Policymakers should start worrying now! Why? First, we’re already at the point where capital markets are starting to take account of some long-term factors. In the past year and a half, most major investment banks have appraised the economic implications of demographic change in industrial countries. Second, these issues are best handled while there is still sufficient time to make adjustments in the fiscal framework and in the behavior of households. Acting now will allow us to foster policies that reduce potential tensions, create incentives to increase appropriate investment, finance research and development to encourage adaptation to relatively certain developments and to narrow uncertainties, and take preventive measures to minimize potential fiscal costs. It will also allow households to begin to adapt their behavior to the financial benefits they can genuinely expect from the government in the future. Third, some of these issues, such as health care, are going to be very difficult to address. There will be troublesome ethical and political dimensions that will take some time to resolve.
Fourth, many fiscal uncertainties remain. Governments typically accept the need to respond to unanticipated shocks even when there is no legal obligation to do so. They need sufficient fiscal leeway, yet we have created enormous fiscal rigidities that will be much harder to tackle if we wait much longer. These issues will have to be dealt with. We’re not going to have tax ratios rising to 70 or 80 percent of GDP, so the question is, how do we deal with problems that we can readily foresee, despite obvious uncertainties? Will they be dealt with smoothly or abruptly, in a way that precipitously changes the positions of households and individuals?
Finally, these are not costs that bear only on remote generations. Those alive today will bear much of the burden: you and I could conceivably live another 40-50 years. While 2050 might seem a long way off, what will happen then is not irrelevant to our welfare and is certainly not irrelevant to that of our children and grandchildren.
The IMF has already started, in its annual surveillance discussions with member countries, to do some analyses of fiscal sustainability that look at long-term fiscal dynamics. These have related mostly to demographic issues rather than a broader composite of possible developments. I also believe that other multilateral institutions—the World Bank, the World Health Organization, the United Nations, the UN Environmental Agency—have a responsibility to take a long-term view in their assessments of global trends and to push hard for greater public awareness of their implications.
We in the IMF could also do more. For example, in our public assessments of fiscal transparency practices, we could underscore more strongly that countries, as a matter of course, must explore and assess alternative long-term fiscal scenarios and carry out long-term risk assessments of their balance sheets. In our research, we could pursue some of the more sophisticated techniques of economics that try to gauge the effects over time of demographic trends and large external shocks, such as climate change.
It means getting away from thinking only about stable, linear scenarios and focusing also on the possibility of adverse shocks and their fiscal consequences. What would be the consequences of several adverse scenarios occurring in a roughly similar time frame? How would we address such situations, and what would be the impact on the fiscal framework?
The challenging question you raised earlier was “how do you make governments think about these things?” Another policy approach involves, essentially, institutionalizing an independent perspective on the long-term fiscal situation. I have already argued that budget laws should require governments to prepare long-term scenarios. I believe that it is vital to have some kind of independent national mechanism (perhaps analogous to the U.S. Congressional Budget Office) to evaluate the long-term assessments that a government makes. Such a body should raise questions and force debate on whether governments have adequately addressed significant future risks and challenges.
I also believe that fiscal rules, such as the euro area’s Stability and Growth Pact (despite its shortcomings), have a very beneficial role to play because they can implant some fiscal discipline in a government, reducing public debt ratios substantially over the long term. Finally, there is no substitute for detailed assessments of how expenditures will evolve over time, taking account of long-term structural factors. When a particular program is likely to become a source of fiscal pressure over the long term, policy reforms to affect the likely time path of expenditure are warranted. We have already begun to see such pension reform initiatives in a number of Western European countries.
IMF Survey: With regard to demographic and other changes, isn’t it fair to say that developing and industrial countries will be confronting different problems with different causes and solutions?
Another potential area of cooperation would involve strengthening the capital markets of emerging market economies and developing countries. The IMF has focused on this issue in the past several years. If we can promote and facilitate flows of capital to these economies where there is the potential for higher rates of return on investment, we’ll all be better off. It’s a win-win solution. But it requires far greater strengthening of governance in the capital markets of these countries to mitigate and reduce the risks investors now face.
Industrial countries risk dampening the pace of global economic growth if they fail to tackle the fiscal issues associated with aging populations.
Addressing global disparities in income is a third area of cooperation. Industrial countries and their populations can lose only if massive income disparities persist in 15 to 20 years. Large parts of the world where people are desperately poor will be a source of global instability. It’s very shortsighted of us not to recognize that the greatest risks we confront are these sources of political instability, which foster terrorism and disruptions to economic activity. A scaling up of official development assistance is long overdue.
Beyond promoting development in the poorer countries through mutually beneficial investment, there’s an equal imperative for industrial countries to promote solutions to long-festering political crises. This means the Israeli-Palestinian conflict, the India-Pakistan dispute over Kashmir, and the North Korean situation. One can also foresee potential tensions associated with the scarcity of water in the Middle East, south Asia, and elsewhere, as well as competition for oil resources in the South China Sea and the Caspian region. The world community must address these issues. The events of September 11 and the SARS epidemic showed that problems arising in one region can quickly have global economic ramifications.
Finally, climate change is something that we’re all very aware of. The Intergovernmental Panel on Climate Change has provided reasonably conclusive evidence that it will happen—affecting precipitation patterns, the sea level, and the frequency and impact of extreme weather events. There is a small probability that such changes will occur abruptly rather than gradually over the century. Industrial countries could sponsor research and development to narrow existing areas of uncertainty on the dimensions of climate change and to develop new technologies that will facilitate adaptation and prevent excessive costs from being borne by affected countries.
Clearly, too, developing countries should explore preventive steps. Large coastal cities are likely to be vulnerable to extreme weather events and a rise in the sea level. This suggests the need for policies to discourage further coastal infrastructure development and to encourage infrastructure and population settlements in less exposed areas.
Thinking long term is also likely to require a stronger emphasis on human capital development because it can increase a country’s options for economic development. It also argues for taking account of the experience of industrial countries and learning from their mistakes, such as in the area of social insurance systems. This means being aware of how demographic change can alter the financial viability of a policy program and the dangers of excessive precommitments of budget resources.
But there are also obvious grounds for pessimism—take, for example, the events of the last couple of years. There’s political disorder in many regions, growing disparities of income, and the prospect of large parts of the world remaining in a kind of “fourth” world state—not privy to the medical care or technologies available even in middle-income countries. There are many uncertainties of climate change that are scary, and we have to worry about them. The myopia of politicians and the public with respect to long-run challenges is also worrying, as is the prospect of a shortsighted, graying electorate. All these issues can make one very pessimistic.
But, on balance, I would rather dwell not on optimism or pessimism but on the stance we take in approaching the future. In working for the international community, I have cast my lot with trying to promote an intelligent response to future challenges.
The myopia of politicians and the public with respect to long-run challenges is also worrying, as is the prospect of a shortsighted, graying electorate.
Copies of Who Will Pay? Coping with Aging Societies, Climate Change, and Other Long-Term Fiscal Challenges are available for $28.00 from IMF Publication Services (please see page 325 for ordering details).