G-7 Countries Need 4% GDP Growth to Cover Aging Costs
G-7 countries will need to engineer an average improvement of 4-4½ percentage points of GDP in their primary fiscal balances from 2005 levels to cover spending caused by the aging of their populations.
That’s one of the conclusions of a new Working Paper published by the International Monetary Fund, Ensuring Fiscal Sustainability in G-7 Countries. The large estimated adjustment in the primary fiscal balance (revenues less non-interest spending) will be needed to ensure long-run fiscal sustainability (i.e. stabilizing fiscal debt at a permanently sustainable level).
Nearly two thirds of the fiscal adjustment reflects the expected rise in age-related spending, while the remaining one third owes to the interest on public debt, according the paper, which is not official IMF policy.
The largest primary gaps are shown for Japan, which had the largest primary deficit and a high debt level in 2005, and the United States, owing to a combination of a high primary deficit and large projected increases in age-related spending.
The smallest primary gap was shown for Canada, whose primary surplus of 5.5% of GDP helps offset the projected impact of the very large expected gain in age-related spending.
The combination of increased longevity, falling fertility rates, and the retirement of the baby boom generation will mean that, by 2050, ratios of elderly people to the working-age population (the old-age dependency ratio) are projected to double in the G-7 countries.
Such developments imply a steep increase in age-related government spending in G-7 countries—by an average of 4 percentage points of GDP over the next 45 years. Estimates vary substantially across countries, with Canada at the high end (with growth estimated at 9 percentage points of GDP), and Italy and Japan at the low end (with growth rising by about 2 percentage points). The bulk of the spending increase is expected to cover additional health care costs, with long-term care and pension spending accounting for the rest.
The report is not all bad news, however. While the overall adjustment required to achieve long-run fiscal sustainability in G-7 countries is large, there are significant growth benefits to putting public finances on a sustainable footing in the near termversus delayed adjustment, the paper finds.
Early adjustment is estimated to deliver a permanent output gain of about 2% of GDP on average.
Postponing adjustment increases the size of the fiscal adjustment required to restore sustainability. Given the upside risks to spending pressures, early fiscal adjustment would also allow greater fiscal space to absorb any higher-than-expected age-related expenditure needs, the paper concludes.
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