How Wealthy Nations Can Avoid a Looming Retirement CrisisPublished: June 05, 2002 in Knowledge@Wharton
The rapid aging of the world's industrialized nations poses problems for consumer and capital markets, including the risk that individual and government retirement plans will come up short as the population of retirees starts to explode over the next 20 years.
But the retirement boom will also have implications for the developing world. If the world's capital is used up by aging nations, resentment toward the world's rich countries could grow and create global instability. If, however, capital is used effectively to create new investment and jobs in emerging markets, the world's aging wealthy nations may be able to avoid their looming retirement crisis.
The extent of the global aging problem and the prospect for globally-based solutions were outlined during a conference several weeks ago on "Risk Transfers and Retirement Income Security" sponsored by Wharton's Pension Research Council and the Financial Institutions Center.
Olivia Mitchell, executive director of the Pension Research Council, and Richard J. Herring, co-director of the Wharton Financial Institutions Center, co-hosted the conference, which featured several Wharton professors. A previous report about this conference looked at helping employees better manage investment risk in their retirement plans.
George Vojta, president of the Financial Services Forum and chair of the Financial Institutions Center board, opened the discussion with a reference to Sept. 11 and the potential for continued violence in a world marked by vast disparities in wealth. Rich countries must increase direct aid, but also step up trade and investment, he said. "What is coming to the fore now is a sense that considerable damage will be [done] to the major economies of the world [because of] global aging. The equation for global prosperity is at risk."
Maureen Culhane, senior member of the strategic relationship management group at Goldman, Sachs & Co., began outlining demographic trends that show starkly the aging of the world's developed nations, while poorer nations will account for future population growth. The impact will be felt in capital markets, in consumer products and across all industries, including defense, she said. "Global aging will change everything in the world."
In 1950, she said, there were seven developed countries among the 12 most populous: The United States, Soviet Union, Japan, Germany, the United Kingdom, Italy and France. But by 2050, United Nations forecasts are predicting that only the United States will remain on the most populous list. The others will be displaced by Pakistan, Nigeria, Brazil, Congo, Ethiopia, Mexico and the Philippines.
"Look at those names," said Culhane, who added that the shift in population from rich countries to poorer nations will only heighten global resentments. "Whereas Europe, Japan and the United States all have approximately the same per capita GDP, this other list of names are still at $800 a year, and they can see us on the Internet and on T.V."
Fertility rates will be the main reason for the shift, said Culhane, who explained that birth rates typically decline as a population grows wealthier and women become more highly educated. She cited U.N. figures that showed the fertility rate in Europe from 1960 to 1965 was 2.6. infants per mother. It is now 1.3 with a projected increase to 1.8 in 2045 to 2050. The same current and future rates are estimated for Japan. The U.S. rate of 3.3 in 1960 to 1965 has dropped to 1.6 and is forecast to rise to 1.9 in 40 years.
Asia and Latin America now have rates of 2.5 and are forecast to drop to 2.1 by 2045 to 2050. Africa, with a current rate of 5.0, is expected to drop to 2.4 in 40 years.
However, she said the up-tick in fertility projected for industrialized countries is suspect. "All these numbers are predicated on an upturn; if it does not happen everything gets worse."
Life expectancy, which has been enhanced in the richer nations in part by improvements in health care, adds to the aging equation. Japan is expected to lead the world with a life expectancy of 88 in 40 years, with Europe, the United States and Canada all expected to be over 80. Meanwhile, the working age population, which typically helps support retirees through government pension schemes, is expected to decline as a percent of population in many countries.
But rapidly aging populations still control the vast majority of the world's wealth, Culhane said. "Follow the money, and the money is all in the Western world." She cited 1998 statistics showing the United States had 46% of the world's financial assets of $63 trillion. Eight countries controlled 92% of the assets.
Economic growth and productivity are likely to slow with aging populations, she added. In Japan's great industrialization period, GDP tripled in 30 years. Now estimates are that Japan's GDP will be just 35% higher in 2050. "With slow GDP growth it is very difficult to stimulate economies." She also noted that by most measures the United States is better off than other aging Western nations, with a higher fertility rate and immigration of one million people a year.
In many rich nations elderly people have been promised rich retirement benefits. "What can they do to pay for this?" Culhane asked. "You have very high taxes." But she also said that high rates of taxation will eventually choke off global competitiveness. She pointed to Germany where workers take home only 49% of their pay. Social security and other payroll taxes consume 34% of a German worker's pay and income taxes another 17%. She said no companies are interested in setting up new business operations in Germany. "No one."
Paul S. Hewitt, director of the Global Aging Initiative, also presented a grim statistical outlook for the world's aging nations. However, he suggested there is a chance that globalization linking the economies of poor, growing nations with the developed countries could create new sources of money to fund the aging world's retirement years.
He envisions two possible scenarios arising from the aging of the Western Industrial nations and Japan. He called the first "The Aging Recession" scenario in which the aging nations wind up resembling financially stricken Argentina. In this view, a rising aged population and low birth rates lead to slow or declining economic growth. Against this political backdrop, however, it would be very difficult to raise taxes or cut benefits. That could lead to default, said Hewitt.
"There will be global capital shortages as everybody sticks a straw into the capital pools and sucks hard," he continued. "There will be political instability because the Third World won't like the fact that old rich countries are using up all the capital they need for investment to be more productive."
The other scenario, which he called "A New Global Era," has a happier outcome. In this vision, global dynamism shifts from Europe to China, for example, and rates of return on investment soar. Meanwhile, European countries adhere to the Maastricht Treaty and do not go deeper in debt. And somehow, the ailing Japanese economy stabilizes. "The developing countries become tremendously wonderful places to invest. We have a boom of cross-border trade, and everybody lives happily ever after," said Hewitt.
Hewitt also discussed the impact of aging and depopulation on financial markets and concluded: "Asset values will be at risk, particularly real estate assets."
In addition, the nature of investment will reflect the aging population, he said. "You will have pressure for higher spending, pressure for protecting older, less efficient industries. Investment preferences will become more conservative and the overall investment environment will be less prone to generate spectacular breakthroughs."
Globalization, said Hewitt, could be the answer. "The good news is that if we invest our pension funds in countries with low productivity and large labor forces, this infusion of capital might be able to generate large returns, which can be shared back. In this way, young people can still support old people over national borders."
Managing this transition will require significant change, particularly to existing entitlement programs. Retirement funds must be more market-based and emphasize economic efficiency over job protection. "All of our social, trade and investment policies are geared toward protecting employment," said Hewitt, "but going forward the primary source of social crisis will be labor shortages."
Finally, Hewitt said there are some advantages to aging. He said that in Sri Lanka the median age has risen to 30 and power seems to be transitioning from rebel bands to more mainstream political institutions. He noted that during China's bloody Cultural Revolution, the country's median age was 18. "It's like getting older personally; a little maturity is a good thing."
William G. Shipman, chairman of CarriageOaks Partners LLC, a consulting firm specializing in retirement finance, and co-chairman of the Cato Project on Social Security Privatization, also put a global twist on the implications of rapidly aging populations. "Retirement income security is one of the most important domestic issues any and all countries will face in the next 25 years or so."
Most governments have responded by raising taxes because, he said, they view the issue as a cash-flow problem. More recently, countries have gone from raising taxes to cutting benefits. But this too, he said, takes a cash-flow approach, rather than addressing the underlying causes of the looming pension-fund shortfalls.
"Neither raising taxes nor cutting benefits has anything to do with, or influences, either the birth rate or life expectancy," said Shipman. "These are nothing more and nothing less than financial patches."
Shipman, too, pointed to a solution involving developing nations. "Maybe what we are going to see over the next 50 years or so is a reordering where there are extraordinary opportunities to sell products to increasingly large populations. It just may not be in the same places we normally go to."
But before developing nations can attract capital and create attractive returns on it they must undergo structural changes, including legal reforms and stable currencies. "We will see movement globally from financing social services by taxing people to financing social services from savings and investment," he said. "If that happens, and if it is done correctly, we may be entering not a difficult period, but a global renaissance in which markets become much more important in achieving the objectives of humanity."