In the coming years, the United States and many other countries are going to be forced to deal with a problem that will plague many nations. Aging. The population of the United States is being dominated by people in its fifty and older age group. In many other countries, this problem is approaching if it has not already begun. Since we are in the early stages of the change in the age structure of the population, the situation can only worsen. Other countries that are currently experiencing large fertility rates will eventually see these offspring move into and expand the fifty and older age group of their respective countries. Not only has the older age group been expanding but also the younger age group has been shrinking. This only leaves a smaller amount of people to support the older generation. This change in age structure that will look like an inverse pyramid age structure is a result of the decline in fertility and mortality rates sweeping across our country. In many other countries where there has not yet been a decline in fertility, we are going to see a more extreme problem than faced in the United States.
This demographic trend toward an older population has several effects on the economy. On the household level, we normally see a “hump” pattern of saving. This entails the use of resources during the periods of childhood and old age. During these times people are dissavers while in between these periods, people are savers. In order to observe how this saving and spending pattern will affect the nation as a whole, we can look at the dependency ratio. This is a measure of the proportion of the population sixty-four years and older and twenty years and younger in relation to the rest of the population. In reflection of the trend of our nation toward an older age structure, this ratio has been rising. The significance of this increasing ratio is that a larger fraction of the population is dissavers and not savers.
In addition to changes on a small economic level, the demographic transition affects government saving. Since a larger proportion of the population is older, a larger percentage of government spending is designated to age related matters. As the elderly population continues to increase, the government will need to spend more on programs to support this age group. Programs that currently target the elderly, such as Medicare, will get increased funding. he shift in population to an older nation will be more difficult to finance and social security programs will become more expensive. Another way to fund these programs is to initiate an increase in payroll taxes. The result of these programs and spending burdens could fall on future generations that will be targeted to support the elderly. This increase in expenses will only mean a lower savings rate for the working population. Currently the median real income of elderly households is rising because of the increase in social security benefits. Future generations will feel a double burden when they are not only paying to support the older generation but are also subjected to their political programs. Since the elderly will have more political power, they may direct government investment to more short-term projects to reflect their short remaining life span.
Not only does a larger elderly population influence the manner in which the government spends its money; they will also have more influence on all governmental activities since they will have more political power. The proportion of the voting population over the age of fifty-five is predicted to steadily increase. The effects of this political power can mean policies directed at increasing social insurance spending. In addition, instead of bearing the burden of supporting their generation themselves, the elderly may move the spending burden to other generations. In total, these effects will have a shrinking effect on national savings. People in younger generations may feel increased pressure to support the elderly since they will have a minority voice in political debates. Another trend we will see with an older population is that people are more likely to change their level and consumption of wealth. Since these people are older and facing the last stage of their life, they will be less likely to hold risky assets and also may change the size and type of housing that they own. The elderly no longer need large homes to house families and they also may not need a home at all. Many seniors move into family homes or retirement communities, diminishing the large responsibilities that face homeowners.
How to correctly model the saving pattern of individuals and nations has been the central problem facing economists and demographers. In the U.S. we have seen a drop in savings in the 1980s which has continued up to the present time. The increasing spending rate has been the result of an increase in private consumption, however we also see that this pattern is not captured well by any of the existing savings models.
One of these models is the life cycle model of saving. It predicts that households save in order to even out consumption in the presence of a fluctuating income. In addition it states that the other reason households save is for their bequests. The problem with this model is that the patterns and reasons of saving are largely not understood. The life cycle model predicts a gradual decline in the savings rate due to the increase in the dependency ratio. Since we will have more elderly retired people, the labor supply will grow slowly as will the accumulation of capital. With the growth of the labor supply lower than the growth of capital accumulation, we will enter a period of capital deepening where after some time, there will be more older people than young and middle age workers. This older group of people will also own most of the society’s wealth. One area where we don’t expect investment from the elderly is housing. Since they’ll be the largest part of the population and the largest owners of wealth, demand for housing will decrease.
Effects of Changes in Population Growth in the Life Cycle Model
The life cycle theory of savings sets out to explore the relationship between national saving and national income depending on the rates of population growth and per capita real income growth. It predicts that the inequality between income and consumption will increase with age. The effects of a change in population growth are extensive, affecting the size and age structure of households while also changing the age profiles of consumption, income, and saving. A higher rate of population growth leads to more children per household. This household will consume more than a household without children and will have a lower savings rate. Income and saving rates also vary with the age of the household head. When the head of the household is young, there is normally a lower saving rate since these people usually have children they must support. The model also predicted that a household with more adults than children will consume more than a household with more children than adults. This prediction has two implications. One is that an increase in fertility or population growth will will increase the number of children in households and will therefore decrease consumption. Another is that the large elderly population we are facing will increase national consumption. After analyzing their data, Deaton and Paxson found that changes in the rate of population growth have a small effect on the savings rate.
Although the life cycle model sounds logical in its predictions, it makes some assumptions that limit its validity. The model assumes that the rate of saving for each age group remains more or less constant over time, which may not be true. Naturally it is possible that people within an age group vary their saving rate over time. The basic conclusion mainly drawn from this model is that economics has a difficult time explaining patterns of saving or the behavior involved in it.
References
1) Alan J. Auerbach and Laurence J. Kotlikoff, "The Impact of Demographic Transition on Capital Formation" Anna M. Rappaport and Sylvester J. Schreiber, (editors) Demography and Retirement: the Twenty-first Century, Praeger, Westport, Conn., 1993, Chapter 5, pp. 163-187.
2) Angus S. Deaton and Christina H. Paxson, "The Effects of Economic and Population Growth on National Saving and Inequality", Demography, Vol. 34, No. 1 February 1997, pp. 97-114.