1 Introduction
Over coming decades, New Zealand’s population will age substantially. Statistics New Zealand (2000) suggests, for instance, that the number of people aged 65 years and over could rise from the current level of about one-eighth of the population to about one-quarter by 2051. Even if labour force participation rises, the ratio of consumers to workers is almost certain to increase. Most analysts expect that an increase in the ratio of consumers to workers will lead to an increase in the proportion of gross domestic product devoted to government social expenditures, a fall in savings, a tightening in labour markets, and perhaps slowing economic growth (Creedy and Scobie 2002, Polackova 1997, Stephenson and Scobie 2002).
Some have argued that these problems constitute an ageing ‘crisis’: that population ageing poses a serious threat to the consumption levels of future generations. This raises the question as to whether the level of savings expected under current and projected policies is ‘adequate’ to avoid placing an unreasonable ‘burden’ on future generations. Addressing these questions requires an economic framework or model that can trace out the likely effects of ageing on paths for consumption, savings, debt, investment, and other macroeconomic variables. Furthermore, such a framework needs to be able to weigh up the competing interests of different generations. How much weight, for instance, should be given to protecting the consumption levels of the New Zealand population in 2051? The population of 2051 may experience slower economic growth than the current population, but this must be balanced against the fact that the population of 2051 may be considerably wealthier than the current population. In short, to what extent would foregoing consumption today (through higher savings) increase welfare in the long run?
This paper addresses the question of optimal time paths through the use of a Ramsey-Solow model of optimal saving, adapted for investigating problems of population ageing (Cutler, Poterba, Sheiner and Summers 1990, Elmendorf and Sheiner 2000, Guest and McDonald 2001, 2002a). Typical of this class of models, some strong assumptions are made in order to readily identify the main macroeconomic impacts of population ageing. There is, for instance, the highest possible level of aggregation, implying no distinction between the public and private sectors. The model also implies nothing about the distribution of savings among individuals.
The model does, however, highlight the impact of demographic change on consumption possibilities, capital requirements, the return to saving, and the consequent effects on macroeconomic aggregates. Also, the model allows the analyst to evaluate the welfare implications of demographic change, by specifying an explicit social welfare function in terms of the ultimate objective of economic activity: consumption.
The results from the analysis in this paper can be summarised as follows. In our simulations of the New Zealand economy, living standards, as measured by consumption levels, approximately double by the year 2051, notwithstanding population ageing. It must be acknowledged that population ageing imposes a cost on living standards: we calculate this cost to be of the order of 12% by 2051. This magnitude varies very little under different demographic scenarios and parameter values. That is to say, the simulations suggest that if we could somehow turn back the clock, remove the post-war baby boom and maintain current rates of fertility, mortality and immigration indefinitely, then living standards in 2051 could be double their present levels, plus about 12%.
Under our benchmark simulation, it is optimal for national savings to rise by less than 0.5 percentage points of GDP for approximately the next 10 years and then to fall below current levels. Varying the demographic and macroeconomic parameters produces somewhat different results: under some parameter settings it is optimal for savings to rise somewhat higher, and under other settings it is optimal for savings to fall immediately. Given the uncertainties surrounding future demographic and economic developments, there is inevitably some uncertainty about the optimal level of national savings. In summary, however, the results suggest that population ageing per se would not justify increases in national savings significantly beyond those contemplated by current policies.
The remainder of the paper is organised as follows. Section Two of the paper explains the method of constructing the demographic projections under alternative assumptions about rates of fertility, mortality, and immigration. It describes the impact of the projections on the support ratio in each case. Section Three describes the Ramsey-Solow model of optimal savings. Section Four presents the results of the simulations, including an analysis of the sensitivity of the results to alternative specifications and a comparison between birth cohorts. The final section summarizes the findings and discusses the policy implications.
