Adair Turner: The demographic shape of things to come

Changing population ratios pose an enormous challenge to pension systems around the world, says Adair Turner. The world is relentlessly growing older – with good and bad consequences. Immigration may help rich countries prop up their pensions systems short term, but it won’t solve the problem for good

Pension system reforms are near the top of the policy agenda in most developed countries. Immigration as a solution to Europe’s demographic change is extensively debated, but is not a sustainable solution according to mathematicians and statisticians, according to Adair Turner.

But the policy debate still fails to reflect the scale and the global nature of demographic change. During the coming century, the whole world will probably have to come to terms with an ageing but also stable population.

In many ways that is wonderful: it means longer lives and a limit to environmental damage. But it poses huge problems for traditional economic and social models, eventually across the whole world.

Once the global nature of the challenge is understood, many proposed solutions to pension crises turn out to be effective only in the short term.

Around the world people are living longer. Tragically in many poorer countries progress has been interrupted by Aids. But in all successful economies life expectancy at birth, and also at 65, is increasing relentlessly – by something like one and a half years each decade.

This trend will continue for many decades and possibly for centuries. Whether eventually there is a limit to life we do not know. But there is certainly no indication of it in recent figures, which reveal an accelerating fall in mortality rates among older people in many rich countries.

Birth rates are falling across the world, and have fallen to or below replacement levels in all successful economies. They are below the replacement level of about 2.05 children per woman in every European country, east and west, except Albania.

Italy and Spain are the lowest at 1.2, but even France and Iceland, the highest apart from Albania, have below-replacement rates of 1.89 and 1.95 respectively. But this phenomenon is not confined to “old Europe”.

The recent increases in US birth rates from 1.8 in the early 1980s to 2.05 in the late 1990s are sometimes hailed as signs of American social optimism. But break the American figures down by ethnic group, and we find that whites and Asian-Pacific immigrants have birth rates of 1.85 (which are not rising), that black fertility rates have fallen dramatically in the past 10 years, and indeed that fertility rates have fallen in every ethnic group.

The rise in the average has occurred only because the fall in Hispanic fertility (both in the US and in the countries of origin) has recently been offset by the rising Hispanic proportion of the total population. As Hispanic birth rates fall further, the American average will fall back below replacement level.

In Asia, meanwhile, fertility rates have fallen dramatically wherever there is economic success. South Korea, Singapore and Japan all have fertility rates below average European levels. Hong Kong’s rate, at 1.0, is below that of Italy.

China’s rate of 1.85 reflects in part the state’s one child policy, but the behaviour of overseas Chinese communities suggests that the fall would have occurred naturally, though later, in response to rising prosperity.

And Catholic Brazil, Sunni Muslim Turkey and Shiite Iran are all on course, according to the United Nations medium variant projection, to go below replacement fertility within 15 years.

We sometimes talk of deep cultural divides, and are wary of asserting universal sociological laws, but the evidence suggests that we face one here. Wherever there is economic prosperity, high female literacy and a supply of contraceptives that is legal and reasonably cheap, women choose birth rates at or below replacement levels.

Increased life expectancy and lower birth rates transform demographic structures. From the industrial revolution until the past few decades, population age structures were predominantly pyramid-shaped – both because each successive generation was larger than the one before, and because many people died in childhood and middle age as well as in old age.

Increasingly these shapes are and will be columns with small pyramids on top – with each generation the same size as the one before and most people living to at least 60 or so, before dying off over 30 to 40 years thereafter. Some – such as those of Italy, Russia or Japan – will be columns that narrow toward the base. As a result, for any given retirement age, the ratio of workers to retirees will plummet.

Italy’s ratio of 20-to-64-year-olds to over-65-year-olds is forecast to fall from 3.4 to 1.4 between now and 2050; South Korea’s from 9.0 to 1.7; Britain’s from 3.7 to 2.1; even Iran’s from 10.5 to 3.4. And if eventually the whole world can achieve economic success, this will happen across the whole world.

These changing ratios challenge existing pension systems. The problem is often described as one of ageing, but increased longevity is actually the less important and more tractable of the two challenges.

If fertility rates had not fallen, an increase in retirement ages proportional to the increase in longevity would be a sufficient response to preserve the solvency of any pension system – leaving contribution and benefit levels unchanged.

And, as people live longer, retirement ages can and should rise. Given sensible lifestyle decisions and well-designed health care, ageing can mean more years of healthy active life, not more years of disability. Many aspects of public policy and business practice need to evolve to support a rise in retirement ages. But in principle it is feasible and essential.

But a proportionate rise in retirement ages is not sufficient to deal with pension crises if fertility rates have also fallen. For the mathematics of the pension systems put in place in the 20th century – the relationship of contribution levels to benefit levels – were only sustainable on the assumption that each generation was larger than the one before.

Twentieth century populations structures were pyramids, and the pension schemes designed in the early and mid-20th century were to a degree pyramid schemes (such as Ponzi schemes or chain letters) – where the benefits to any one generation in the chain are vitally dependent on there being more participants in the next generation.

The pyramid scheme is coming to an end. Some mix of poorer pensioners, higher worker contributions or retirement ages rising even more than proportionately with life expectancy is unavoidable.

That is true whether pension systems are unfunded public pay-as-you-go (PAYG) schemes, or funded private schemes. In any pension system the retirees, who consume but do not produce, are dependent on a transfer of resources from the workers, who produce but sacrifice or defer some consumption via either taxes or savings.

In PAYG schemes the resources are transferred via taxes or contributions. In funded schemes, they are transferred via profits and dividends to pension funds. But the underlying economics are the same. There are no clever technical fixes to the fundamental demographic challenge.

There are, however, transitional approaches – such as foreign investment and immigration – which exploit differences in demographic structure among countries.

Investing pension savings overseas allows future retirees in developed countries to receive resource transfers from future workers in countries with still growing populations.

Immigration can rebuild the base of American and European demographic pyramids by importing workers from poorer countries where birth rates have not yet collapsed.

For the next several decades, and for already rich countries, these responses are at least feasible. But neither solution is possible in the long term and on a global scale.

China’s ratio of 20-to-64-year-olds to 65-plus-year-olds will likely fall from 8.8 today to somewhere around 2.4 in 2050. Workers in Europe cannot plan to retire on the basis of resource transfers from future Chinese workers except at the expense of future Chinese retirees.

Faced with its collapsing support ratio, China should plan to become a net investor overseas, not a capital importer. But all countries cannot be capital exporters at the same time.

Adair Turner continues: The limits are similar with immigration. The decline in the US’s support ratio is likely to be significantly offset not by greater American fertility, but by large-scale immigration.

With still rapidly growing populations in western Asia and Africa, Europe could choose the same strategy. But immigration can only permanently offset support ratio declines if it is both permanent and growing.

Europe would need to expand its population by about 50% over the next 50 years and another 50% in the subsequent 50 years, and so on ever thereafter, in order to stabilize present support ratios – even if it also achieved proportionate rises in retirement ages. Many Europeans might consider that unattractive for environmental reasons. In the long run it will also become impossible as population stabilization spreads. If the world population stabilizes, we cannot solve a global pension crisis by encouraging immigration from the moon.

Global population stabilization is, of course, many decades away. Some countries, such as Pakistan and much of Africa, still face the alternative challenge of rapidly growing populations, imposing huge economic and environmental costs.

But wherever there is economic prosperity, populations stabilize and age. And we should want economic prosperity for the whole world, both for the direct benefits of prosperity and because the resultant population stability is needed to limit environmental destruction.

To propose overseas investment or immigration as permanent rather than transitional solutions to demographic change is therefore to assume or wish that at least some countries remain sufficiently poor to keep producing excess workers to support rich country retirees.

The challenge will only gradually become global. But eventually we will have to design human economies and societies that can deal with column-shaped demographics.

We must ensure that we enjoy the benefits of longer life and population stabilization – but with radically changed attitudes to the whole idea of retirement, and with a radical redesign of the inter-generational compacts that were put in place in a different demographic era.

Adair Turner
Adair Turner is chairman of the UK Pension Commission and vice-chairman of Merrill Lynch Europe.