In 1950, the median age in developed countries was 29. By 2000, the median age had risen to 37. By 2050, this figure is projected to rise to 45. As populations age, a larger proportion of people become dependent on working adults for support. What are the economic effects of an aging population? How does this demographic shift affect savings and consumption, today and in the future? What does an aging population imply for government finances, and in particular for social security?

To address these issues, the author first examines the causes behind population aging. Understanding the demographic shifts that lead to population aging is critical to deciphering its economic consequences. Successively the author focuses on the elderly’s three main forms of support: their private savings, government transfers, and support from their families. Through recent data and existing studies on population aging, he derives predictions about how an increase in old-age population will affect these sources of funding.

Increased life expectancy and declining birth rates have been the two key demographic trends causing population aging, with the latter cause dominating. The young and the elderly are the two age groups that tend to consume more than they produce, and they rely on working-age adults to support their consumption. As birth rates fall, youth dependency - defined as the ratio of youth to working-age adults - falls. Initially, working-age adults have fewer young dependents to support and experience an increase in their consumption possibilities. Over time, however, old-age dependency - defined as the ratio of elders to working-age adults - will rise. Coupled with the fact that the elderly tend to live longer, the long run effect of these demographic shifts is an increase in total dependency.

Simply put, an aging population implies that in the future there will be more retirees being supported by fewer workers. Consider Japan, a country with one of the fastest aging populations: in 1950, there were 9.3 people under 20 for every person aged 65 and older. By 2030, this ratio is predicted to fall to 0.59. Over time, there will be fewer people entering the workforce than those leaving it, leading to a potentially devastating problem for the funding of pensions and medical care.

The above analysis implies that today’s workers should save for their old age, accumulating capital during the longer periods of low dependency brought on by reduced birth rates. In fact, private savings are the first way to support the consumption of the elderly. However, and this is the paper’s key observation, private savings are likely to be adversely affected by aging population. Lower fertility implies reduced growth in the labor force. With fewer workers, the capital/labor ratio increases causing the return on investments to fall, and reducing the incentive to save. In addition, growing strains on government retirement programs such as social security may cause an increase in payroll taxes, shrinking the amount that people are able to save for their retirement. Finally, there is evidence that aging population may cause asset prices to fall. People tend to sell their assets as they age to finance their retirements, thus depressing their prices.

A second prominent way in which the elderly are supported is through government transfer programs, such as public pensions. In Germany, government transfers make up 65% of the income of people aged 65 and older. Furthermore, transfers to the elderly have become an increasingly large part of government spending. In 2005, the US government spent nearly 6.5% of GDP on transfers to the elderly. A shift of 10% of the population into retirement would cause federal transfers to increase by 4.7% of GDP - or over $500 billion. This funding problem is exacerbated by the fact that government revenues fall when a larger proportion of the population moves into retirement and starts paying less income taxes. To stay solvent, the US social security program should raise payroll taxes from 16% in 2000 to 21% in 2030. In Germany, where government support is larger, payroll taxes should rise from 28% to 40% over this period.

If anything, these numbers may be underestimated, as higher taxes may push some people out of the labor force, especially since the taxes they pay are not going to themselves or their families. The author argues that this is a key problem of government transfer programs. An economy that could function smoothly with a high level of old-age dependency financed by personal savings would collapse instead if financed by taxes. Despite this impending funding crisis, changing these systems will become increasingly difficult from a political viewpoint. Between 2003 and 2030, the fraction of elderly voters in the United States will rise from 19.8% to 30.5%.

The reliance on government transfer programs to support old-age dependency is a relatively recent phenomenon. In the past, family transfers and cohabitation of the elderly with their children was much more common. For example, the fraction of elderly widows who lived with their children in the United States fell from 67% in 1920 to 20% in 1990. Furthermore, only 2.7% of the over 60s rely on family transfers as their primary means of support. Thus, aging population’s primary support are personal savings and government transfers. The former method is likely to decline as the return on savings decreases, while the latter faces a solvency crisis.

Is population aging a temporary trend or is it a long term demographic shift? The author argues that increased aging may actually further lower birth rates. Keeping government retirement programs solvent will require an increase in taxes, lowering disposable income for working-age adults. In response to reduced income, working families may choose to have fewer children, exacerbating future population aging. While the paper does not offer any solutions to the challenges posed by population aging, it does provide a solid framework to understand an issue that will become increasingly prominent in years to come.