PA
PE
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POLICYRESEARCHDIVISION
woRKING
Population Aging and the
Rising Cost of Public Pensions
John Bongaarts
2004 No. 185
Population Aging and the Rising Cost of Public Pensions
John Bongaarts
John Bongaarts is Vice President, Policy Research Division, Population Council.
This material may not be reproduced without written permission from the author. For a list
of Policy Research Division Working Papers, including those available for downloading in
PDF format, see www.popcouncil.org/publications/wp/prd/rdwplist.html
ABSTRACT
Rapid population aging is raising concerns about the sustainability of public
pension systems in high-income countries. The first part of this study identifies the four
factors that determine trends in public pension expenditures: population aging, pension
benefit levels, the mean age at retirement, and the labor force participation rate. The
second part presents projections to 2050 of the impact of demographic trends on public
pension expenditures in the absence of changes in pension benefits, labor force participation,
and age at retirement. These projections demonstrate that current trends are unsustainable,
because without reforms population aging will produce an unprecedented and
harmful accumulation of public debt. A number of projection variants assess the potential
impact of policy options aimed at improving the sustainability of public pension systems.
Although the conventional responses are considered, particular attention is given to the
demographic options of encouraging higher fertility and permitting more immigration.
This analysis is illustrated with data from the seven largest OECD countries.
3
Since 1950, the median age of the population in the developed world--North
America, Japan, Europe, and Australia/New Zealand--has increased from 29 years to 37
years, and it is expected to reach 45 years in 2050 (United Nations 2003). In contrast, the
median age in the developing world--Africa, Asia (excluding Japan and Australia/New
Zealand), and Latin America--stands at only 24 years. However, declines in fertility and
mortality in these regions will inevitably also result in rapid aging, with the median age
projected to reach 36 years in 2050. The developing world therefore will remain younger
than the developed world, but the gap between them is closing. The present study focuses on
the developed world.
Population aging has raised concerns about the sustainability of public pension
systems (OECD 1998; World Bank 1994). In the past, the limited old-age support that
existed was usually provided through informal family and community arrangements, but
these have weakened nearly everywhere. Much of the support for the elderly in contemporary
advanced societies is provided by public and private pensions and by government
health care. These programs have been successful in closing the income gap between the
elderly and the working-age populations, and poverty rates among the elderly have declined
substantially. However, expenditures by widely implemented pay-as-you-go public pensions,
which rely on transfers from younger to older generations, are becoming increasingly
burdensome on the contributors and are eventually unsustainable as old-age "dependency
rates" rise to high levels. A study from the International Monetary Fund suggests that failure
to address these fiscal stresses in pay-as-you-go pension systems could inflict "serious
macroeconomic damage, both on the domestic economy and, in the case of large industrial
countries through international linkages, on the world economy" (Chand and Jaeger
1996: 1). The need to identify and implement reforms of public pension systems under these
changing demographic conditions represents an urgent challenge for public policy.
The first part of this study examines cross-country variation in current levels of oldage
dependency and public pension expenditures and benefits. The second part presents
projections to 2050 of demographic trends and pension expenditures in the absence of
changes in pension benefits or labor force participation. These projections provide the basis
for assessing the potential impact of policy options aimed at improving the sustainability of
social security systems. The main objective of this study is to demonstrate that current
trends are unsustainable and to calculate sensitivities to policy options. Although the conventional
responses are considered, particular attention is given to the demographic options
of encouraging higher fertility and permitting more immigration. This analysis is illustrated
with data from the seven largest OECD countries (Canada, France, Germany, Italy, Japan,
the United Kingdom, and the United States) for which comparable demographic, labor
force, and pension system statistics are available from the UN and the OECD (see Appendix
for further details). These countries--often called the G7--are quite diverse in terms of their
current and projected demographic conditions, retirement and labor force participation
patterns, and the generosity of public pensions.
4
OLD-AGE DEPENDENCY
The conventional old-age dependency ratio (ODR) is defined as the ratio of the
population aged 65 years and older to the population aged 15­64. The inverse of this ratio is
called the support ratio. For the developed world as a whole the old-age dependency ratio in
2000 stood at 0.25, which implies a support ratio of four people of working age to every
person aged 65+. The light gray bars in Figure 1 present results for the G7 countries. The
dependency ratio ranges from about 0.25 in the four European countries and Japan to about
0.19 in the United States and Canada. The similarity of the values for the European countries
and Japan reflects their broadly similar past levels of fertility, mortality, and migration. The
United States and Canada have experienced somewhat higher levels of fertility and migration
in recent decades and their ODRs are therefore lower.
The old-age dependency ratio is widely used in studies of population aging in part
because it is easy to calculate and interpret, and data on levels and trends are available for all
countries in the world from published estimates and projections of the United Nations
(United Nations 2003). However, the ODR is flawed as an indicator of the demographic
dimension of the "burden" of providing pensions in countries with pay-as-you-go systems
for two reasons.
First, the number of pensioners usually exceeds the population aged 65 and older.
Although 65 is the standard age at which retirees qualify for a full pension, reduced pensions
are available at younger ages. The minimum age of eligibility for public pensions is 60 years in
Canada, France, Germany, Japan, and the United Kingdom, 62 years in the United States, and
55 in Italy (Gruber and Wise 1999). For present purposes the number of pensioners is estimated
as the population aged 65 and older plus anyone under age 65 who is retired and over
this minimum age of eligibility1
(Disney and Johnson 2001). In 2000 the pensioner ratio
(PR)--defined as the number of pensioners divided by the population aged 65+--ranged from
1.10 in the United States to 1.47 in Italy. The difference in the pensioner ratios of these two
countries is largely due to the substantially higher average age at retirement in the United
States than in Italy (64 vs. 58). In general, a higher age at retirement is associated with a lower
proportion retired below age 65 and hence a lower pensioner ratio (see Figure 2).
Second, the number of workers is smaller than the population aged 15­64. Substantial
proportions of the population of working age are not currently employed, either because
of nonparticipation in the labor force or because of unemployment. In 2000 the employment
ratio (ER)--defined as the number of employed persons divided by the population aged 15­
64--was lowest in Italy (0.55) and France (0.61) and highest in Japan (0.74) and the United
States (0.76). Employment ratios are higher for males than for females; in 2000 male ERs
averaged 0.77 for the G7 countries, and female ERs averaged 0.57. Although age at retirement
is only one of several factors determining the employment ratio, the expected positive
correlation between these variables is evident in Figure 2.
A more accurate indicator of the demographic burden of supporting the elderly is the
ratio of pensioners to workers. The dark gray bars in Figure 1 show the pensioner/worker
ratio in 2000 for each of the G7 countries. Values differ widely, from a low of 0.27 in the
5
FF
F
F
FF
F
B
B
B
B
BB B
0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
56 58 60 62 64 66 68
Ratio
Mean age at retirement (years)
CanadaFrance
Germany
Italy
Japan
United
Kingdom United
States
Canada
France
Germany
Italy
Japan
United
Kingdom
United
States
Figure 2 Relationship between pensioner and employment ratios and mean age at
retirement in 2000
Employment ratio
Pensioner ratio
Note: The pensioner ratio equals the ratio of pensioners to the population aged 65 years and older. The
employment ratio equals the number of employed persons divided by the population aged 15­64. The
mean age at retirement is estimated with the method proposed by Latulippe (1996).
United States
United Kingdom
Japan
Italy
Germany
France
Canada
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8
Ratio
Figure 1 Old-age dependency ratio and pensioner per worker ratio in 2000
Old-age dependency ratio
Pensioners per worker
Note: The old-age dependency ratio equals the ratio of the population aged 65 years and older to the
population aged 15­64. The number of pensioners is defined as the population aged 65 and older plus
anyone under age 65 who is retired and over the minimum age of eligibility for a public pension.
6
United States to a high of 0.71 in Italy. This ratio is much larger than the conventional oldage
dependency ratio in all seven countries, and in France and Italy the former is more than
twice the latter.
The relationship between the pensioner/worker ratio (PWR) and the old-age dependency
ratio (ODR) is summarized as
PWR = ODR x PR/ER.
The pensioner/worker ratio is directly related to the old-age dependency ratio and the pensioner
ratio, but is inversely related to the employment ratio. For example, the highest
pensioner/worker ratio value of 0.71 is observed in Italy, a country that also has the highest
values for the old-age dependency ratio (0.27) and the pensioner ratio (1.47) and the lowest
employment level (ER=0.55) among the G7 countries. In contrast, the lowest pensioner/
worker ratio of 0.27 is observed in the United States, which has the second lowest old-age
dependency ratio (0.19), the lowest pensioner ratio (1.10), and the highest employment ratio
(0.76). The pensioner/worker ratio is one of the key determinants of the overall level of
expenditures on public pensions, as discussed next.
PENSION EXPENDITURES AND BENEFITS
The main objective of mandatory national public pension systems is to protect
people from steep declines in income after retirement from the labor force. This objective
has now largely been achieved in OECD countries, where people over age 65 typically have
a disposable income that, on average, corresponds to 70 to 80 percent of the income of
people in the later working ages below age 65 (OECD 2001a). This estimate is based on
income from all sources (public and private pensions, savings, and earnings) and holds even
though the generosity and distributive nature of public pension systems varies considerably
among countries.2
The success of these programs has been achieved in part by providing
increasing levels of benefits over the past few decades. The expansion of individual benefits
together with declining age at retirement and the aging of populations has resulted in a rapid
rise in the overall cost of public pension systems.
The level of expenditures on public pensions is measured here as the pension expenditure
ratio, PER, calculated as current total annual spending on public pensions divided by
current total pre-tax annual earnings of workers (see Appendix for source of data). Expenditures
include all old-age public pension spending as well as survivor benefits and minimum
social assistance pensions (OECD 2001b; Dang et al. 2001). Earnings include wages, salaries,
and self-employed income.3
In pay-as-you-go pension systems, the pension expenditure
ratio is close to the social public pension tax or contribution rate; but in some cases total
annual contributions exceed expenditures, resulting in a temporary surplus that accumulates
as a reserve against future liabilities (e.g., in the United States).4
In other countries contributions
fall short of pension spending, with the deficit being covered from general government
revenue (e.g., in France, Germany, and Italy).
7
Table 1 Estimates of public pension expenditure, benefit, old-age dependency, pensioner,
employment, and pensioner per worker ratios in 2000
Public pension Old-age Employ- Pensioner
expenditure Benefit dependency Pensioner ment per worker
ratio ratio ratio ratio ratio ratio
PER BR ODR PR ER PWR
United Kingdom 0.08 0.20 0.24 1.19 0.73 0.40
United States 0.08 0.31 0.19 1.10 0.76 0.27
Canada 0.10 0.33 0.18 1.21 0.72 0.31
Japan 0.14 0.36 0.25 1.16 0.74 0.39
Germany 0.24 0.51 0.24 1.33 0.68 0.48
France 0.29 0.58 0.24 1.25 0.61 0.50
Italy 0.35 0.49 0.27 1.47 0.55 0.71
Note: Bold numerals indicate the three highest values for each ratio, except for ER.
PER equals the ratio of public pension expenditures to total pre-tax annual earnings of workers. BR equals the
ratio of the average public pension benefits per pensioner to average earnings per worker. ODR equals the ratio
of the population aged 65 years and older to the population aged 15­64. PR equals the ratio of pensioners (the
population aged 65 and older plus anyone under age 65 who is retired and over the minimum age of eligibility
for a public pension) to the population aged 65 years and older. ER equals the proportion of the population
aged 15­64 that is employed. PWR equals the ratio of pensioners to workers.
Source: See Appendix.
Table 1 presents the public pension expenditure ratio in 2000 for the G7 countries.
Pension expenditures amount to 10 percent or less of earnings in Canada (10 percent), the
United Kingdom (8 percent), and the United States (8 percent), but they equal about one
quarter of earnings in France (29 percent) and Germany (24 percent), and they slightly
exceed one third of earnings in Italy (35 percent). This large variation among countries in
expenditures is in part explained by variations in benefit levels.
The public pension benefit level is measured as the benefit ratio (BR), which equals
the average public pension (per pensioner) divided by the average earnings (per worker).5
Estimates of the benefit ratio are presented in the second column of Table 1. Average public
pension benefits are most generous in France, Germany, and Italy, where they equal or
exceed half of average earnings. Benefits are lower in Canada, Japan, and the United States
at only about a third of average earnings, and they are least generous in the United Kingdom
at one fifth of average earnings. In interpreting these estimates it is important to note the
following about the benefit ratio:
--No adjustments are made for taxes on earnings and pensions.6
Average tax rates
are higher on earnings of workers than on the income of retirees because incomes of workers
are on average higher than those of retirees and pensions often receive favorable tax treat-
8
ment. Furthermore, retirees do not make pension contributions. As a result, the after-tax
(net) benefit ratio is substantially higher than the (gross) benefit ratio presented here (Disney
and Johnson 2001). Unfortunately, estimates of levels and trends in taxes are not readily
available.
--Many retirees have sources of income other than public pensions, including
corporate pensions and savings. The proportion of all income that is provided by these other
sources tends to be highest in countries in which public pensions are least generous. As a
result, the total income from all sources varies much less among countries than does the
level of public pension benefits. Generous public pensions seem to "crowd out" private
provisions (Disney and Johnson 2001).
--Countries differ widely not only in the average benefit but also in the distribution
of pensions among retirees (OECD 2001a). In the United States, the United Kingdom, and
Canada, where public benefit ratios are relatively low, public pension replacement rates are
substantially higher for workers with low than with high earnings. In contrast, in countries
with the most generous public pensions (France, Germany, and Italy) replacement rates are
high regardless of individual earnings.
The public pension expenditure ratio equals the product of the benefit ratio and the
number of pensioners per worker:
PER = BR x PWR.
Figure 3 plots the country-specific relationships between the public benefit ratio and the
pensioner/worker ratio. Various combinations of the benefit ratio and the number of pensioners
per worker can produce the same value of the expenditure ratio. For example, the
public expenditure ratio in the United States and the United Kingdom is very similar at 0.08,
but the benefit ratio is substantially higher in the United States than in the United Kingdom
(0.31 vs. 0.20) while the reverse is true for the pensioner/worker ratio (0.27 vs. 0.40).
Countries with high public benefit ratios tend to have a high number of pensioners
per worker (see Figure 3). This association is likely to be the result of two-way causation. A
larger number of pensioners provides the voting power to ensure that public benefits are
high, and high public benefits induce workers to retire early.
Substitution of the equation for PWR derived in the preceding section gives
PER = BR x ODR x PR/ER.
This result implies that the public expenditure ratio is determined by four factors: the benefit,
old-age dependency, pensioner, and employment ratios.7
Table 1 presents estimates of
these factors with countries ordered from lowest to highest expenditure ratio (bold indicates
the three highest values for each ratio except for the employment ratio). As noted, the
highest expenditure ratio (0.35) is found in Italy. This value is the result of Italy's having the
highest old-age dependency and pensioner ratios, the third-highest public benefit ratio, and
9
Expenditureratio(expenses/earnings)
0.4
Figure 3 Relationship between the public pension benefit ratio and the
pensioner/worker ratio
B
B
B
B
B
B
B
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
Benefitratio
(averagepublicpension/averageearnings)
Pensioner/worker ratio
United
States
United
Kingdom
Canada Japan
Germany
France
Italy
Public pension expenditure ratio
(expenses/earnings)
0.0
0.1
0.2
0.3
1960 1980 2000 2020 2040 2060
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
Ratio
Figure 4 Old-age dependency ratio, estimates 1970­2000 and projections 2000­2050
United States
United Kingdom
Canada
France
Germany
Italy
Japan
Note: The old-age dependency ratio equals the ratio of the population aged 65 years and older to the
population aged 15­64.
Source: UN (2003).
10
the lowest employment ratio. The United Kingdom has the lowest expenditure ratio, which
is the result of its very low public benefit ratio, below-average value for the pensioner ratio,
and third-highest employment ratio.
PROJECTIONS OF PUBLIC PENSION EXPENDITURES:
THE REFERENCE SCENARIO
The construction of a reference projection is the first step in the analysis of future
trends in public pension expenditures. The purpose of this reference projection is not to
forecast the most likely trend in public pension expenditures and related demographic
factors, but rather to serve as a simple benchmark against which alternative projections can
be assessed.
The reference projections of annual public pension expenditure levels from 2000 to
2050 are based on the following assumptions regarding the four factors that determine the
expenditure ratio.
Old-age dependency ratio
Future population trends are taken from the medium variant of the UN population
projections (United Nations 2003). These projections are based on a number of assumptions
about future levels of fertility, mortality, and migration. The details are specific to
individual countries, but in general the UN assumes that mortality improvements will
continue, that fertility will rise appreciably in countries with very low fertility, and that
the flow of migration will remain close to current levels. Figure 4 summarizes these
projections. Trends are not linear over the next 50 years. During the next decade the pace
of aging is expected to be modest in France, the United States, the United Kingdom, and
Canada, but quite rapid in Italy, Germany, and, in particular, Japan. By 2010 Japan's oldage
dependency ratio is likely to reach about 0.35, double the level of 0.17 observed in
1990. After 2010 the pace of aging is high in all seven countries, resulting in large increases
in the old-age dependency ratios by 2050. The most rapid aging will occur in
Japan and Italy, which are expected to reach old-age dependency ratios around 0.7, nearly
triple the level of about 0.25 in 2000. Even in the countries with the least amount of aging,
the old-age dependency ratio is expected to increase by more than half: from 0.19 to 0.32
in the United States, from 0.24 to 0.38 in the United Kingdom, and from 0.18 to 0.43 in
Canada. The range of values of the projected old-age dependency ratio in 2050, from 0.32
for the United States to 0.72 in Japan, is much wider than in 2000. This divergence of
trends is a result of differences in the projected levels and trends in fertility, mortality, and
migration and in the current population age structure. Differences in average levels of
fertility and migration during the projection interval appear to be particularly crucial. The
two countries with the lowest projected levels of future fertility and migration (Italy and
Japan) are expected to have the highest old-age dependency ratios in 2050. In contrast, the
old-age dependency ratio in 2050 is much smaller in the United States, the country with
11
one of the highest projected fertility and migration levels. The role of variation in fertility
and migration in determining future levels of old-age dependency will be examined in
greater detail below.
Employment ratio
Figure 5 plots estimates of the employment ratio from 1970 to 2000, based on
available OECD data (see Appendix). These trends are determined by a multiplicity of
factors, including rising female labor force participation and rising age at entry into the labor
force as well as earlier retirement. These partially offsetting factors have resulted in modest
increases in the employment ratio where the rise in female employment has dominated (e.g.,
in Canada, Japan, and the United States), or in modest declines in the employment ratio
where later entry into the labor force and declining age at retirement have dominated (e.g.,
in France). In the reference projection to 2050, I assume that age- and sex-specific employment
rates will remain invariant at levels observed in 2000 for the duration of the projection.
The future trends in the employment ratios implied by this assumption are also plotted in
Figure 5. Only minor changes in the ER are projected and these future changes are entirely
due to future changes in the age composition of the population of working age.
Pensioner ratio
As shown in Figure 6 the pensioner ratio (estimated with the procedure described
earlier) changed relatively little between 1970 to 2000. Some countries (e.g., France and
Germany) have experienced slight increases and others (e.g., Canada, Japan, the United
Kingdom, and the United States) small declines. These changes are the net result of trends in
three underlying factors: the age at retirement, labor force participation (which affects the
pensioner ratio even if the retirement age is unchanged),8
and a changing population age
structure. For purposes of the reference projection, I assume that the age and sex pattern of
employment remains constant from 2000 to 2050, which implies a fixed age at retirement.
Although age at retirement has declined since 1970, this trend seems to have run its course
with little change in retirement age during the 1990s. Any changes in the pensioner ratio
projected for the next half century are therefore due solely to future changes in the age
structure of the population of elderly.
Benefit ratio
Throughout the reference projection I assume that this ratio remains constant at 2000
country-specific levels. This is equivalent to indexing pensions to wages.
In sum, the reference projection reflects fixed employment and retirement patterns
by age and sex, and no change in the benefit ratio. The projections for expenditures are
therefore driven by demographic trends, mostly the rise in the old-age dependency ratio but
also minor effects of the changing age structure on the pensioner and employment ratios.
12
1960 1980 2000 2020 2040 2060
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
Numberemployed/population15­64
Figure 5 Employment ratios, estimates 1970­2000 and projections 2000­2050
United States
United Kingdom
Canada
Germany
France
Italy
Japan
Source: Up to 2000 OECD (see Appendix); 2000­50 see text.
1960 1980 2000 2020 2040 2060
0.6
0.8
1
1.2
1.4
1.6
Pensioners/population65+
Figure 6 Pensioner ratio, estimates 1970­2000 and projections 2000­2050
Italy
France
Germany
United Kingdom
Canada
United States
Japan
Source: Up to 2000 OECD (see Appendix); 2000­50 see text.
13
1980 2000 2020 2040 2060
0
10
20
30
40
50
60
70
80
Expenditures/earnings(percent)
Figure 8 Public pension expenditures as a percent of earnings, baseline projections
2000­2050
United States
United Kingdom
Canada
France
Germany
Italy
Japan
Source: Calculated from estimates in Figure 7. Estimates for 2000 from OECD (2001b) and Dang et al.
(2001). See Appendix.
1960 1980 2000 2020 2040 2060
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
PensionersperworkerFigure 7 Pensioners per worker, estimates 1970­2000 and projections 2000­2050
United States
Canada
United Kingdom
France
Germany
Italy
Japan
Source: Calculated from estimates shown in Figures 4, 5, and 6.
14
The reference projection does not attempt to incorporate effects of recent policy changes
that are intended to reduce future deficits in pension systems.9
The reference projections of the pensioner/worker ratio are summarized in Figure 7.
As one would expect from the upward trends in the old-age dependency ratio, the number of
pensioners per worker rises sharply by 2050 in all countries. In Italy the number of pensioners
is expected to exceed substantially the number of workers by 2050, with the PWR
reaching 1.55. In 2050, Japan is projected to have an old-age dependency ratio similar to
that of Italy, yet its pensioner/worker ratio remains lower (0.96) owing to a later age at
retirement in Japan. Even in the United States, the country with the least rapid population
aging, the pensioner/worker ratio is projected to reach 0.46 in 2050, a substantial 70 percent
increase from 0.27 in 2000.
The related public pension expenditure projections are presented in Figure 8. Since
benefit ratios are assumed to remain at levels observed in 2000, the projection for the expenditure
ratio is proportional to the projected trend in the pensioner/worker ratio. Large increases
in expenditures are expected in all seven countries. The largest rise is projected for
Italy, where the expenditure ratio grows from 35 percent to 75 percent of earnings between
2000 and 2050. Smaller but still substantial increases are expected in the United States
(from 8 to 14 percent of earnings) and the United Kingdom (from 8 to 12 percent). These
trends are clearly unsustainable over the next few decades for Italy and other continental
European countries, and even the smaller projected growth in expenditures in the United
Kingdom and the United States is often considered problematic.
POLICY OPTIONS
Governments of major industrial countries are urgently considering pension reform
with the strong endorsement of the IMF, OECD, and World Bank. Avoiding action is no
longer a feasible option because an unprecedented and harmful accumulation of debt would
then result. In the past, the rising cost of public pension benefits has often been covered by
raising public pension tax rates. This revenue-enhancing approach has become unsustainable
in many countries because contributions have reached very high levels and expenditure-reducing
approaches are now given highest priority.10
Another reason for urgency is
that legislative changes are usually made many years before they have a significant impact,
to allow workers and retirees to adapt to the new policies.
A range of policy options are available to reduce or end the growth of public pension
expenditures. These options can be divided into four groups corresponding to the four
factors that determine public pension expenditures:
Counteract population aging
Since population aging is the main cause of the future deterioration of the fiscal
balance of public pension systems, it is natural to consider ways to counteract aging as a
partial solution. Two demographic options are available:
15
Encourage higher fertility. Increasing fertility above projected levels raises the size
of younger age groups relative to older age groups, thus reducing the old-age dependency
ratio and the number of pensioners per worker. The size of this fertility effect is estimated
with a set of alternative hypothetical "higher-fertility" projections in which half a birth per
woman is added to the fertility trajectory in the reference projection. In the reference projections
the average total fertility rates (TFRs) from 2000 to 2050 are assumed by the UN to be
as follows: Canada (1.6), France (1.9), Germany (1.6), Italy (1.5), Japan (1.6), the United
Kingdom (1.7), and the United States (2.0). (These projected rates are broadly similar to
levels observed in the late 1990s, with small increases in Germany, Italy, and Japan.)11
Figure 9 compares estimates of the expenditure ratio in 2050 in the reference and higherfertility
projections. As expected, the pension expenditure ratio is lower in the higherfertility
than in the reference projections. For example, in Italy the reference scenario has an
average TFR of 1.5 for 2000­2050 and a projected pension expenditure ratio of 0.75 in
2050. Raising fertility by 0.5 births per woman to 2.0 between 2000 and 2050 lowers the
expense ratio to 0.59 in 2050, a 20 percent reduction. Interestingly, the lines representing the
results for each country in Figure 9 are close to parallel (note logarithmic scale on the
vertical axis). This finding implies that a given absolute increase in fertility results in a
proportional reduction in the expense ratio that is approximately the same for each country.
Specifically, on average for each increase in fertility of 0.1 births per woman, the expenditure
ratio in 2050 declines by 4 percent.
Permit more immigration. In contemporary developed countries the average age of
immigrants is lower than that of the resident population. As a result, increasing the number
of immigrants reduces both the average age of the population and the old-age dependency
ratio (United Nations 2001). I estimate the size of this immigration effect with a set of
hypothetical "higher-migration" projections in which the annual net migration rate in the
reference projection is raised by 2.5 net migrants per 1,000 population. In the reference
projections the average annual net migration rates for 2000 to 2050 are assumed by the UN
to be as follows: Canada (4.7), France (1.2), Germany (2.6), Italy (1.2), Japan (0.4), the
United Kingdom (2.2), and the United States (3.2). (These rates are broadly similar to levels
observed in the late 1990s.)12
As shown in Figure 10, adding 2.5 per 1,000 to these migration
rates reduces the expenditure ratio in 2050 in the higher-migration projection compared to
the reference projection. For example, raising Japan's annual net migration rate from 0.4 to
2.9 per 1,000 cuts the expenditure ratio in 2050 from 0.35 to 0.29. As was the case for the
fertility variants, the parallel lines in Figure 10 imply that a given rise in the average migration
rate reduces the pension expenditure ratio by roughly the same proportion. On average,
an increase in the annual net migration rate of 1 per 1,000 population reduces the expenditure
ratio in 2050 by 5 percent.
Although trends in population size are not the focus of this analysis, it is worth
noting that the United Nations projects population declines between 2000 and 2050 in
Germany (from 82 million to 79 million), Italy (from 58 to 45 million), and Japan (from 127
to 110 million). In the higher-fertility projection population size in 2050 is higher than in the
16
X
XH
X
XHX
XH
X
XH
X
XH
X
XH
X
XH
0.1
1.0
1.0 1.5 2.0 2.5 3.0
Expenditureratio2050
(logarithmicscale)
Total fertility rate 2000­2050
Figure 9 Effect of an increase in the total fertility rate by 0.5 births per woman
(2000­2050) on the pension expenditure ratio in 2050: Comparison of reference and
higher-fertility projections
Italy
France
Germany
Japan
Canada
United StatesUnited Kingdom
Higher-fertility
projectionReference
projection
X
XH
X
XHX
XH
X
XH
X
XH
X
XH
X
XH
0.1
1.0
0 2 4 6 8 10
Expenditureratio2050
(logarithmicscale)
Annual net migration rate (per 1,000 population)
Figure 10 Effect of an increase in the annual net migration rate by 2.5 per 1,000
population (2000­2050) on the pension expenditure ratio in 2050: Comparison of
reference and higher-migration projections
Italy
France
Germany
Japan
Canada
United States
United Kingdom
Higher-migration
projection
Reference
projection
17
standard projection by 22 percent on average, with relatively little variation in this fertility
effect among countries (range from 20 to 23 percent). Similarly, the higher-migration
projection added 21 percent on average to the reference projection. An increase in fertility of
half a birth per woman or an increase in the annual migration rate of 2.5 per 1,000 would
therefore be more than sufficient to prevent the population declines expected in Germany
and Japan, but Italy's population would still experience a small decline (by 4 percent with a
rise in fertility and by 5 percent with a rise in migration).
Increase labor force participation
A substantial proportion of males and an even larger proportion of females between
ages 15 and 64 are not currently employed. Any rise in the employment ratio would directly
reduce the pensioner/worker ratio. A secondary effect of an increase in employment levels
would be to reduce the pensioner ratio by raising the number of workers above the minimum
age of pension eligibility. Future increases in labor force participation are most feasible in
countries where it is relatively low on average or where the gap between males and females
is large. For example, the overall employment ratio in Italy in 2000 is a relatively low 0.55
in part because of a large gap between male and female employment ratios (0.70 vs. 0.40). If
future female labor force participation were to rise to equal that of males, the overall employment
ratio would increase from 0.55 to about 0.70. This effect alone would cut the
pensioner/worker ratio by 21 percent.
Raise the age at retirement
An increase in the age at retirement reduces the pensioner/worker ratio by simultaneously
reducing the number of retirees and raising the number of workers. I simulate the
total effect of such a shift in a set of hypothetical "later-retirement" projections in which five
years are added to the age at retirement between 2000 and 2050 in equal increments. The
results from this projection are presented in Figure 11. The proportional effects of a shift in
retirement age are again approximately the same for the various countries. On average, a
one-year increase in age at retirement reduces the pensioner/worker ratio in 2050 by 6
percent.
The trend in age at retirement over the past several decades has been downward for
two main reasons (OECD 2002a; Gruber and Wise 1999). First, public and employerprovided
pensions have become more generous and the average income of retirees is now
not much below that of the average worker. Second, there is usually little incentive to
continue working once a retiree qualifies for a pension because working an additional year
implies paying additional taxes supporting the public pension scheme and forgoing a pension
for that year with little or no compensatory increase in future pensions. Eliminating this
disincentive to continue working may halt the decline in the age at retirement and will be
essential to reversing this past trend.
18
X
XH
X
XH
X
XH
X
XH
X
XH
X
X
0.1
1.0
55 60 65 70 75
Expenditureratio2050
(logarithmicscale)
Mean age at retirement
Figure 11 Effect of an increase in the retirement age by 5 years (2000­2050) on the
expenditure ratio in 2050: Comparison of reference and later-retirement projections
Italy
France
Germany Japan
Canada
United States
United Kingdom
Later-retirement
projection
Reference
projection
19
Reduce public pension benefits
Benefit levels are determined by rules and formulas that vary from country to
country. Most countries have earnings-related pensions whose initial value at the time of
retirement depends on the number of years worked and on the level of past earnings with
adjustments for inflation. After retirement, pensions are adjusted annually for changes in
the cost of living. Tax treatment of pensions also varies considerably among countries.
Cuts in benefits can be achieved by changing any of these rules, regulations, and adjustments
either for all pensioners or for selected subpopulations such as high-income groups.
The effect of a reduction in the benefit ratio on the expenditure ratio is of course straightforward
to estimate because any proportional decline in the former results in an equal
proportional decline in the latter.
If these efforts to bring expenditures in line with contributions are not successful,
two other options are available: increase taxes or accept a deficit and accumulate debt. Both
alternatives are unattractive. Public pension taxes have been raised in the past, but there is
strong resistance to further increases. This is especially true in countries where tax rates are
already very high (Italy, France, Germany). It seems unwise, however, to rule out any
further tax increases as a partial solution to reducing the projected fiscal deficits in countries
such as the United States and the United Kingdom where these taxes are still relatively low.
Table 2 compares the effects of the different options by providing an estimate of
the change in each factor that is required to bring about a 10 percent proportional decline
in pension expenditures in 2050. To prevent the large increases in expenditures expected
in the reference scenario, countries can adopt one or more of these options. Relying on
any one option alone will probably not be sufficient. For example, to prevent the expenditure
ratio from rising after 2000, Italy could choose to cut benefits only. But the required
cuts would be very large, reaching 55 percent by 2050. This is likely to be politically
difficult to implement, and the government must therefore also consider other options.
The most likely outcome in most OECD countries is that the large increases in expendiTable
2 Change required in demographic, labor force, retirement, and benefit
variables to reduce pension expenditures by 10 percent in 2050 (G7 average)
Policy variable Change required
Fertility (2000­2050) Increase of 0.27 births per woman
Net migration rate (2000­2050) Increase of 1.8 net migrants per 1,000 population
Employment ratio (2050) Increase of 9 percenta
Mean age at retirement (2050) Increase of 1.6 years
Pension benefits (2050) Reduction of 10 percent
aThis rise in the employment ratio also causes a 1 percent decline in the pensioner ratio.
20
tures expected in the reference projection will be avoided by taking a combination of
several and perhaps all of the measures listed in Table 2. In addition, taxes may be raised
in some countries.
DISCUSSION AND CONCLUSION
This study confirms findings from previous research that current public pension
arrangements in the largest OECD countries are unsustainable in the long run because they
rely almost exclusively on pay-as-you-go schemes. Without major reform, rapid population
aging will lead to large increases in pension expenses over the next several decades. For
example, spending on public pensions in Italy can be expected to require an implausible rise
from 35 percent to 75 percent of earnings between 2000 and 2050 in the absence of changes
in labor force participation and retirement patterns or in the pension benefit ratio. This huge
growth in pension costs is largely attributable to a more than doubling of the number of
pensioners per worker from 0.7 in 2000 to 1.5 in 2050. Very large increases in the expenditure
ratio by 2050 are also projected for France (from 29 percent to 54 percent of earnings)
and Germany (from 24 to 45 percent). The urgency to act is greatest in these countries
because aging is most rapid (owing to low fertility and migration levels), retirement ages are
youngest (owing in part to high pension benefits), employment rates are lowest (owing in
part to late entry into and early departure from the labor force and generous unemployment
benefits), and public pension benefits are highest (owing in part to the absence of employerprovided
pensions and private savings). In the English-speaking countries--the United
Kingdom, the United States, and Canada--and to a lesser extent in Japan, the future growth
in pension expenses, while large, is more manageable because, relative to the large continental
European countries, labor force participation and age at retirement are higher, benefits
are less generous, and retirees rely to a greater extent on other sources of income.
Reductions in the generosity of future public pensions seem inevitable. To maintain
relative standards of living for future retirees requires that other sources of income be found.
Many governments are now encouraging the expansion or creation of alternative funded
systems in which workers save for their own retirement. Numerous approaches are available
for implementing such systems: private or public, mandatory or voluntary, with or without
subsidies or tax incentives, employer or personal. The fiscal problems of the current unfunded
pay-as-you-go systems would have been avoided if countries had adopted funded
systems in the past. Unfortunately, switching now from unfunded to funded systems entails
large transition costs. Reallocating a portion of current contributions and investing them in
private pensions is possible, but such a diversion would make the fiscal predicament of the
public system even more difficult. Governments therefore avoid this approach and instead
encourage additional contributions that complement rather than substitute for the public
pension program.
Demographic options are generally ignored in the debate about pension reform.
Many governments are reluctant to support pronatalist measures because of a disinclination
to interfere with personal decisionmaking regarding family size, or because of the apparent
21
inconsistency of advocating pronatalism at home while supporting efforts to reduce fertility
in poor developing countries; in addition, they may hope that fertility will soon increase
again without intervention (Caldwell et al. 2002; Demeny 2003; Gauthier 1996). Furthermore,
low levels of recent fertility have not yet led to declines in population size in most
developed countries, because the effects of below-replacement fertility have been offset
temporarily by modest levels of immigration and population momentum. It seems likely,
however, that growing concerns about the implications of population aging will stimulate
more interest in efforts to encourage higher fertility directly or indirectly. For example,
family-support measures such as subsidized childcare, reduced taxes for families with
children, and paid parental leaves are widely acceptable and could be expanded. A recent
review of the impact of such measures by Caldwell et al. (2002) concludes that they do raise
fertility modestly, provided the subsidies are sufficiently large. This finding is not surprising
since on average actual fertility is lower than desired family size, and reductions in the cost
of childbearing will make it easier for women to combine a career with their preferred level
of childbearing.
The migration option is often considered problematic for social, economic, and
cultural reasons. For example, raising the net migration rate in Japan from its current very
low level of 0.4 per 1,000 population to 2.9 per 1,000 (which is still lower than the current
rate observed in Canada and the United States) for the next half century implies that by 2050
18 percent of Japan's population would consist of new immigrants and their descendants.
Such a change in the population composition is and has been acceptable in countries such as
the United States, Canada, and Australia, which have experienced high immigration in the
past, but it is not welcomed in Japan and parts of Europe.
Despite these concerns, the demographic options can make significant contributions
to the goal of creating fiscal equilibrium in public pension systems as part of a comprehensive
package of reform. In addition, slower population aging brought about by higher future
levels of fertility and migration has other desirable effects that have not been considered
here, including lower future health care costs, a larger labor force, and possibly higher living
standards (McDonald and Kippen 2001; United Nations 2001; OECD 1998). It therefore
seems desirable to pay more attention to the demographic options and to investigate further
their cost-effectiveness compared to more conventional measures.
Most governments of OECD countries are cognizant of the challenges posed by
population aging, and some reforms aimed at restoring fiscal balance to their pension systems
have already been adopted and further changes are planned (Disney and Johnson 2001;
Feldstein and Siebert 2002; Jackson 2002). These efforts focus on achieving reductions in
future benefits, even though this option is difficult politically because large proportions of
pensioners receive most of their incomes from public pensions. In addition, efforts are being
considered to encourage later age at retirement by removing incentives to early retirement.
Reforms adopted in recent years are generally phased in slowly, thus leaving current pensioners
largely unaffected, and their impact will therefore be felt mainly by future retirees.
Today's workers will have to save more, work longer, retire later, receive less generous
22
benefits, and perhaps pay more taxes. The modest ongoing reforms are a step in the right
direction but they are far from adequate.
APPENDIX: DATA SOURCES
Population. Estimates (1970­2000) and projections (2000­2050, medium variant) of population by
age (5-year age groups) and sex as well as total fertility rates and migration rates from United
Nations (2003). These data are available online at http://esa.un.org/unpp/.
Employment. Estimates of employment and labor force participation rates by age and sex from 1970
to 2000 from OECD web site http://www1.oecd.org/scripts/cde/. Proportion of total employment
that is self-employed from same source.
Earnings. Wages and salaries and GDP from OECD National Account Statistics (OECD 2002b).
Self-employed income estimated by assuming that average earnings per self-employed worker equal
the average earnings of employees.
Pension expenditures and benefits. Estimates of pension spending as a proportion of GDP in 2000
from OECD (2001b) and Dang et al. (2001). Total benefits in 2000 are assumed to equal total
pension expenditures.
Mean age at retirement. Estimated from labor force participation rates by age and sex with method
proposed by Latulippe (1996).
NOTES
1 Estimates of the number of pensioners are not entirely accurate because some retirees may
elect to delay accepting benefits or may not qualify for pensions even if they are past the
minimum age of eligibility. In addition, some pensioners continue to work while receiving
benefits. Estimates of these partly offsetting effects are not readily available, and no effort
at correction is made here.
2 The most generous public pension systems tend to be the least redistributive. As a result,
variation in generosity of public pensions is reflected primarily in differences in the entitlements
of high-income workers. Benefits of poor workers are more similar across countries
(OECD 2001a).
3 Employers' public pension contributions are not included in earnings.
4 Administrative costs are another reason why contributions exceed pension expenditures.
5 An alternative indicator of relative benefits is the so-called replacement rate, which compares
pensions of retirees with the incomes they received before retirement. Estimates of
replacement rates are difficult to obtain because they require income data from household
surveys.
6 In addition, no adjustments are made for differences in household composition between
pensioners and workers.
7 A similar decomposition of public pension expenditures into four components is presented
23
by Dang et al. (2001). The main difference between their decomposition and the one used
here is that the former uses GDP rather than earnings in the denominators of the pension
expenditure ratio and in the benefit ratio.
8 A rise in the overall level of labor force participation reduces the number of pensioners
because it reduces the number of people under age 65 who are retired and above the minimum
age of eligibility for public pensions. This effect is independent of changes in the
mean age at retirement or the age of eligibility.
9 Dang et al. (2001) summarize official country projections that include the impact of these
reforms, which vary widely in nature and scope among countries. See Jackson (2002) for a
criticism of these official projections.
10 Nevertheless, further increases in public pension taxes are planned in Japan and Canada
(Jackson 2002).
11 Estimated total fertility rates for 1995­2000 are: Canada 1.6, France 1.8, Germany 1.3, Italy
1.2, Japan 1.4, United Kingdom 1.7, and United States 2.1 (United Nations 2003).
12 Estimated annual net migration rates for 1995­2000 are: Canada 5.1, France 0.7, Germany
2.6, Italy 2.0, Japan 0.4, United Kingdom 2.0, and United States 4.5 (United Nations 2003).
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2004
185 John Bongaarts, "Population aging
and the rising cost of public
pensions."
184 Mark R. Montgomery and Paul C.
Hewett, "Urban poverty and
health in developing countries:
Household and neighborhood
effects."
2003
183 Agnes R. Quisumbing and Kelly
Hallman. "Marriage in transition:
Evidence on age, education, and
assets from six developing
countries."
182 Paul C. Hewett, Barbara S.
Mensch, and Annabel S. Erulkar,
"Consistency in the reporting of
sexual behavior among adolescent
girls in Kenya: A comparison of
interviewing methods."
181 Zachary Zimmer, Linda G.
Martin, and Hui-Sheng Lin,
"Determinants of old-age
mortality in Taiwan."
180 Frank K. Nyonator, J. Koku
Awoonor-Williams, James F.
Phillips, Tanya C. Jones, and
Robert A. Miller, "The Ghana
Community-based Health
Planning and Services Initiative:
Fostering evidence-based
organizational change and
development in a resourceconstrained
setting."
179 John Bongaarts and Griffith
Feeney, "Estimating mean
lifetime."
178 Elizabeth F. Jackson, Patricia
Akweongo, Evelyn Sakeah,
Abraham Hodgson, Rofina Asuru,
and James F. Phillips, "Women's
denial of having experienced
female genital cutting in northern
Ghana: Explanatory factors and
consequences for analysis of
survey data."
177 John Bongaarts, "Completing the
fertility transition in the
developing world: The role of
educational differences and
fertility preferences."
POLICY RESEARCH DIVISION WORKING PAPERS
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*No longer available as a printed publication. Download electronic file from Web site only.
176 Cynthia B. Lloyd and Paul C.
Hewett, "Primary schooling in
sub-Saharan Africa: Recent trends
and current challenges."
175 James F. Phillips, Tanya C. Jones,
Frank K. Nyonator, and Shruti
Ravikumar, "Evidence-based
development of health and family
planning programs in Bangladesh
and Ghana."
174 Geoffrey McNicoll, "Population
and development: An introductory
view."
173 Paul Demeny, "Population policy:
A concise summary."
172 Zachary Zimmer, Napaporn
Chayovan, Hui-Sheng Lin, and
Josefina Natividad, "How
indicators of socioeconomic status
relate to physical functioning of
older adults in three Asian
societies."
171 Sajeda Amin and Nagah H. AlBassusi,
"Wage work and
marriage: Perspectives of
Egyptian working women."
170 Ravai Marindo, Steve Pearson,
and John B. Casterline, "Condom
use and abstinence among
unmarried young people in
Zimbabwe: Which strategy, whose
agenda?"
169 Zachary Zimmer and Julia
Dayton, "The living arrangements
of older adults in sub-Saharan
Africa in a time of HIV/AIDS."
168 Paul C. Hewett, Annabel S.
Erulkar, and Barbara S. Mensch,
"The feasibility of computerassisted
survey interviewing in
Africa: Experience from two rural
districts in Kenya."
2002
167* Dominic K. Agyeman and John B.
Casterline, "Social organization
and reproductive behavior in
southern Ghana."
166* Carol E. Kaufman and Stavros E.
Stavrou, " `Bus fare, please': The
economics of sex and gifts among
adolescents in urban South
Africa."
165 Kelly Hallman, Agnes R.
Quisumbing, Marie Ruel, and
Bénédicte de la Brire,
"Childcare, mothers' work, and
earnings: Findings from the urban
slums of Guatemala City."
164 Cynthia B. Lloyd, Cem Mete, and
Zeba A. Sathar, "The effect of
gender differences in primary
school access, type, and quality on
the decision to enroll in rural
Pakistan."
163 Barbara S. Mensch, Wesley H.
Clark, and Dang Nguyen Anh,
"Premarital sex in Vietnam: Is the
current concern with adolescent
reproductive health warranted?"
162 Naomi Rutenberg, Carol E.
Kaufman, Kate Macintyre,
Lisanne Brown, and Ali Karim,
"Pregnant or positive: Adolescent
childbearing and HIV risk in
South Africa."
*No longer available as a printed publication. Download electronic file from Web site only.
161 John Bongaarts, "The end of the
fertility transition in the
developing world."
160 *Julia Dayton and Martha
Ainsworth, "The elderly and
AIDS: Coping strategies and
health consequences in rural
Tanzania."
159 Carol E. Kaufman, Shelley Clark,
Ntsiki Manzini, and Julian May,
"How community structures of
time and opportunity shape
adolescent sexual behavior in
South Africa."
*No longer available as a printed publication. Download electronic file from Web site only.
158 Geoffrey McNicoll,
"Demographic factors in East
Asian regional integration."
157 Zachary Zimmer and Sovan Kiry
Kim, "Living arrangements and
socio-demographic conditions of
older adults in Cambodia."
156 John Bongaarts and Griffith
Feeney, "How long do we live?"
155 Zachary Zimmer, Linda G.
Martin,
and Ming-Cheng Chang,
"Changes in functional limitations
and survival among the elderly in
Taiwan: 1993, 1996, and 1999."