No other force is likely to shape the future of national economic health, public finances, and policymaking as the irreversible rate at which the world’s population is aging. For several years, Standard & Poor's has been providing in-depth analysis of the worldwide implications of demographic change on sovereign ratings and its impact on public finances. Marko Mrsnik, associate director of sovereign ratings at Standard & Poor's, highlights the findings of our latest Global Aging Report.
What are the key findings of Standard & Poor's Global Aging Report 2010?
Our analysis shows that without fresh measures to address long-term, age-related spending trends, government debt burdens in most advanced economies could reach unsustainable levels of over 300% of GDP in the next 40 years. Population aging will lead to profound changes in economic growth prospects for countries around the world, alongside heightened budgetary pressures from greater age-related spending needs.
In the absence of appropriate budgetary adjustment, additional reforms to pension and health-care systems, or structural measures to improve the growth potential of sovereigns, our projections show the future fiscal burden will increase significantly across the board. We do not expect this burden to fall equally, though. The projected deterioration in public finances over the period 2010-2050 is particularly significant in advanced economies and emerging market economies in Europe.
The projected deterioration in public finances between now and 2050 is particularly significant in advanced economies, whereas many emerging market sovereigns outside of Europe will have a slightly more positive trajectory. Population aging in emerging markets is projected to take place against the background of relatively higher economic growth than in advanced sovereigns. However, as the emerging sovereigns develop, with associated widespread changes to the social fabric, government welfare spending may grow faster than GDP, as has been the trend in advanced economies during the second half of the 20th century.
How do Asian sovereigns fare generally compared with European sovereigns?
European countries generally have a high level of existing social security coverage and a rapid worsening in demographic profile. For Asian emerging market sovereigns, the projected change in demographics is likely to be similar, although the proportion of elderly in the population will be lower. As these sovereigns also tend to have relatively smaller welfare networks, we expect the projected fiscal burden will be lower than in advanced economies.
China, for example, has several advantages over other advanced economies in Europe. It has a comparatively favourable demographic profile, and the government is starting from a position where it pays a much smaller proportion of pension and health care costs compared with other advanced economies. In addition, the Chinese government had already begun reforms in the late 1990s, and is now seeking to broaden these efforts.
Nevertheless, as Asia's emerging economies develop, the likely demand for better and expanded social security systems will put pressure on their budgets.
How does China's demographic profile compare with other Asian sovereigns and advanced economies in Europe?
The UN has forecast that China's working-age population -- defined as those between the ages of 15 and 64 -- will peak in the next few years. This means that, going forward, the proportion of the country's population contributing to the government's revenue is likely to begin to fall. Though Japan's reached its high many years ago, China will still be among the first group of Asian economies -- together with Singapore and Thailand -- to experience such a fall.
China's working-age population will likely peak earlier than in a few advanced economies, such as the Republic of Korea. Nevertheless, the Chinese working-age population in 2050 will remain larger than that in most advanced economies (see chart below). This is because of the slower slide in the Chinese birth rate. Although the one-child policy has been in force since the late 1970s, the country's fertility rate remains close to 1.8. Due to the numerous exceptions allowed under the policy, the restriction applies only to a little more than a third of the population today.
What would happen in the next 20 or 50 years if current aging-dependent public expenditure policies remain unchanged?
Under our hypothetical scenario of unchanged policies and a continuation of current aging-dependent public expenditure programmes (and associated interest payments), fiscal deficits and government debt is projected to increase rapidly from the middle of this decade. Some key numerical findings of our 2010 study include:
The median country deficit may rise from 5.3% of GDP to more than 6% of GDP by the mid-2020s, assuming no policy change. The median general government net debt burden may increase to almost 50% of GDP through to 2020, and accelerate thereafter. By the 2030s, the median net debt burden may be almost 90% of GDP, and accelerate to above 260% of GDP by 2050. The economic size of the state may increase significantly: Government spending may rise to almost 60% of GDP in 2050, from 44% today.
Standard & Poor's believes it is highly unlikely that governments will allow debt and deficit burdens to spiral out of control in the manner outlined above or that the creditors would be willing to underwrite such debt burdens. Nevertheless, the scenario reveals the dimension of the task facing governments in reducing benefits granted by unfunded state-run social security systems or achieving further fiscal belt-tightening.
What are the trends in age-related spending items across the sample?
In the absence of further policy measures, we generally expect population aging will lead to increases in overall budgetary expenditures that are sensitive to demographic change, although according to our estimates the impact will differ significantly among the countries in our sample. The categories considered in this study are old-age pensions, health care, and, where data is available, long-term care for the frail, and unemployment benefits. Overall, pensions remain the biggest spending item, followed by health care and long-term care. The expected decline in unemployment benefits is typically very small and, we believe, will not produce significant relief for government spending.
For most sovereigns, the old-age dependency ratio (the number of people over 65 relative to the population aged 15-64) is expected to double. In Eastern Europe, Asia, and Latin America, the demographic dynamics appear to be particularly affected in terms of changes in the old-age dependency ratio. However, the overall projected dynamics do not fully illustrate the variations in the level of the ratio, which for Eastern European sovereigns is projected to be substantially higher than in other regions by 2050. In general, the strongest pressure on government budgets is expected in those sovereigns where reforms to pay-as-you-go pension systems are still pending.
What is Standard & Poor's view on Australia's projected age-related spending and the impact on its budget?
Australia is ahead of many peers in addressing age-related economic challenges through reforms directed at raising productivity and workforce participation, promoting greater health-care system efficiency, pre-funding government employee pension entitlements, and mandating the long-term self-provision of retirement incomes.
In our view, an aging population will likely place substantial pressure on economic growth and public finances. State pensions and demand for publicly provided health care and long-term care services could increase. Without further government reforms (which is our base-case scenario), total age-related public expenditures in Australia are projected to rise to 14.4% of GDP in 2050, from 9.6% in 2010. This 4.8-percentage-point increase is less than the expected 7.8-percentage-point increase for the median of our 49-sovereign sample. We expect the bulk of Australia's age-related spending will go toward health-care outlays, followed by pension expenditures. In our view, the increase in age-related spending in Australia will be moderate until the early 2030s, when spending will likely grow at a faster pace as more people enter retirement age.
Our projection of a gradually increasing trend in age-related spending until 2030 suggests a relatively stable budget in the long term. Nevertheless, the weight of general government spending -- including social security -- could rise significantly as age-related spending, if unmanaged, increases, and as the interest bill, deficits, and debt mount.
