that school leaving and retirement ages vary. The World Bank’s standardised measure is the ratio of under 15’s and over 64’s to the working-age population – those between 15-64. In economic terms, the dependency ratio can be seen as an approximation of the ratio of net consumers to net producers (UN) and as such represents a considerable challenge to policy makers, both in terms of the impact of this on public finances, and in terms of policies that may have to be introduced to deal with it. It also represents opportunities and challenges for the private sector in terms of the provision of goods and services targeted at older aged consumers.

Perhaps of more significance is the old-age dependency ratio - generally regarded as the ratio of 65 and over to the number of persons of working age (from 15 to 64). In 1997 – when the baby-boomer generation was still ‘at work and at its activity peak’, the ratio was, arguably, a manageable one in most developed economies. For example, it was 19 in the US, 23 in both Germany and Greece, with the UK at 24.5 and Italy at 25.5. By 2013, this had risen to 33.2 in Italy, 31.3 in Germany, and 30.9 in Greece – the highest levels in Europe. Over the same period the UK’s had risen to 26.4, and in the US to just 21. This is dwarfed by Japan, whose old age dependency ratio had risen to 41 in 2013. Within just 5 years (by 2020) the UK’s old-age dependency ratio is predicted to exceed 30.

Public debt, taxes and spending

If spending on healthcare and pensions continues to increase at its current rate it is clear that the ageing population is creating a potential ‘debt-time bomb’ and an extensive ‘fiscal challenge’. In the UK in 2014, State benefits, social protection and publicly funded health spending accounted for over 50% of all government expenditure (Public spending). Perhaps the single biggest effect on future spending is the increase in the numbers of over-85s, who cost around three times more in terms of the provision of both hospital and community health services than those aged 65 to 74. 

Tax yields

The effect of the ageing population on tax yields is especially difficult to estimate, given so many unpredictable variables, and given considerable variations within a geographical region. In a recent study in the US, individual income tax revenues were expected to fall, on average, by 2.4 percent per person by 2030.  

In terms of the burden on those still working (the Old Age Support Ratio – OSR), it is predicted that each state pensioner in 2035 will be supported by only 2.87 people of working age, compared to 3.22 people in 2015 - a decrease in the OSR, of 38%. The OECD defines the OSR as the number of people there are of working age relative to the number of retirement age (65+). 

Given the probability that tax yields will at the very minimum not increase as a result of the ageing population pressure to reduce spending on age-related benefits and care will inevitably increase. In its report, A decade of austerity? The Nuffield Trust looked specifically at the financial pressures facing the NHS in England over the next decade. It found that demand pressures on the NHS are likely to grow at around 4% a year up to 2021.

Without significant increases in health service productivity, funding for the NHS in England will need to continue to increase in real terms between 2015/16 and 2021/22 to meet this demand. If this increase does not happen, cuts to the service or a fall in quality are almost inevitable. If NHS funding is not increased beyond the current spending review period, the NHS in England could experience a funding gap worth between £44 and £54 billion in 2021/22 - unless this can be offset by increases in productivity. If, they argue, NHS funding is increased in line with the long run average (at 4%) after 2014/15, this would be sufficient to meet the projected demands. Annual spending on the NHS per head has risen by around £100 per year over the last 20 years (NHS). However, such an increase is highly unlikely - because it will entail either a large impact on other public services and welfare spending, or major tax rises.

Policy options

In response to the Nuffield Foundation report, the House of Lords (Ready for Ageing) recommended a number of policies to reduce the pressure on the health service, including increasing the state pension age; reviewing pensioner benefits; and a movement in NHS strategy from acute and emergency care in hospitals to preventative health and care which would reduce demand for hospital admissions among older people. It also recommended attempt to improve health service productivity, and introduce attempts to integrate across health and social care services. Following the Turner Report in 2005, the UK government is committed to phase in a higher retirement age over 30 years, eventually rising to 68 for both men and women.

The Institute of Economic Affairs (IEA) has gone further and warned the UK Government that it must reduce public spending by a quarter in order to get Britain's debt mountain down to sustainable levels. In its proposals, it argued that increases in state pensions should not be guaranteed by being index linked to inflation or average earnings, or guaranteed to increase at any specific annual rate.

Labour market effects

One obvious implication of the ageing population in terms of the labour market is that, as the baby-boomer generation ages, the numbers of prime age workers – that is, those between 25 and 49 (and who are the most active) - will begin to fall. In the UK it is estimated that, by 2020, just 20 million workers will fall into this highly active category. The number of prime age male workers has fallen and is projected to continue to do so, while the number of prime age female workers is actually increasing and is predicted to rise up to 2020.  These changes mean that labour market shortages are almost inevitable in certain industries and occupations. This is especially true in occupations where ageing has a clear adverse effect, such as building, construction, farm work and other manual work. However, participation of over-65’s has doubled over the last decade, from around 550,000 in 2005 to 1,100,000 in 2015. (ONS) Estimates suggest that this trend will continue. For men, the estimate of average age of complete withdrawal from the labour market increased from 63.8 years in 2004 to 64.6 in 2010 (Parliamentary Report) and for women, it increased from 61.2 years in 2004 to 62.3 years in 2010.

Migration

 Migration can also offset some of the adverse effects of an ageing population on the labour market, with the average age of migrants lower than the host population. In the UK, migration increases activity, especially in the 16 to 35 age group.  Clearly, the downside effect of the ageing host labour force is compensated by younger migrant workers who are willing and able to undertake manual work. Hence, the overall labour supply is likely to be maintained through increases in the labour market withdrawal age – either voluntarily or through changes in the retirement age – and through net migration.

It’s not all bad news

An ageing population is, of course, not ‘all bad’. From an employment perspective it can shift attitudes towards older workers, and permanently reduce age-related discrimination. Changes in the age structure also present opportunities for firms to develop new niche products and services. This is clearly true for the financial services sector who may develop new and attractive savings and pensions products. Patterns of investment may also change, with age-related investments, such as those related to the performance of pharmaceutical companies, doing well into terms of growth and opportunities. It may also provide opportunities for firms in the leisure and entertainment industries, who will look to understand and exploit these demographic changes.