Background Paper for the 2021 Statement on the Long-term Fiscal Position: The Economic Impacts of an Ageing Population in New Zealand

Conclusion#

Population ageing is occurring in all developed countries, although at varying speeds. As it is an unprecedented phenomenon, there is significant uncertainty about the ways in which it will affect society. The fiscal impact is relatively easy to fathom; a few calculations are sufficient to show that an ageing population will put an immense strain on public funds over the long term if we do not start taking action now. On the other hand, the economic implications are much harder to pin down; we have to rely on models that use historical data to project a future that will look entirely different. For example, it is problematic to try to predict what effect an increase in the old-age dependency ratio will have if the extent of the increase has never in the past been experienced. The global average old-age dependency ratio has never before been above 15; over the next 40 years it is projected to more than double.[1] There are other problems too, such as behavioural responses, policy changes, measurement issues, and the validity of assumptions. In this paper, we assessed the available literature on the economic effects of an ageing population complemented with our own analysis in order to provide our best possible judgement. Our key findings are summarised below.

Labour force growth will decline. As people get older, they are less likely to participate in the labour force and, if they do participate, they generally work fewer hours. In this regard, as people age, the aggregate labour force participation rate will decline. The extent of the overall decline in labour supply can be softened by an increase in the labour force participation rate and hours worked by both women and elderly people. In New Zealand, the elderly's labour force participation has already increased significantly. As such, the scope and potential effect of further increases are arguably limited. There is potentially still some scope for female labour supply to increase, but it will not change the overall picture of a slowdown in labour force growth.

Labour force productivity might decline slightly, but it is not a given. There is considerable evidence that at least some types of cognitive abilities decline with age. Older workers make up for this at least partially by their experience, as well as their breadth of industry knowledge and networks. Moreover, there is also macro-level evidence that suggests that having a relatively older workforce might even have positive effects on labour productivity and company performance. A relatively smaller labour force will also increase the amount of capital per worker, which should boost productivity levels. Therefore, on the whole it is difficult to make an overall assessment on the impact of ageing on labour productivity. If there is a negative impact, it is unlikely to be substantial and could be addressed by targeted training programmes.

Ageing will tend to increase the average propensity to consume and this will have knock-on effects on both goods and capital markets. Assessing the net impact of population ageing on interest rates is challenging, as there are both downward and upward pressures. A slowdown in labour force growth will increase the capital/labour ratio, which in turn will put downward pressure on interest rates. Further, if productivity growth slows down, this will also tend to lower interest rates. Of crucial importance is also how adequately people are financially prepared for their retirements. Theoretically, there should be a positive relationship between life expectancy and savings and consequently population ageing should, at least initially, result in an increase in savings, which will exert downward pressure on interest rates. In contrast, as more people move into retirement and start drawing down on their funds, aggregate savings will fall, putting upward pressure on interest rates. Furthermore, international capital flows should also be considered. It is reasonable to assume that capital will increasingly flow to relatively younger developing countries with growing labour forces, provided there is an adequate amount of profitable investment opportunities. In turn, this will raise the return on capital in developed economies. On balance, the net effect of ageing on interest rates is difficult to pin down and it might conceivably first decline for a number of years before it starts increasing.

The composition of consumption will look different in an older society, shifting, for example, away from education and towards health. Since retired people will tend to have a higher propensity to consume, consumption per capita should increase assuming net worth levels are high enough, which could benefit retailers. As a consumer group, older people will increase in importance meaning that companies will have to adjust their brand and marketing strategies to stay relevant.

Fiscal changes in response to population ageing will have economic effects as well. If there is no fiscal response, public debt will reach unsustainably high levels, implying that at some stage policy changes will simply have to be made. The economic impact of these changes will depend on the specific suite of policies that are implemented and their timing and magnitude. It is important to stress that some of these policies could have feedback effects to demographic factors such as fertility such that the fiscal policy response to population ageing might reinforce the ageing trend. More research, however, is required in this area in order to better understand all the linkages.

The net effect on economic output is uncertain. By lowering labour supply growth and possibly also labour productivity growth, population ageing might lead to a reduction in potential output. While some endogenous growth models show a negative relationship between population ageing and GDP growth, others reveal a positive relationship. Ultimately, estimates of how ageing will affect GDP growth depend heavily on the model specification, assumptions, countries assessed, and the time period. It is therefore difficult to come to a definite conclusion. There are also potential mitigative effects that must be considered, such as behavioural and public policy responses, technological progress, shifts in relative prices and wages, and lifestyle changes.

To summarise, population ageing is likely to lead to a slowdown in labour force growth, might reduce labour force productivity slightly, and may lead to lower savings and higher interest rates in the long term. But what will the overall wellbeing impact of the economic effects of population ageing be? People are living longer, healthier lives, and this must surely be a positive, provided that it does not unduly influence the ability of future generations to enjoy the same benefits. Whether GDP, savings, and/or the capital stock move to permanently lower levels is, arguably, irrelevant, since it could merely indicate that the optimal levels for these aggregates have changed along with the structural change in the composition of the population. Population ageing will arguably have more of a fiscal than an economic impact; if the former is managed well, the negative impact on wellbeing should be minimised.

The main objective of this study was to provide a comprehensive review of the literature on the economic implications of an ageing population. Although there is a substantial amount of research on this topic in general, there are still some specific gaps in the literature. In particular, further research is required on the capital markets impact, especially in a New Zealand context. Likewise, while the topics of technology and population ageing have been explored extensively separately, research on the interaction between the two is limited. Further research would also be worthwhile on the general demand-side effects, as well as the age-structure impact on productivity in a New Zealand context.