China, Germany, Japan and the US are the world’s four largest economies. Together, they make up 45% of global GDP (at market exchange rates). The world’s third and fourth-largest economies, Germany and Japan, have already entered a phase of demographic stagnation and decline. So, amazingly, has China, whose working-age population peaked in 2011.
The fact is that fertility rates in virtually all advanced (and most top-tier emerging) economies have already fallen to, or below, replacement levels. Absent immigration, all of them are set to experience not only population ageing and population decline over the long term, but they will also be experiencing declining labour forces and rising dependency ratios. In the so-called population dividend model, a declining dependency ratio leads to an acceleration of per capita growth. By the same token, a rising dependency ratio represents a drag on economic growth due to the relative decline in the labour supply and a declining savings ratio. As an aside, it would be useful to explore how demographic decline affects an economy’s innovation potential, that is, its ability to switch from extensive to intensive (total factor productivity) growth.
So how do the Big Four stack up against the predictions of the population dividend model? While Germany’s gross savings ratio has fluctuated between 20-25% of GDP since 1980, gross savings in Japan and the US have declined. Investment has declined in all three countries over the past three decades. Interestingly, net savings positions (= current account position) have not changed much, except in the case of Germany. The US has been running deficits, while Japan has been running surpluses worth 2-3% of GDP. Post unification, Germany did run small current account deficits, but starting in the early 2000s, the external balance moved back into significant surplus. This surge was due to both a rise in savings and a decline in investment.
How do the present and projected demographic dynamics matter for public debt? A rising old-age dependency ratio not only affects household savings, but also impacts public finances and national savings rates. The impact on public finances typically stems from declining revenue (due to declining trend growth) and rising pension and healthcare expenditure. Naturally, the precise impact is heavily dependent on pension and healthcare regimes.
According to the OECD, old-age-related social expenditure rose in Japan from 8.2% of GDP in 1990 to 13% in 2009. During the same period, it − amazingly − fell from 9.4% to 9.1% in Germany, while it rose from 5.2% to 6.1% in the US. A similar pattern can be observed with regard to social security expenditure as a share of GDP. While German expenditure rose from 20% of GDP to 25% from 1990 to 2000, the share has remained unchanged since. By contrast: while the readings for Japanese and US expenditure were much lower in the 1990s, amounting to 11% and 14% of GDP, respectively, they rose sharply between 2000 and 2012, increasing from around 15% of GDP in each country to 22% and 20% of GDP, respectively.
Under current legislation, government spending on pensions and healthcare is set to increase in all three countries. The IMF provides estimates of the net present value (NPV) of the increase in health and pension expenditure during 2011-50. Germany and Japan seem much better positioned than the US, where the implicit liabilities stemming from future healthcare expenditure exceed 150% of GDP in NPV terms. In terms of spending change measured as a share of GDP, US spending is set to increase by almost 6% of GDP, while both Germany and Japan are set to experience far less dramatic increases. A lot will, of course, depend on how entitlement spending is reformed in the coming decades. As of now, however, the US appears far less favourably positioned than Germany or Japan – despite a far more favourable demographic profile.
When assessing public-sector debt sustainability it would be negligent to disregard implicit government liabilities. Gross and net debt ratios provide merely a snapshot, failing to capture medium and long-term fiscal dynamics. If one sums up government debt and the implicit debt arising from government pension and healthcare spending commitments (appropriately discounted), the US government’s debt is almost twice as large as Japan’s and almost three times as large as Germany’s. Food for thought.
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| Source: IMF |