22 October 2016
Population ageing and burden on future generations have been cited by the Hong Kong government as important reasons for rejecting a universal PAYG retirement system. Photo: HKEJ
Population ageing and burden on future generations have been cited by the Hong Kong government as important reasons for rejecting a universal PAYG retirement system. Photo: HKEJ

Population ageing and retirement protection systems

Population ageing is considered a problem because it signals a decreasing number of workers having to support an increasing number of retirees. It is also said to create a crisis in the universal tax/contribution-based PAYG (pay-as-you-go) pension system in that the system will burst unless more taxes/contributions can be collected from the working population or pensions are cut.

To avoid undue burdens on future working populations in the face of ageing, there have been calls in different societies to discard the PAYG pension system and instead adopt a system that requires each generation to save up enough while still young for their own retirement.

In the context of Hong Kong, population ageing and burdens on future generations have been cited by the government as important reasons for rejecting a universal PAYG retirement system and for keeping to the current system based primarily on private savings.

However, even leaving aside the issue that not everyone in a generation is necessarily able to save up enough for retirement and the related question of how to justly distribute the responsibilities of supporting the elderly within society, is the suggested policy response likely to achieve its intended purpose – i.e. releasing the burden of the working population while protecting the livelihood of retirees?

From the perspective of an individual, it might be intuitively true that saving up for one’s retirement should help avoid reliance on one’s children. Yet, what works for an individual does not necessarily work for the collective. It will be erroneous to infer from the truism that an individual can avoid being a burden to one’s children through sufficient personal savings that a generation can similarly avoid being burden to future generations through saving up enough for themselves.

The error in the inference becomes apparent once certain economic facts are made explicit and understood.

Firstly, a society’s output is produced by its working population, not by its retirees. This means that retirees’ consumption is produced entirely by the working population. For a given level of aggregate output, retirees’ consumption cannot be increased without a corresponding decrease in the consumption of the working population.

Secondly, since population ageing means a decline in the workforce, unless productivity grows, its underlying problem is a fall in output or production.

Thirdly, savings, either in the form of piles of money or in the form of financial assets, are claims or purchasing power over future production. People are not inherently interested in money or financial assets but in consumption, such as goods and services (i.e. that which can be bought with money). What matters to people therefore is not the savings they own but whether the production after they have retired is sufficient to meet their desired level of consumption. Money is irrelevant unless there are sufficient goods and services for retirees to buy!

From these basic facts, it can be easily seen that in an ageing society, because of a decline in the workforce, output will fall unless productivity grows. In the goods and services market, less may be available for purchase by both retirees and workers. As such, retirees will be able to consume at the level they desire only if those working reduce their consumption.

If the desired consumption level of both retirees and workers remain unchanged, demand will exceed supply in the goods market. This will cause price inflation and erode the purchasing power of retirees’ savings (as well as workers’ earnings). In the end, retirees will be unable to consume what they have saved up for in retirement.

Falling output also affects retirees’ desired level of consumption through the assets market. Falling output means that workers’ aggregate demand for financial assets decreases unless workers increase their desired level of savings.

For retirees, if some of their savings are in the form of financial assets, in order to finance their consumption in retirement, the assets will have to be sold in the market. It is possible that retirees’ desired asset sales may exceed desired asset purchases on the part of workers. Excess supply in the assets market thus reduces asset prices and hence retirees’ purchasing power. Again, retirees will be unable to consume what they have saved up for in retirement.

The messages from the foregoing analysis are clear. Population ageing means a drop in the workforce. Everything else being equal, this leads to a drop in production. As a result, a society’s consumption in aggregate has to be cut. Either the consumption of retirees or that of the working population or both has to be cut. Retirees will be unable to consume their desired level of goods and services if those working do not reduce their consumption.

In the final analysis, this means that retirees remain reliant on the working population for their living. From the perspective of the working population, retirees remain a burden to them. How much more consumption retirees can enjoy depends on how much the working population is willing to cut their own consumption.

From the viewpoint of pension system design, discarding the PAYG pension system and replacing it with a system based on private savings will only change the way by which consumption is cut in the face of shrinking output.

In a PAYG pension system, the consumption of retirees is reduced by a pension cut while that of the working population is reduced by an increase in taxes or contributions. The reduction in both cases is done through a political-collective decision process.

In a system based on private savings, the consumption of both retirees and the working population is cut by a change in prices through the operation of the market.

Admittedly, the analysis above is highly simplified and premised on a closed economy. The analysis nonetheless suffices to shed light on several policy lessons for addressing the issue of population ageing. Rendering the analysis more detailed or extending it to an open economy will not change the underlying logic or the conclusions.

Population ageing in itself is not necessarily a problem. It is a problem only if it causes a fall in production output; the problem is solved to the extent that falling production output can be prevented.

Thus, to deal with the problem, the key is to attain economic growth. Appropriate policy responses to the problem would be measures that promote economic growth in the context of a shrinking workforce. These include:
  — adoption of more and better capital equipment
  — upgrading labor through more education and training
  — increasing labor supply, for example, through better child-care facilities for married women
  — raising the retirement age
  — importing labor directly
  — importing labor indirectly by exporting capital to countries with a young labor force

The difference between the PAYG pension system and a system based on private savings lies mainly in the way by which retirees’ consumption level is determined.

In a PAYG pension system, retirees’ consumption level is determined by a political-collective decision process. In a private savings system, on the other hand, their consumption level is determined mainly by the market.

Which system is to be chosen should primarily be decided by a society’s outlook on which system can better protect retirees’ livelihood and meet the requirement of justice.

Unless retirement system design has positive impact on economic growth, ageing is not a reason for discarding the PAYG pension system. Nor is it justification for adopting a system which requires people to save up for their own retirement. Ageing or otherwise has no direct relevance in this regard.

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