Select Committee on Economic Affairs Fourth Report



3.1. Population ageing can directly affect macroeconomic performance through both the labour and capital markets. It can also indirectly affect macroeconomic performance via its impact on public expenditure. The extent of potential interaction between demographic structure and the economy is vast, and this chapter does not attempt to examine all possible influences of demography on the macro economy. Attention is here confined to the specific question of whether the ageing of the UK population will have a significant negative impact on the long-term growth potential of the economy via its effect on macroeconomic aggregates, particularly on labour supply and on the rates of saving and capital accumulation. The microeconomic impact of ageing on individual worker productivity is discussed separately in chapter 5, and the potential impact of ageing on public pension expenditure is considered in chapter 10.

Ageing and aggregate labour productivity

3.2. Population ageing will reduce the rate of growth (and ultimately the absolute size) of the working-age population. If age-specific labour force participation rates remain at their current levels (an issue discussed further in chapter 4 below), the ratio of inactive to employed people will rise. Labour productivity will therefore have to increase to maintain the level of Gross Domestic Product (GDP) per person.[26]

3.3. Because the United Kingdom experienced "baby booms" in the late 1940s and in the 1960s, the impact of ageing on aggregate labour supply is "lumpy" rather than linear; as the large baby-boom cohorts move from middle age to retirement, they are likely to have a big impact on the relative size of worker and pensioner populations. The Treasury estimates that employment growth will contribute 0.25 per cent per annum to growth of GDP in the decade 2011-20, but will account for -0.25 per cent of GDP growth in 2021-30, followed by zero impact over the two decades 2031-50.[27]

3.4. This physical impact on GDP growth of changes in the number of workers needs to be set in the context of expected future increases in labour productivity. Analysis of the impact on the UK economy of demographic ageing by the Bank of England makes the assumption that labour productivity will grow in the long run by a constant 1.75 per cent per annum, with 30-44 year olds consistently exhibiting 40 per cent greater productivity than younger and older workers (although, as noted in chapter 5 below, empirical evidence on the relationship between age and productivity is inconclusive). This productivity growth dominates the stagnation in the size of the future workforce, producing a more than doubling of "effective" labour supply in the period 2001-51.[28] An additional (and cautious) assumption of a growth in capital stock by 10 per cent per decade results in a projection that income per capita will more than double in real terms over the next half-century.

3.5. Estimates of this sort are subject to a degree of error. It was noted by Professor Richard Disney (Professor of Economics, University of Nottingham) that labour economists do not know how ageing will affect productivity (Q802); this issue is discussed further in chapter 5 below. However, projections of long-run productivity growth are based on assumptions that future improvements in the quality of human and physical capital will be broadly distributed throughout the economy, and will produce economic returns consistent with long-run historical experience. Even if assumptions about the level of age-specific productivity prove to be incorrect, such errors will have only a small impact on future income as long as similar rates of productivity growth are achieved by workers of all ages.

3.6. Population ageing over the next 50 years is likely to have a small negative impact on the growth of income per capita, primarily by reducing the size of the workforce relative to that of the inactive population. Any action that can be taken to increase age-specific participation rates would diminish this negative economic impact (we discuss such possibilities in chapters 4, 5 and 6 below). However, the expectation of continued labour productivity growth in the long run, together with continued capital accumulation, is likely to ensure that real income per capita grows, most probably doubling its 2002 level by the middle of the 21st century. For those entering the labour force today and retiring in the middle of the century, GDP at present growth rates will be 2 to 2.5 times what it is now.

3.7. We conclude that population ageing does not pose a threat to the continued prosperity and growth of the United Kingdom economy; in this sense, therefore, there is no looming "crisis" of population ageing in the United Kingdom.

3.8. This does not mean that the future growth of the economy is in any sense guaranteed; that depends on how we manage our economic resources. A failure, for example, to sustain historic rates of technological progress and productivity growth might drastically reduce future growth rates below those projected here. We conclude, however, that such risks exist independently of any demographic pressures on the economy.

Ageing, inflation, saving and capital accumulation

3.9. As well as affecting the size of the working population, ageing will also increase the proportion of the population that is retired, if current age-specific participation rates are maintained. This could have important economic effects on inflation, saving and capital accumulation. Evidence on these issues was presented by Professor Philip Booth (Professor of Insurance and Risk Management, City University Business School), who had previously undertaken a study of the economic impact of demographic changes for the Foresight Ageing Population Panel of the Department of Trade and Industry in 2000. Note was also taken of the Bank of England's assessment of these issues.

3.10. In theory an increase in the proportion of the population of non-working age will increase demand for goods and services relative to the ability of the working population to supply such goods and services, thus leading to inflationary pressures. However, such pressures for a relative increase in the supply of consumption goods are likely to be met by a reduction in the demand for capital goods, together with a liquidation of overseas assets accumulated by retirees during their working life. Professor Booth concludes that "there may be changes in the equilibrium level of interest rates and exchange rates necessary to contain inflation and such changes may mean that the management of monetary policy is more complex. However, there is no reason to believe that there will be an increase in inflation."[29]

3.11. An increase in the relative size of the retired population could affect rates of saving, interest, and capital accumulation. The Bank of England has noted that this represents a key area of uncertainty for two separate reasons: it is unclear how the savings behaviour of older people in the future will develop; and domestic savings may not be the primary determinant of domestic investment in a competitive international capital market.[30]

3.12. Uncertainty about future savings behaviour is likely to be minimised if individuals feel that they can save with confidence. In general, conditions of low and stable inflation will produce a consistent relationship between real and nominal interest rates, which will be conducive to savings. The Government's commitment to a low and stable rate of inflation, as monitored by the Monetary Policy Committee of the Bank of England, can thus be seen as providing an appropriate economic context for population ageing.

3.13. Standard economic theory posits that individuals will pursue a pattern of "life-cycle savings" in which they accumulate assets during their working years, and decumulate them during retirement. Population ageing over the next 50 years will increase the number of individuals living in the decumulation phase of life, while the number living in the accumulation phase will remain constant or decline slightly. This could lead to more individuals wishing to sell assets than buy (a decline in the net savings rate), which would tend to reduce asset values and increase interest rates (though it should be noted that household saving in the United Kingdom in 2000 accounted for just 3.5 percentage points of GDP, out of an aggregate savings total of 16 per cent of GDP).[31]

3.14. On the other hand, actual outcomes may be very different. Over the last quarter of the 20th century, measured savings rates recorded in household surveys tended to rise with age, with households aged 75+ exhibiting higher saving rates than younger households, including those of prime working age who are likely to be in the middle of their accumulation phase.[32]

3.15. These recorded savings rates appear to overstate the true level of net savings, because they do not include the effective decumulation of pension assets by retired households. Analysis by Professor David Miles, which makes an adjustment for this mis-measurement, indicates that demographic change could reduce the United Kingdom aggregate national savings rate by 8 percentage points by 2030.[33] The Bank of England notes that a change in aggregate savings of this amount would, by reducing capital accumulation, slow down the rate of growth of output.[34]

3.16. Any such decline in domestic savings would put upwards pressure on the rate of return on domestic capital, and so would tend to attract capital from abroad, though this effect would be diminished to the extent that other industrial countries face greater demographically induced reductions in their domestic savings rates.

3.17. On balance the Bank of England concludes that there remains considerable uncertainty about the impact of ageing on saving, interest rates and capital accumulation, but on the balance of probability the net effect is likely to be small. Both Professor Booth and the Bank of England concur that ageing is most unlikely to cause a collapse in asset values as more people begin to decumulate.[35] They note that the long-run volatility of United Kingdom equity and bond yields in the past has not been correlated with underlying demographic trends, and there is little reason to suppose it will be in the future.

3.18. We conclude that population ageing may affect savings, interest rates and capital accumulation, but its effect is likely to be small relative to the large range of other economic and political factors which determine the course of these economic aggregates.[36]

26   DWP, volume II, p 3 Back

27   HM Treasury, Long-term public finance report: an analysis of fiscal sustainability, November 2002, cited by DWP, volume II, p 3 Back

28   Garry Young, The implications of an ageing population for the UK economy, Bank of England Working Paper 159, July 2002, p 13 Back

29   Professor Booth, volume II, p 276 Back

30   Young, The implications of an ageing population for the UK economy, p 35 Back

31   Ibid, p 16 Back

32   Ibid, p 17 Back

33   David Miles, 'Modelling the impact of demographic change upon the economy', Economic Journal, vol 109 (1999), pp. 1-36 Back

34   Young, The implications of an ageing population for the UK economy, p 35 Back

35   Booth, volume II, p 271; Garry Young, 'Ageing and the UK economy', Bank of England Quarterly Bulletin, Autumn 2002, p 290 Back

36   Similar conclusions have been drawn for the United States: J.M Poterba, 'Demographic structure and asset returns', MIT mimeo, 2000 Back

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