...against fictions and other tall tales

Saturday, 25 February 2012

Sense and nonsense about the aging of the population

Earlier this week, the federal minister responsible for overseeing Canada's public pension and old age security programs, Diane Finley, suggested that the aging of the population and the future cost of social programs targeted to retirees and seniors will lead to massive increases in taxes, crippling debt and a huge debt burden on future generations.  To remedy the situation, Minister Finley is proposing to raise the eligibility age to Canada's old age security program as a way to reduce future costs and preserve the "sustainability" of federal budget costs.

The rationale for the proposed program changes is based on the fact that the ratio of working-age people to seniors is projected to decline in the next decades or, as Minister Finley puts it, "as we go forward, we’re going to have three times the expense in Old Age Security as we do now, but we’re only going to have half the population to pay for it".

But is it really correct to say that the government is headed for a demographic shift that will jeopardize the sustainability of the federal budget in years to come?  I am not convinced. And here's two reasons why I think the problem of population aging is currently overblown.*

The ratio of workers to seniors

First of all, it's important to understand that the so-called "ratio of workers to seniors" is, by itself, a fairly uninformative concept for analyzing the issue of population aging.  The reason for this is simple: the ratio of workers to seniors tends to distort the true burden associated with the aging of the population.  Focusing on the ratio of workers to seniors, as most commentators and policymakers are currently doing, obscures the fact that seniors are, and will remain, a relatively small share of the total population.  Also, it's important to keep in mind that the working population must also "support" itself and the youth, in addition to supporting the senior population.

Instead, a more useful concept for analyzing the impact of population growth on the economy is the ratio of the total population to working-age population.  By using this ratio, one gets a much better sense of the real impact of population growth on the economy and, as a result, on future government budget outcomes.

Figure 1, Source: OCA, 2010
Figure 2, Source: OCA, 2010
Figure 1 provides a good snapshot of the increase in population projected (broken down for each age category) between 2011 and 2030 in Canada (see Figure 2 for the period 2011-2050).**  As shown in Figure 3 below, if the focus is solely on the population over age 65, the picture looks worrisome: over the next two decades (2011 to 2030) the number of people 65 and older will rise 78% relative to those 20 and 64.  When adding those under 20 to those 65 and older, the dependency ratio rises by 36% over the next two decades.  And when the entire population is considered relative to the working-age population, we note that the ratio rises from 159% to 180%, a much more manageable 13% increase over the next two decades (note: 13% of 159 is 21).

In other words, the actual "burden" of aging based on current projections consists of an additional 13% more people per working-age person.  This is much smaller than the 78% that is currently being mentioned by commentators and politicians.

Figure 3, Source: OCA, 2010 and author's calculations

Figure 4, Source: OCA, 2010 and author's calculations

Now, some people may argue that this amount is still quite high and, as a result, the government should nonetheless intervene to reduce future outlays to seniors.  This brings me to the second reason why I'm skeptical about the argument that population aging will have deleterious effects on the economy and public sector budgets: productivity growth. 

Productivity growth

Discussions about the aging of the population rarely, if ever, highlight the critical role that productivity growth plays in enabling the economy to afford the cost of programs destined to retirees and seniors.  Yet, the role that productivity growth plays is actually very important because as people become more productive at work, more income is generated to support those who aren't in the labour force such as the youth and seniors

In fact, if we look at the average rate of productivity between 1981 and 2011 for Canada, we find that productivity grew at a rate of approximately 1.3 percent per year (Martel et al., 2011).  This productivity gain greatly contributed to helping the Canadian economy shoulder the increased burden of aging during previous decades.  In 1981, the ratio of workers to seniors was approximately six to one whereas today it is approximately four to one. In 2030, it is expected to be below three to one (Statistics Canada, 2011).  Therefore, assuming that the average rate of productivity will remain at this level until 2031, we find that productivity will have nearly doubled between 1981 and 2031.***

Thus, once you consider the impact of productivity growth, the picture doesn't look so bleak anymore:  three workers in 2031 are expected to produce approximately the same level of output that six workers produced in 1981, fifty years earlier.  In other words, because of productivity growth, the worker in 2031 will generate almost twice as much output per hour as the worker from 1981.

A simple rule of thumb is that population aging remains "sustainable" as long as productivity rises faster than population.  Therefore, assuming an average productivity of 1.3% per year between now and 2031 (the same level as for the period from 1981 to today), we find that productivity will grow 28% whereas population will grow by 13%, as shown in Figure 3.  This is a noticeable difference that would enable Canada's economy to shoulder the burden of population aging while also increasing the population's standard of living.  Comparing this amount to the projected increase in population of 13%, we see that productivity growth will more than make up for the future increase in population.

Now, it is possible that future gains from productivity may not be entirely reflected in increased income for workers (via rising real wages).  Productivity gains may end up being disproportionally absorbed by businesses through increased profits.  However, it is important to understand that this problem is an entirely different one from that of the sustainability or solvency of public pensions and retirement programs.

In the event that future productivity gains get absorbed disproportionally into business profits, the remedy would be for government to ensure that a fair share of the gains from productivity be diverted toward real wage growth for workers.  Certainly, such a scenario would not warrant making drastic changes to the federal government's old age security program by raising the program's eligibility age from 65 to 67, as Minister Finley is proposing to do.

To conclude, I am not saying that taxes will not need to be raised by some amount to cover the future cost of public pensions and other retirement benefits.  The point here is that increased costs to taxpayers and workers should not be overly onerous.  The resources will be there to support the senior population in the future since productivity growth should more than make up for the 13% growth in the total population that working-age people will have to support in the coming decades.

The FRB blog invites your comments. Please share your thoughts below.

* This analysis is based on the excellent article by Spriggs and Price (2005).
** All figures are based on OCA, 2010, p. 96 and author's calculations. See Figure 5 below.
*** An average rate of productivity of 1.3 percent between 2011 and 2031 is a conservative assumption. Some economists are suggesting that Canada's future rate of productivity will rise in the coming decades. See Arlene Kish's IHS Global Insight dated October 2011, as well as the October 2011 edition of the Bank of Canada's Monetary Policy Report, (p. 19) regarding the expected increase in productivity the next few years. Note: a quick and easy way to approximate the number of years it takes for a variable growing at a constant rate to double is to use the "Rule-of-70" or dividing 70 by the chosen growth rate.

Figure 5, Current population and projections,
Source: OCA, 2010 (in thousands) and author's calculations
Hoc dicatur meum filium Vincent, cui futurum quasi electa ut sol. Ut non factus hostiam logica. 


OCA (Office of the Chief Actuary), The 25th Actuarial Report on the Canada Pension Plan, November 2010

OCA (Office of the Chief Actuary), The 10th Actuarial Report Supplementing the Actuarial Report on the Old Age Security Program, August 2011

Martel, L. et al., Projected trends to 2031 for the Canadian Labour Force, Statistics Canada, August 2011

Spriggs, W. and Lee Price, Productivity Growth and Social Security's Future, Economic Policy Institute Issue Brief #208, May 2005.

Statistics Canada, Revisions to Canada and United States Annual Estimates of Labour Productivity in the Business Sector 2006-2009, March 2011 (Table 4)


  1. An excellent piece, especially linking up the missing essentials. Great work!!!

  2. This is one problem that I used to believe the feds had a legitimate case to act on(that is, until reading this). The visuals are a valued addition.

  3. nod! thick piece circuit. i agree with TP that your graphics are exceptional. they synthesize so well that some staffers should learn follow your paths. nice that you nipped the rub! by integrating productivity into the compensatory evaluations of pension liabilities.

    i like to think that some regulators and analysts have done a diligent job in highlighting the weaknesses of many plans by pointing out the analytical shortcomings of inappropriate discounting techniques and rates, aggregate funding ratios, asset-benefit ratios and similar gadgets made to appease. the accounting approach has its own problems to cover the sinking fund. strict funding requirements may compel sponsors replenish funding shortfalls in bad economic times and lead them to invest more conservatively, thereby increasing net funding costs, fair value accounting standards (with immediate recognition of actuarial gains and losses) can, on the other hand, contribute to higher funding levels than required by regulators...and on
    on the demographics as methodological base, i think MI would be better to judge, but i surmise our demographics for the case are somewhat different than the US and this may skew perceptions.

    in fact, i doubt that Cda imminently or even the much longer term faces any asset exhaustion. on the other hand, i don't think that the policy changes are wholly motivated by the Cda's pension scheme. pushing the age requisite out has a twofold purpose: it adds a two year tax revenue stream for govt, along with its secondary contributions to the niche and reduces the benefit period by the same. the differential is enticing for any 'clever' pmo staffer and fairly simple to justify. making it an inter-generational issue is 'gibberish' within our projected demographics, given the depth of other economic and social issues.

    i agree with you that the scheme is not the problem but another pretext for unfortunately fiscal retrenchment.

    1. Thanks for the thoughtful comment. Yes, there clearly is another reason behind why the government is signaling their intent to move forward with this proposal. Fiscal retrenchment sounds just about right. Fear mongering is the instrument of choice for those seeking to put the axe. The other is to make the policy proposal (or a variation of) apply to elected officials (interesting twist). Also, I'm glad to hear someone calling out the storyline on inter-generational unfairness for what it is: gibberish.

      I agree with your second paragraph completely. Thanks for posting your thoughts on these methodologies and accounting techniques.

  4. I concur with JH that the recent ‘ proposal’ by your Govt to extend the retirement age is an unimpressive mime for 'fiscal retrenchment' (check the FRBPH- a remarkable literary usage in this particular case). Actually, considering extension of the retirement age in the OAS case is superfluous and not worth the deliberation. I trust that polity deferred to opine or opted contra.

    On the advantages identified by jh, I would only highlight that among the secondary contributions for extending workers is the nominal recurrent of EI and CPP-which in themselves, and alongside Canadian Health Care are leviathian challenges-the latter moreso than the former. The former underpin Canadian Labour, but the latter undermines the nature of your constitutional dynamic with provincial counterparts (I assume) in matters of health and related issues. These are, I assume jh's deep "other economic and social issues" that require serious deliberation.

    In the case of the majority of plans and programs, asset exhaustion is a dreaded concern. In the case of OAS, jh's cynical highlight that there is no "asset exhaustion' is welcome when inspired from someone who usually advocates risk-sharing: OAS contrary to Social Security is a federal budget ‘allocation’ or as some would have it a ‘carve-out’. The task for a Canadian policymaker is not to find the money, nor to evaluate parameters, returns, ensure the future etc..: it's to trust that Parliament maintain its currency...BoC can print all shortfall requirements on a PAYG basis if it refuses to tax. I will defer the technical shortfalls of the PAYG -in Canada's case, for this post and for a sovereign currency issuer, it's a non-issue.

    Conventionally, worker/beneficiary is the standard. I would address two points however, and do not wish to belabor the appropriateness of certain ratios suggested by Lee and Spriggs. L&S are serious analysts. Among the insights, I retain that many indicators at the worker level have not followed growth in productivity and that the analytical setting has accordingly been modified quite dramatically. Their purpose is not to opt out of an analytical standard, but rather to signal the need for a complementary tool to deter excessive alarmism. In the Canadian OAS case, the notion- alarmism, is anachronistic because there is no de facto possibility of insolvency. For almost all plans of similar nature, gains in life expectancy are not a serious problem.

    The bigger problems are weak wage growth and rising earnings inequality. Earnings inequality is critical because most sovereign schemes cap contributions. Slower wage growth enhances the costs /taxable earnings. In the US federal programs for example, real issues are rising health care costs, which create a growing wedge between compensation and taxable wages, a falling birth rate, and higher disability take-up are also contributing to the projected shortfall of plans.

    With L&S, I highlight the distinction: productivity growth (output) is not necessarily commensurate to wage growth. Significant rises in GDP do not flow through necessarily to labour. The benefits may end up, depending on certain businesses and industry sectors, in corporate balance sheets. As a result, the only way to access the benefit of enhanced productivity is to calibrate corporate taxes, because the labour force may actually stagnate, if not diminish on a per output basis, over the next 50-75 years.

    The medieval proverb is a gem: ‘you don't have to raze the city in order to save it'. So too, you don't have to extend the retirement age in order to save the program, because in fact extension cuts benefits for average retirees. If you do, then tell it as it is. It is now my understanding that the Govt is revising the CPP rather than the OAS program. That is a somewhat different matter, but no less elementary.

    The challenge for credible policymakers is to improve the benefits!

    1. Excellent add-on, MI. I also thought L&S's take on productivity had to be complimented by a discussion about the challenges in ensuring that productivity growth translates into real wage gains. You, however, rightly emphasized the option available to government of targeting corporate profits. Finally, your take on L&S's use of unconventional rations and analytical standards as a manner to deter excessive alarmism is good read. In the case of population aging, I think this approach is warranted.

  5. I think that forcing into the open the controversy over the retrenchment on retirement age is important. Over the last five decades Canada has offered credible models for social programs financed within reasonable measures. Their quality and structure has been praiseworthy, and canadian social policy has been certainly avant-garde since the days of your silver tongued Mr. Tommy Douglas. There is little need to address the OAS to find fiscal restraints. The LP&S take on productivity is actually a timely reference for the Canadian setting. To your merit to have invoked its pertinence, even if the LP&S intent is non-canadian.

  6. @all,

    Taking a second look at work-force efficiency has presented me with a conundrum you might be able to shed some light on.

    The PBO released some numbers suggesting that annual improvements in productivity are a proportion of annual GDP growth. Kind of makes sense. However, Rifkin states that in 2009 the USA had a productivity growth rate of ~4%, which was higher then the GDP growth rate that year, so it resulted in a net job loss. The lion's share of this increased efficiency took form as private sector profitability which, however, did not materialize as capital investment or real wage increases but accumulated in the form of dry powder. From this example, it would appear that efficiency gains have the potential to detriment fiscal stability by inciting capital out of economic circulation, and by consequence away from repeated taxation.

    The problem is that this conclusion is at odds with what is sensible. Wouldn't (increased efficiency)+(surplus labour)+(surplus investment capital)=increase in SMEs/startups? From there, the capital and labour should enter back into the market resulting in higher employment and tax revenue. Yet, in the USA at least, dry powder is not making its way back into the economy, not really. Have I missed a step somewhere? Perhaps this is a documented phenomena that one of you will be familiar with?

    1. Great concern JD!!!

      I would have liked to read the Rifkin reference. maybe you can pass it on at some point. As far as your query: Productivity can definitely lead to "dry powder" as you call MS, and commensurate increase in unemployment. If there is no reciprocal increase in aggregate demand, there is no reason for corporates to invest in either jobs or expansions and investment.

      In a simplified model, increases in unemployment will convert, over time, into reductions in demand if there is no commensurate growth in wages. (One of the readers MI and Circuit make the point well) Profits will continue to hoard on B/S until management decides to reward shareholders for their patience and support. There is always some fiscal imbalance in this type of "circuit" that taxation can't optimize on. In that sense, one can deem the conclusion as not sensible, but then, one can also deem it as the most appropriate venue given the circumstances. Managers protect their shareholders at the expense of the other trade-off pole: employment. Not the best from labor's or policy perspective.

  7. Very interesting. Are there any apparent barriers to the capital moving to SMEs? Obviously, that kind of monetary flow is much more difficult than it sounds, but do you see any kind of macro-economic reason impeding that? It strikes me that on an individual basis, there are nothing but incentives for incorporation. While it is certainly possible that the only barrier to entry is 'psychology', there has to be a more scientific explanation.

    Otherwise, I've dug up that Rifkin quote for you.

    'Industry after industry, from factory production to banking services, companies have experienced dramatic increases in productivity, which allow them to produce more output with fewer workers... GDP remained unchanged in the four quarters of 2009, but payrolls declined by 4%. In other words, companies increased their output per worker by 4%.' (Rifkin, J, The Third Industrial Revolution. p 261)

  8. Why can't 'business psychology' be scientific. As kp suggests, if I follow his drift, modern portfolio theory, for some, is scientific. As far as barriers: the allocation of capital (capital budgeting) is simple "asset allocation" seeking optimal rewards. Cost/Benefit. Some of the variables playing into the basic analysis include taxation, f/x, regulatory parameters (inc costs and benefits of incorporation) and cost structures (most important being the opportunity costs of endorsing local human resources compared to other relevant jurisdictions)

    You wrote: "Rifkin states that in 2009 the USA had a productivity growth rate of ~4%, which was higher then the GDP growth rate that year, SO (my emphasis) it resulted in a net job loss." Isn't that different from what Rifkin wrote.

  9. I’ll commend JD for insisting to share his desire that macroeconomic concerns should find scientific legitimacy. Unfortunately, it’s not the case yet. There are too many schools of thought to make any coherent and pragmatic sense of it. However, I welcome RK’s dare that ‘business psychology’ is scientific-Keynes is the best rep when he evoked ‘animal spirits’ and then went on to “outline” a framework (re the‘general’ qualifier) wherein some macroeconomics could be formulated. Although Keynes’s last words leaves hope for the earnest, and appease the cynical.

    Although this may not be the issue for JD, his emphasis on matching macroeconomics and science suggests it, moreso his attempt to 'reduce' policy and business to macroeconomics. It reminds me of a comment by an excellent macroeconomist that Macroeconomics indulges in "dimension reductions."

    I surmise that there is a long and arduous road to follow, if any way according to some, before the transition is credible in order for macroeconomics to rigorously forge public policy. Policy handles that and may do so in manners unimaginable to macroeconomists. If macroeconomics is an optic metaphor for policy, the relationship is usually diffractive, sometimes refractive, certainly doesn’t reflect. The attempt to mathematize it may be in vain, although some very good minds are betting their efforts on it. However, it seems to me that the fundamental perquisites to articulate and refine aggregation, agent heterogeneity, distribution issues, calibration, and on and on are still a long way off from solutions.

    Jim Heckman notes on the current status in an interview (yes the fed again): http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=3278 section on Heckman’s Labor Supply… Paul Samuelson reflects a similar dose of scepticism in a later write-up.

    Sometimes macroeconomics cannot spell out the behavioural preferences of certain agents. It’s like a lighthouse. It can give some insight into the seascape and coastline, but it can’t guarantee that the captain will steer the ship accordingly, or that if the captain does, the ship won’t meet with disaster. The variables are too many and complex. The recent experience of 2007 onwards unfortunately for the victims attests to its pauperage.

    To respond to JD, yes the capital should find its way back into the system by certain distributional channels; but sometimes the system doesn’t coerce or impel, and practice demonstrates it won’t for a while or everso.

  10. I agree with mi. Profits usually generate a reciprocal growth in investment and wages. If there's no wage growth or investment growth, then household consumption drops which entails a decrease in aggregate demand which should ultimately nip the corporate in the butt by decreasing demand for products. Corporates, under the circumstances in turn pursue the downsizing representing the paradigmatic response to cost controls and stabilizing margins. Meanwhile corporate cash reserves, like household savings, deplete in order to sustain the contraction. The only measure of surrealism is what I find MI suggesting, that the equilibrium may never be achieved. Here I straddle.