<p>Shrinking populations pose a formidable fiscal challenge. Declining fertility and increasing longevity will lead to a slower-growing, older world population. In most countries, population is projected by the United Nations (UN) to peak sometime this century and decline thereafter. For the world, the share of the population older than age 65 could increase from 12 percent today to 38 percent by 2100. To some extent, this represents the culmination of a long-term demographic transition associated with technological progress as well as the rise in the demand for human capital which initially boosts populations (as observed for most of human history), but eventually leads to lower fertility. This, in turn, contributes to a more sustainable pattern of development and reduced pressures on the environment.</p>
<p>These developments would place public finances of countries under pressure, through two channels. First, spending on age-related programs (pensions and health) would rise. Without further reforms, these outlays would increase by 9 percentage points of GDP and 11 percentage points of GDP in more and less developed countries, respectively, between now and 2100. The fiscal consequences are potentially dire: such spending increases could lead to unsustainable public debts, require sharp cuts in other spending, or necessitate large tax increases that could stymie economic growth. Second, declining populations can reduce economic growth and—if not accompanied by a commensurate reduction in interest rates—make it more difficult for countries to reduce their public debt as a share of GDP.</p>
<p>Projecting demographics is a risky business, and policymakers should be prepared to deal with an even faster transition to declining populations. The authors warn that their fiscal projections rely on the UN’s medium demographic scenario and should be interpreted with caution, as in the past fertility and mortality have declined at a much faster pace than projected. The fiscal risks associated with this uncertainty are mammoth in the long term.</p>
<p>Given the magnitude of the needed policy response, a multi-pronged approach will be required:</p>
<ul>
<li>entitlement reform—starting now but at a gradual pace. Reforms should start now but be gradual in order to spread the burden across generations and to avoid policy reversals</li>
<li>policies that affect demographics and labor markets. Boosting fertility rates could offset aging. But, at the same time, the ability of public policies to control birth rates appears limited. Raising migration from the younger, less developed economies to the older, more developed economies would ameliorate spending pressures and provide time to phase in reforms, but it remains a politically sensitive issue. Policies that increase labor force participation of women and the elderly hold promise</li>
<li>better tax systems and more efficient public expenditure. In many countries it will be impossible to fully offset the impact of demographics on age-related spending, thus necessitating broader public sector reforms to improve the public finances</li>
</ul>