The Future of Saving
The Role of Pension System Design in an Aging World

This SDN explores how demographic changes have affected and will affect public and private sector savings, highlighting the interaction between pension systems, labor markets, and demographic variables.

Abstract

This SDN explores how demographic changes have affected and will affect public and private sector savings, highlighting the interaction between pension systems, labor markets, and demographic variables.

INTRODUCTION

1. Looming aging challenge and saving. Many advanced and emerging market economies are facing rapid, unprecedented aging of their populations, driven by declining fertility and rising life expectancy. Previous work (for example, Clements and others 2015) has shown that population aging and dwindling working age populations could place significant pressure on public pension systems, eroding public savings.1 This is because more retirees will receive benefits while fewer people will work and contribute to the system through taxes. Not surprisingly, policy debates around the world have focused on the long-term sustainability and requisite reform of pension systems. However, less attention has been devoted to prospects for private, and hence aggregate, national saving. How will the forthcoming demographic shifts affect private saving decisions? Will the design of pension systems have differential implications for private and aggregate saving patterns across countries?

2. Interaction between public and private saving. Saving patterns typically change with age: the young borrow, prime working age individuals save, and the old dissave after retirement. Aging is thus likely to depress private saving as the percentage of elderly people in the population rises, and longer lifespans mean that people might need to save more for retirement throughout their working lives. The impact of demographic changes on private saving decisions will depend, among other factors, on the design of government pensions and social safety nets.2 Variation in the availability, structure, and coverage of pension systems around the world could influence individuals’ saving decisions. For instance, lack of development and coverage of pension systems could cause households to save too little for retirement, particularly if financial markets do not offer appropriate saving instruments. However, insufficient coverage could also encourage excessive precautionary saving. On the other hand, overly generous pension regimes featuring early retirement provisions could create disincentives to work and affect saving behavior. The interaction between aging and pension systems is therefore crucial to understanding private saving behavior and its evolution across countries.

3. Why does this interaction matter? At the individual level, savings provide households with a cushion to smooth consumption and plan for the future. For those coming of working age now, pensions won’t provide as large a safety net as they did for earlier generations. In many countries, efforts to address the financial sustainability of pension systems by reducing pension generosity could force the future elderly to live in poverty. Furthermore, because most household saving is done by the highest income earners, lack of savings could be a particularly acute problem for the poor. At the macro level, understanding the implications of demographic developments and pension system characteristics for future saving is critical, as national saving is an important source for financing domestic investment and absorbing country-specific shocks, with implications for growth and economic stability. The saving rate also determines how fast a country can rebuild buffers at a time of historically high global debt (IMF 2018b). Motives for personal saving and the design of pension systems could also directly influence individual saving behavior, thereby affecting the overall net foreign asset position of a country and the composition of investment portfolios (Staveley-O’Carroll and Staveley-O’Carroll 2017; Eugeni 2015). This has implications for the dynamics of international capital flows, external imbalances, and global interest rates.

4. This note. This note investigates how forthcoming demographic shifts and the design of retirement systems could influence saving rates across countries. Building on previous studies that highlighted the fiscal consequences of aging, this analysis focuses on the interplay between public and private saving, as well as the role of pension system attributes (coverage of the elderly, benefits, and the type of funding) in shaping saving profiles across countries in the coming decades. The findings suggest that differences in countries’ progression along the demographic transition will interact with their pension system characteristics, resulting in differential paths for private and public saving rates. Aggregate saving is influenced by the promise of generous retirement benefit payouts; rapidly aging countries with generous public pension systems could experience a precipitous decline in both public and private saving. The results also suggest that the aging-related decline in private saving could be mitigated by funded defined contribution (DC) pension systems.

5. Caveats. The analysis does not provide an assessment of the optimal level of saving or the desired degree of generosity of a pension system (IMF 2018a). In addition, aggregate saving in an economy depends on the distribution of income within and across generations, with welfare implications that are not explicitly addressed in this analysis. The analysis also abstracts from behavioral changes and an explicit examination of the demographic impact on growth and productivity. Finally, the note does not examine the consequences for saving of the transition from a pay-as-you-go (PAYG) system to a fully funded system, which can be ambiguous. With those caveats, the partial equilibrium analysis in this note offers simple inferences on the evolution of public and private saving across different countries under a no-policy-change scenario.

6. Roadmap. The next section provides an overview of demographic developments and the current design features of pension systems around the world. It includes a simple overlapping generations (OLG) model to illustrate the channels through which demographic variables (longevity, fertility, old-age dependency) affect both public and private saving. The model provides intuition for empirical estimates of the impact of demographic factors and pension system design on private saving. The estimation results are used in conjunction with public pension spending projections to simulate potential paths for the evolution of national saving rates. Finally, policy implications for improving pension systems and alleviating other structural impediments to saving (for example, financial market constraints and labor market imperfections) are discussed.

DEMOGRAPHIC AND PENSION SYSTEMS TRENDS

A. Demographic Trends

7. Aging societies. The global population is undergoing a significant transition; after a record increase in the 20th century, population growth is decelerating.3 Declining fertility rates, combined with increased life expectancy, will result in older populations in the coming decades (Figure 1). In many countries—especially Japan and some European countries—fertility rates are below those required to replace the population. At the same time, life expectancy at age 65 is projected to increase by around a year per decade. As a result, by 2050, on average, the old-age dependency ratio—the ratio of the elderly population (65 years and older) to the working age population (15–64 years)—will double. Today, Japan is the only country with an old-age dependency ratio over 40; by 2050 more than 55 countries will exceed that ratio.

Figure 1.
Figure 1.

Demographic Developments

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Sources: UN World Population Prospects 2016; and IMF staff calculations.Note: Population weights are used to sum across country groups.

8. Asynchronous demographic transitions and implications. Countries are at different stages of the demographic transition (Figure 2 and Annex 1). The pace and timing of the transition will have different implications across countries for labor supply and for private and public saving rates.

  • Most advanced economies and some emerging market countries (for example, Russia and Ukraine) are in the late stage of demographic transition, with aging well underway and the working age population declining or about to decline. United Nations projections suggest that the working age population will fall by about 20 percent in Europe between 2015 and 2050 and by almost a quarter in Korea. In the United States, Australia, and New Zealand, however, the working age population will still be growing over this period. A lower share of workers in the population means that output per capita will fall and national saving rates could potentially decline, owing to increased transfer payments to and lower private saving rates among the growing elderly cohort.

  • Other emerging and some developing countries (for example, China and some countries in Latin America) are at an advanced stage of demographic transition, having already enjoyed the bonus of a demographic dividend—a period during which the working age population expands relative to the young and the old. More workers makes it easier to take care of a relatively smaller pool of elderly people through intergenerational transfers (pensions or intrafamily transfers) and contributes to higher saving rates in some countries. This bonus has now ended in many countries in this group and will end very soon for the rest.

  • In countries at an early stage of demographic transition (for example, India, Mexico, Indonesia, and countries in the Middle East and North Africa), fertility rates are declining but remain relatively high, with the share of working age population expected to peak in coming decades.

  • Countries in the pretransition demographic phase (mainly countries in sub-Saharan Africa) have yet to experience the benefits of a demographic dividend (IMF 2015a) and are not the focus of this note.

Figure 2.
Figure 2.

Demographic Transitions across Countries

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Sources: United Nations World Population Prospects 2016; and IMF staff calculations.Note: The k-means clustering method was used to create four groups of countries based on their current state in the demographic transition (see IMF 2015b, Annex 1).

9. Workforce aging, labor force participation, and saving. The rapid aging of the labor force in countries at the late and advanced stages of demographic transition is already shifting the composition of the workforce from relatively young to relatively old workers. Workforce aging can affect national saving, as saving rates typically differ by age: individuals borrow when they are young, save during their working years, and deplete their savings once they reach retirement. Aging can also affect labor force participation, as the elderly tend to participate in the labor force at much lower rates.4 Assuming that age and gender cohort-specific labor force participation rates remain unchanged from 2015, the projected change in the age structure of working age population in favor of older age cohorts could lower labor force participation for both men and women (Figure 3).5 The resulting decline in aggregate labor force participation would weigh on the sustainability of social security systems by lowering the ratio of contributors (workers) to beneficiaries (pensioners), a trend that is exacerbated where the working age population is expected to shrink.

Figure 3.
Figure 3.

Projected Changes in Labor Force Participation Rates, 2015–50

(Percentage points)

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Sources: OECD (2017); and IMF staff calculations.Note: Projections are based on population projections under the United Nations’ medium fertility scenario as weighted averages of age and gender cohort-specific labor force participation rates, which are assumed to be constant.

B. Pension Systems and Aging

10. Architecture of pension systems and aging. Differences in pension system arrangements and their funding have important implications for how aging could affect saving (see Box 1 for a taxonomy). Most countries rely on defined benefit (DB) pension schemes, under which benefits depend on the number of years of contributions and the individual’s earning history, typically complemented by a means-tested basic pension (Figure 4). Some countries have defined contribution pension systems based on individual accounts, which often coexist with the DB scheme. Pension systems also differ in the extent to which liabilities are prefunded. Most DB schemes are financed on a PAYG basis, in which general revenues or specific contributions from current workers and employers fund the benefits of current retirees. In contrast, pension benefits in most DC schemes depend on the value of accumulated assets over the individual’s working life. This difference in funding structure implies that aging (by increasing the ratio of elderly beneficiaries to younger workers who fund benefits) is likely to have a direct impact on public saving in PAYG schemes and (through the life-cycle theory of saving) on private saving in DC systems.

Figure 4.
Figure 4.

Design Features of Mandatory Old-Age Pension Systems around the World, 2015

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Sources: US Social Security Administration (2015-16); and IMF staff calculations.Note: Charts are based on data for 36 advanced economies and 135 emerging and developing market economies. DB includes traditional defined benefit as well as basic pension schemes (flat rate or means-tested). DC includes mandatory individual account schemes. Other includes basic pension schemes only. DB = defined benefit; DC = defined contribution.

11. Public pension system parameters and private saving. The parameters of public pension systems can influence workers’ consumption-versus-saving decisions. The impact on private saving depends largely on pension system generosity, which encompasses both the size of benefits per person (the benefit ratio) and the coverage (the percentage of elderly people who receive a pension). With a more generous pension system, retirees will have to rely less on private saving. As a corollary, low benefit ratios or low coverage can induce higher private saving, as people save on their own to avoid a large drop in their living standard at retirement.6 There is significant cross-country heterogeneity along these two dimensions (Figure 5). In Europe, for instance, Greece and Cyprus provide pension benefits that are about 65 percent of the average economy-wide wages. The corresponding number is less than 30 percent in Latvia and Ireland. Advanced economies provide some type of public pension benefits to nearly all of their elderly citizens. In most emerging and developing economies, however, only a third to two-thirds of the elderly are covered, because pension systems were designed to cover salaried workers or those in urban areas, leaving those who are self-employed or in the informal economy outside the system.7

Taxonomy of Pension Systems

Arrangements. In defined benefit pension schemes, benefits typically depend on the number of years of contributions and ultimate (or average) covered earnings; in defined contribution pension schemes, benefits depend on contribution history and the returns on these contributions. Some countries also offer a flat-rate component that does not depend on previous earnings and that might be means-tested (Australia, Iceland, Indonesia, Malaysia, New Zealand, South Africa).

Funding. Another distinguishing feature of pension systems is whether they are pay as you go (PAYG) or fully funded. PAYG systems use current employer and employee contributions to pay for current benefits to the retired. For their long-term sustainability, they depend on the ratio of contributors to pensioners. In funded systems, contributions are invested in assets with the objective of financing future retirement benefits. Most public systems are PAYG, although a few have some degree of private funding (Canada, United States). In contrast, private pensions are typically fully funded. Different arrangements can be funded in different ways. For example, notional defined contribution systems are defined contribution but financed on a PAYG basis (Italy, Sweden) and some defined benefit systems are funded (private defined benefit schemes in the Netherlands and the United Kingdom).

Compliance. Most governments mandate participation in some type of pension scheme, with participation requirements, benefit eligibility, and benefits defined by law. This is the case for most public pensions, but some countries (many in Latin American and Europe) also mandate participation in private schemes. Some schemes are voluntary, typically intended to complement the mandatory schemes, with the choice to participate left to individuals and their employers. This is often the case for private pension systems, such as the 401(K) retirement saving schemes in the United States.

12. Aging and fiscal support for pension systems. Pressures on public saving may arise even in funded systems, because increases in longevity or lower than expected investment returns could cause funding to fall short of providing adequate pension benefits at retirement. Governments might have to make up part of the future shortfall, draining public resources. Fiscal support ratios that relate taxpayers to public pension system beneficiaries are also estimated to rise between 2010 and 2050 in many advanced economies. For European countries, tax revenues would have to be between 14 percent and 28 percent higher than they are today (or expenditures commensurately lower, or some combination of the two) just to offset the increased costs of aging populations (Lee and Mason 2017). For Japan and the United States, the corresponding numbers are 26 percent and 11 percent, respectively.

Figure 5.
Figure 5.

Frequency Distribution of Coverage and Benefit Ratios around the World, 2015

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Sources: European Commission 2015 Ageing Report; World Bank Pension Database; and IMF staff calculations.Note: Coverage of the elderly is defined as the number of old-age pensioners divided by the population 65 years and older. The data are reported for 148 countries. Coverage may be over 100 percent where people can retire before age 65. The benefit ratio is defined as the ratio between the average pension benefit and the economy-wide average wage. These data are reported for 29 countries in Europe.

13. Trade-offs associated with recent pension system reforms. To deal with the costs of aging, many countries have enacted significant pension reforms in recent years. Reforms aim largely at containing the growth in the number of pensioners, typically by changing the key parameters of the pension system; for example, increasing the retirement age, tightening eligibility rules, or reducing the size of pensions by adjusting benefit formulas. Many of these parametric reforms have improved the long-term sustainability of DB/PAYG pension systems. However, additional reforms may be needed; for example, rationalizing generous grandfathering arrangements in earlier reforms (Italy, Portugal); reducing benefit ratios (Argentina, Brazil); and curtailing early retirement benefits (Russia). In many countries, reforms have been designed to protect current pensioners, shifting most of the adjustment burden to future generations of retirees (Chen and others 2017). In some countries, changes in the indexation of pension benefits are likely to erode real pension benefits over time, potentially contributing to old-age poverty (Hernandez de Cos, Jimeno, and Ramos 2017). In the 1990s a number of countries introduced DC systems that were funded by redirecting contributions from existing public PAYG systems. This transition put pressure on public saving, as it worsened the finances of the public scheme. In addition, lack of advance funding, low coverage, and low contribution rates continue to plague many DB and DC systems, with attendant implications for pension adequacy down the road. Because pension savings tend to be concentrated in high-income households for both types of pension systems, rapid aging could also exacerbate income inequality in the future.8

IMPACT OF DEMOGRAPHIC DEVELOPMENTS ON SAVING

A. Theoretical Underpinnings

14. Model framework. Building on the existing literature, a small open economy overlapping generations model is developed to illustrate the interactions between demographics, pension system design, and saving. A theory of national saving evolves from its components: private and public saving. The model’s findings provide guidance for the ensuing empirical analysis (see Annex 2 for a more detailed description).9 In the model, economic agents live for three periods: (1) as children, (2) as workers, and (3) if they survive into old age, as retirees. The assets of those who do not survive into old age are redistributed to the workers as bequests, capturing within-family intergenerational transfers. Members of the working age population are the only active economic decision makers. They optimally choose their labor supply, consumption, and saving. They also give birth to offspring at an exogenous fertility rate and bear childrearing costs that are proportional to the number of offspring.10 Economic agents survive into old age and become retirees with an exogenous probability of survival. The two exogenous demographic parameters—life expectancy (longevity) and the fertility rate—jointly determine the old-age dependency ratio. A higher survival probability translates into higher life expectancy at birth. Other than longevity risk, the model abstracts away from uncertainties that could give rise to motives for precautionary saving. The small open economy takes the global interest rate as given.

15. Modeling pension systems. The model features both private pensions and a public PAYG defined benefit scheme that covers all retirees. Workers save to fully fund their private pension benefits, which can be viewed as a DC pension plan. The public pension benefit that a retiree receives is proportional to his or her wage income during the working years. Given universal coverage, the public pension is considered more generous the higher the benefit ratio. The government levies an income tax on labor at an exogenous and constant rate to finance the public pension system, which can be financially unbalanced. The government can thus engage in borrowing or saving, and public saving reacts to changes in demographic trends and pension parameters. A pension deficit reduces public saving, whereas a surplus increases it.

16. Model predictions. This stylized model illustrates the main channels through which demographic developments and public pension systems affect national saving. In particular, it examines the impact on public and private saving of a one-time permanent (steady-state) increase in life expectancy and reduction in fertility rate, as well as changes in pension system generosity.

  • Demographic change and private saving: A lower fertility rate increases private saving, as households need to spend less on childcare. This effect is partially mitigated by a labor supply response: a smaller fraction of labor income devoted to childcare encourages individuals to work more, thus increasing consumption. In line with theoretical models that capture life-cycle behavior, higher life expectancy at retirement raises private (DC pension) saving of the working age population to finance old-age consumption.11 However, the impact of a longer lifespan on labor supply depends on a number of offsetting factors (see Annex 2). Both lower fertility and higher life expectancy increase the old-age dependency ratio and thus the share of dissavers relative to savers in the economy. This demographic compositional effect depresses private saving. Thus, the overall impact on private saving depends on which effect dominates.12

  • Public pension system generosity and private saving: Public pension generosity has both a direct and an indirect effect on private saving. Public pension benefits and private saving are substitutes when it comes to providing old-age retirement income: higher pension benefits mean that individuals have to save less to finance consumption in retirement.13 This result is consistent with both theoretical and empirical findings that countries with PAYG systems tend to have private saving rates that are lower in direct proportion to the generosity of public pension benefits (Eugeni 2015; Samwick 2000; Curtis, Lugauer, and Mark 2017; Rezk, Irace, and Ricca 2009; Bloom and others 2007; Feldstein 1976). There is also an indirect effect. The magnitude of the impact of aging on private saving depends on pension generosity, as demographic variables and pension generosity jointly determine the level of saving. In particular, higher generosity amplifies the positive effect on private saving by the working age population as life expectancy rises. Thus, economies with similar demographic trends can exhibit different private saving behavior owing to differences in pension system characteristics.

  • Public saving: A reduction in the fertility rate or a higher life expectancy increases the old-age dependency ratio, lowering public saving because public pension expenditure rises relative to tax revenue. The negative impact on public saving is more pronounced in countries with relatively generous public pension systems. Higher pension generosity reduces both public and private saving.

  • Changes in the global interest rate: The model also sheds light on the impact on private saving of changes in the global interest rate. A lower return on assets discourages saving (the substitution effect), but lower future income from savings can induce workers to reduce current consumption, thereby increasing saving (the income effect).14 The overall impact depends on which effect dominates. In addition to these income and substitution effects, a lower interest rate also reduces the size of bequests relative to the size of the economy. Because bequests are another source of saving in the economy, a lower global interest rate reduces private saving as a share of GDP.

17. Transition dynamics. This analysis does not explicitly capture the transition dynamics of an aging economy or the costs involved in moving from PAYG to funded pension systems.15 In general, a switch from an unfunded to a funded system would require one generation of workers to pay for two retirements—their own and that of the generation ahead of them—or would require several generations to bear the transition costs. Such a transition could raise national saving by reducing the consumption of the transitional generations, but it would also leave workers in those generations worse off. A study by Boersch-Supan and others (2006) suggests that the saving rate increases during the transition from a PAYG pension system to a partially funded pension system; however, other studies (Aguila 2011; Samwick 2000; Villagomez and Hernandez 2010; World Bank 2006) find the impact of such pension reforms on saving rates to be inconclusive.

18. Additional considerations not captured in this framework. The small open economy setting of this framework simplifies the analysis but precludes an assessment of how demographic changes affect the global interest rate and international capital flows. An extension to the model featuring two countries and unrestricted international capital flows shows that the impact of aging on private saving is dampened by the decrease in the global interest rate, lowering incentives to save. Further, the model does not incorporate financial and labor market imperfections that could affect saving decisions. For instance, private saving could increase with the availability of financial instruments that satisfy the diverse portfolio preference of savers or raise the net return on savings.16 Financial sector development could also alleviate credit constraints, driving down precautionary saving (Jappelli and Pagano 1994; Bandiera and others 2000). Similarly, labor market conditions (for example, the risk of unemployment) can affect saving decisions, as workers have a stronger motive for precautionary saving when the risk of unemployment is higher (Berloffa and Simmons 2003; Engen and Gruber 2001).17 The risk of the government defaulting on its pension obligations is not explicitly modeled; however, the model does imply that the working age population will save more if this risk becomes more prominent and effective pension generosity declines. With all these limitations, the model nevertheless offers useful insights into how demographics and pension system attributes, and the interaction between the two, affect saving rates, and how these effects can vary across countries.

B. Empirical Estimation of Private Saving

19. Empirical specification for private saving. The model’s predictions for the interplay between public saving, demographic variables, pension systems, and private saving are empirically tested using reduced-form cross-country panel regressions (see Annex Table 3.2 for a summary of empirical model specifications used in the literature). Results are presented in Table 1, and a set of robustness checks is discussed in Annex 3. Pension system characteristics are represented by two variables. The first captures whether the pension system is generous, as the theoretical model suggests that saving behavior is different in countries with more generous pension systems. Pension generosity is defined as the product of the benefit ratio and the coverage ratio.18 This definition encompasses both the size of the benefits an elderly person receives and the number of elderly people covered by the pension system, providing a comprehensive measure of public pension spending (see World Bank 2013). The second variable captures the existence of a DC pension scheme. As suggested by the theoretical model, the presence of a DC scheme should lead to higher private saving. The interaction terms in the specification capture how pension system attributes influence the impact of demographics on private saving. The impacts of credit constraints, labor market conditions, and other macroeconomic variables are included as controls, with the choice of variables informed by the existing theoretical and empirical literature (see Grigoli, Herman, and Schmidt-Hebbel 2014; Loayza, Schmidt-Hebbel, and Serven 2000; Aizenman and others 2017). The baseline empirical approach relies on fixed-effect panel regressions using annual data, covering 75–100 advanced and emerging market economies over the past four decades (see Annex 3 for model specification). Table 1 reports the results of a static regression specification similar to that of Bloom and others 2007; Gutierrez 2007; and Li, Zhang, and Zhang 2007 (see Annex 3 for robustness to alternative estimation methods).

20. Impact of public saving and demographics. Consistent with the predictions from the life-cycle model, there is a negative and statistically significant relationship between the old-age dependency ratio and private saving (columns 1–5 in Table 1).19 A longer lifespan (proxied by the expected longevity of a current 40-year-old) is associated with higher private saving, with each year of expected additional life adding about a percentage point to the private saving rate. There is also evidence of a partial, yet substantial, direct offsetting movement in private saving owing to higher public saving, which, in turn, is affected by demographic factors and pension system sustainability.20, The net impact of a one dollar reduction in public saving is a private saving increase of 60 cents, pointing to the presence of some degree of Ricardian equivalence through intergenerational links. 21 This result is consistent with the view that the perceived sustainability of the public pension system (captured by public saving) is negatively correlated with private saving.

Table 1.

Private Saving Panel Regressions

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Source: IMF staff calculations.Note: The table reports results of private saving regression estimated using fixed-effects panel regressions with robust standard errors clustered at the country level. All regressions include a constant term and time dummies. ***, **, * indicate statistical significance at the 1 percent, 5 percent, and 10 percent level, respectively. A list of countries included in the regressions can be found in Annex 3. DC = defined contribution, PPP = purchasing power parity

21. Pension system design matters. The effect of aging (higher old-age dependency ratio or declining working age population) on private saving is mediated by pension system attributes. Higher pension system generosity amplifies the negative effect of a changing age structure (the composition effect) on private saving. Moreover, the impact of aging on saving is mitigated in the presence of a DC pension system. Specifically, the results suggest that a 1 percentage point increase in the old-age dependency ratio decreases private saving by 0.5 percentage points in countries without a DC scheme and with nongenerous PAYG/DB public pensions (see column 4 of Table 1). For countries with generous PAYG/DB public pension schemes but no DC scheme, private saving falls by about 0.6 percentage points, as retirees need to rely less on their own savings. However, this effect is reversed in countries with a DC pension system, as such schemes induce employed people to save more for their self-funded retirement. Overall, accounting for pension system design, the results suggest that a 1 percentage point increase in the old-age dependency ratio results in a 0.3 percentage point decrease in the private saving rate. These results hold across specifications and estimation methods.22 The interaction between longevity and pension system characteristics is less robust (for example, it loses significance in column 5 of Table 1 for the presence of a DC scheme), as the effects of generosity and the presence of DC schemes are likely captured by their interaction with the old-age dependency ratio.

22. Caveats. Caution is advised in drawing definitive policy implications from cross-country regression analysis, as different pension system policies are likely to have varying effects across countries and at different points in time. Moreover, pension system characteristics are multidimensional by nature, and measurement limitations (for example, coverage, retirement incentives, replacement rates in public PAYG and funded systems) must be considered in comparing these dimensions. Reverse causality and nonlinear relationships between some covariates and the private saving components are also possible.23 However, even when the structural relationship linking these variables is unlikely to be fully captured and there is limited focus on transition dynamics, the exercise can still be used to examine the outlook for private saving.

C. Saving Projections

23. Future of saving. How will forthcoming demographic changes affect private saving and public finances, and thus national saving, through 2050? To address this question, the analysis addresses the impact of demographic changes and pension characteristics on public and private saving. The first step is to estimate the effect of expected demographic developments and enacted pension reforms on public pension system outlays, relying on the authorities’ projections for future pension spending, which incorporate assumptions about reforms adopted to date (including changes that will take effect in the future).24 It is assumed that the projected increase in public pension spending translates fully into lower public saving. This impact can be viewed as a lower bound of the effects of demographic change, as other aging-related spending—health expenditure in particular—is assumed not to increase (see Box 2). Second, model coefficients from the empirical analysis (column 4 of Table 1) are used to project private saving as a function of demographic factors (changes in old-age dependency ratios and life expectancy), pension system characteristics (pension generosity and the existence of a DC system), and projected public saving saving (owing to changes in public pension spending)25. Demographic variables are assumed to evolve in line with the United Nations medium-fertility variant scenario, while all other determinants are held constant. The analysis supports exploratory inferences about how differences in countries’ progression along the demographic transition will affect their saving profiles in the coming decades, given their pension system attributes.

Health Care and Saving

Health care costs constitute an important channel through which demographic changes can affect both private and public saving. As with pensions, the impact of demographic changes on saving depends on the characteristics of health care systems, including the generosity, coverage, and quality of public health care programs and the extent of participation in private health insurance. Health care costs tend to follow a life-cycle pattern: average per capita costs tend to be higher in early years, drop during adolescence, and increase progressively beginning in the mid-forties. Thus, the projected increase in the relative number of elderly people is expected to push up health care spending. Aging-related pressures on overall saving grow with higher longevity, as needs for precautionary saving in response to uncertainties regarding medical expenditure and long-term care rise disproportionately with higher old-age life expectancy and incomes (De Nardi, French, and Jones 2009).

Health care costs are also affected by nondemographic factors, including the adoption of new technologies and the relatively lower productivity increases in services relative to other sectors of the economy (Baumol 2012). This renders projections of health care spending subject to more error than projections of pension expenditure. For instance, prices of medical services and medicines are determined in part by market conditions, and technological innovations not only affect processes but also make new treatments available. Thus, any projections of health care spending have a high degree of uncertainty, even assuming an unchanged policy environment.

24. Declining public saving. Demographic developments will drive up pension costs, putting public saving on a long-term downward trend globally. Worldwide, public pension spending pressures could depress public saving by just over 2 percentage points of GDP by 2050, with significant differences across countries.26 Reflecting recently enacted reforms, public saving in most advanced economies could fall modestly (by about 1 percent of GDP) between now and 2050 (Figure 6). For instance, in rapidly aging Germany, past reforms to curtail generosity and increase retirement age are projected to contain pension spending increases to slightly over 2 percentage points of GDP by 2050. In contrast, the United States has undertaken less significant reforms but has a relatively younger population and higher population growth. Hence, population aging is more gradual, resulting in a projected increase in pension spending of 1.6 percentage points of GDP by 2050 (Figure 7). Overall, in advanced economies, the projected spending on public pensions under current policies implies significant future reductions in the average pension (Figure 6). In other words, implicit or explicit commitments on generosity can be kept only if public pension spending increases beyond authorities’ current projections. The projected decline in public saving is larger for emerging markets and developing economies, and particularly pronounced for countries experiencing rapid aging and those in which pensions have yet to be reformed.27 For instance, in Brazil and China, pension expenditure is projected to increase by 7 and 6 percentage points of GDP, respectively, by 2050.

Figure 6.
Figure 6.

Projected Pension Spending and Generosity in Advanced Economies, 1970-2050

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Sources: Eurostat; OECD (2017); and IMF staff calculations.Note: Average pension-to-GDP per worker can be viewed as a proxy for the benefit ratio (the average pension divided by the average preretirement earning). They both measure the extent to which an individual’s pension adequately substitutes for his or her preretirement earnings. As GDP per worker is higher than average preretirement income, average pension-to-GDP per worker is lower than benefit ratios. Data after 2010 are projections.
Figure 7.
Figure 7.

Contribution to Pension Change, 1990–2050, Select Countries

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Sources: Country authorities’ pension spending projections; and IMF staff calculations.Note: Generosity is defined as the product of public spending per pensioner as a ratio of the average GDP per worker and pension coverage (number of pensioners as a fraction of the population 65 years and older). Employment measures the fraction of the population of working age that is employed. Aging is captured by the old-age dependency ratio, which measures the number of elderly people in relation to the working age population. Projections for Poland do not include the decrease in retirement age since October 2017.

25. Evolution of private and aggregate saving. The evolution of private and national saving depends on the interaction of demographic developments with pension system attributes. Assuming unchanged country weights, global saving could potentially decline by about 3 percentage points of GDP between now and 2050.28 In emerging markets and developing countries collectively, higher private saving by relatively younger populations offsets the projected decline in public saving, resulting in broadly stable national saving. In contrast, private saving rates in aging advanced economies are expected to contract sharply, leading to a steep overall decline in aggregate saving rates (Figure 8). These aggregates mask substantial heterogeneity across countries, driven by differences in demographics and pension system design.

Figure 8.
Figure 8.

Saving Projections by Country Groups

(Percent of GDP, averages)

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Sources: IMF World Economic Outlook; and IMF staff calculations.Note: Projections in 2016 and later years include data for 74 countries that accounted for over 80 percent of world GDP in 2016.

26. Saving rate heterogeneity: stage in demographic transition. Differences in the timing of the demographic transition play a role in influencing saving dynamics across countries (Figure 9). In late-stage transition countries, private saving is projected to fall significantly as older age groups (which have high dissaving) make up an increasing share of the total population. Together with lower public saving, this translates into a sharp projected decline in national saving by over 4 percentage points of GDP, on average, between now and 2050. In contrast, national saving among countries in the advanced demographic transition stage is projected to remain broadly stable, as higher private saving offsets public dissaving. However, large disparities in saving rates underlie this average. Saving in many countries in Latin America and the Caribbean that will experience rapid aging has hovered below 20 percent of GDP in recent decades. In contrast, China is notable for its high saving rate over the past 35 years (Box 3). Countries in the early transition stage will see the bonus from a growing working age population and declining family sizes fade, moderating the increase in private and aggregate saving observed in the recent past. In pretransition countries, both public and private saving are projected to increase significantly given their relatively young and rapidly growing populations.

Figure 9.
Figure 9.

Changes in Saving Rates by Demographic Transition Stage

(Percentage point change)

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Source: IMF staff calculations.Note: The box denotes the 25–75 interquartile range as well as the weighted average. World GDP is calculated as the sum of the US dollar values of the countries. Changes between 1980 and 2015 represent actual data; changes between 2015 and 2050 are based on projections.

27. Saving rate heterogeneity: role of pension system characteristics. Within the demographic groupings above, saving projections differ markedly depending on pension system generosity and the presence or absence of a DC scheme. Private saving is projected to increase in countries with DC schemes, on average by about 8 percentage points of GDP by 2050. This effect more than offsets the projected decline in public saving, owing to the simultaneous presence of PAYG public pensions in some countries (Figure 10, left). In contrast, private saving is expected to decrease by about 6 percentage points of GDP in countries with PAYG pension schemes, as the system itself does not encourage higher wealth-holding by individuals. This, in combination with higher age-related public pension spending, will lead to a substantial decline in national saving (Figure 10, right). In general, benefit generosity pushes up pension spending while weighing down public saving. Private saving falls somewhat as retirees need to rely less on their own saving; thus, aggregate saving in countries with generous public pension systems is projected to decline sharply (Figure 11, left). Conversely, inadequate pensions can drive up private saving, as they induce retirees to save more for their mainly self-funded retirement. This effect is especially pronounced when precautionary motives against longevity or earnings risk are an important component of household saving decisions. In countries with the least generous public pension systems, private saving is therefore projected to increase slightly by 2050 (Figure 11, right).

Saving Trends in China

Saving trends in China have received considerable attention. China has one of the highest national saving rates in the world, exceeding 40 percent of GDP since 2000 and peaking at 52 percent of GDP in 2008, with a gradual decline thereafter. Several studies have identified precautionary motives as important drivers of this trend (Chamon and Prasad 2010; Zhang 2017). A weak social safety net, including limited pension system coverage, encourages households to save to be able to deal with adverse events through private means. Although reforms introduced in recent years have led to an increase in pension outlays, pension generosity remains relatively low. Other factors that contribute to high household saving include rapid economic growth, a growing share of the working age population, and tight credit constraints (World Bank 2013).

Population aging will lead to a reduction in China’s saving in the future. However, the interaction of aging with pension system characteristics suggests that the decline in aggregate saving may be less pronounced than aging alone would suggest. China is in the advanced stage of demographic transition, with a rapidly aging population structure owing to much lower fertility than other countries at a similar stage of economic development. The old-age dependency ratio is expected to more than triple between 2015 and 2050 from the current level of 13 percent, exerting downward pressure on both public and private saving. Still, assuming unchanged policies, low pension generosity, and the presence of a defined contribution system, the model suggests that national saving will broadly hold steady rather than decrease over the projection horizon.

Figure 3.1
Figure 3.1

Saving Projections for China

(Percent of GDP, averages)

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Source: IMF staff calculations.

Policy efforts and behavioral changes could lead to a further reduction in saving (IMF 2017). As detailed in Zhang (2017), strengthening the social safety net and changing consumption behavior of younger generations will likely decrease the national saving rate by about 4 percentage points by 2022.

Figure 10.
Figure 10.

Saving Projections by Type of Pension System

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Source: IMF staff calculations.Note: World GDP is calculated as the sum of the US dollar values of the countries. DC=defined contribution.
Figure 11.
Figure 11.

Saving Projections by Pension System Generosity

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Source: IMF staff calculations.Note: World GDP is calculated as the sum of the US dollar values of the countries. The generosity grouping is taken for the year 2015.

28. Individual country trends. The importance of pension system design for saving is clear when countries with similar demographic patterns but different pension system characteristics are compared (Figure 12). Take Tajikistan and Pakistan, two countries in the early stage of demographic transition. The pension system in Tajikistan features a DC scheme; that in Pakistan does not. This difference in pension system design leads to significant differences in the evolution of saving: between now and 2050, aggregate saving rates are projected to increase by 2 percentage points of GDP in Tajikistan and to decline by about 2½ percentage points of GDP in Pakistan. Another example is Russia and Australia, two countries in the late demographic transition stage.29 Both countries have a DC system, but pensions in Russia are more generous relative to national income than those in Australia. As a consequence, aggregate saving in Australia is expected to increase at a much faster pace than in Russia. Projections for China and Korea also suggest that low pension generosity drives up precautionary private saving.

29. Illustrative projections. While this framework provides simple inferences on the evolution of public and private saving across different countries under a no-policy-change scenario, several considerations apply. First, the framework is based on partial equilibrium analysis and abstracts from behavioral and policy changes and price effects. For instance, the evolution of government saving patterns in the future could depend on other factors that moderate the fiscal impact of aging, such as tax and labor market reform and changes in non-age-related spending. Second, relationships observed in the past between aging and private saving (that is, the estimated regression coefficients) may not be good predictors of the future. In addition, cohort effects may be important in shifting profiles of saving at different ages; for example, in the future, middle-aged people might increase their saving in response to longer lifespans.30 Third, the analysis of the effects of demographic changes on saving through the prism of pension systems could be further refined; for example, by using more granular data on replacement rates or accounting for pension system assets. Finally, changes in saving rates would be driven by long-term trajectories of productivity growth, but demographic changes could depress productivity and growth prospects, lowering the rate of return on savings. Given these considerations and the substantial uncertainty surrounding demographic projections, the projections in this discussion note should be viewed as illustrative and are not intended as forecasts.31

Figure 12.
Figure 12.

Saving Projections for Individual Countries

(Percent of GDP, averages)

Citation: Staff Discussion Notes 2019, 001; 10.5089/9781484388990.006.A001

Source: IMF staff calculations.

CONCLUSIONS AND POLICY OPTIONS

30. Aging challenge and saving. Aging populations will have important consequences for the evolution of saving rates across countries. Under current policies, public pension outlays in advanced and emerging market economies will increase by an average of 1 to 2½ percentage points of GDP, respectively, by 2050, depressing public saving. The impact on private and aggregate saving depends on the interaction of asynchronous demographic transitions and the design of retirement systems; that is, funding, coverage, benefits promised to the elderly, and when they would start receiving those transfers. Thus, the appropriate responses to the aging challenge will vary across countries and will have to account for country-specific policy and institutional settings, including how pensions are determined and financed. For instance, in countries with relatively high saving rates and inadequate social security systems, increasing generosity may be warranted. In rapidly aging countries with relatively low saving rates and rising pension liabilities, the challenge will be to increase saving ratios in a sustainable way. For today’s younger generations in many countries, saving more for the future will become increasingly important to ensure retirement income security.

31. Public pension system reforms. Overly generous pension benefits (owing to high benefit ratios or a low statutory retirement age) can interact with projected demographic trends to lower aggregate saving. Reducing public pension generosity (for example, curtailing early retirement benefits or reducing benefit ratios) could attenuate long-term fiscal vulnerabilities and moderate the fall in aggregate saving. To counter these trends, today’s workers will need to prepare for the future by saving more and extending their work lives. In advanced economies where pensions have been largely reformed, for those born between 1990 and 2009, simulations suggest that increasing the retirement age by five years (from today’s average of 63 to 68 in 2050) would close half the projected gap in benefit ratios relative to today’s retirees. If members of the same cohort were to put aside an additional 6 percent of their earnings each year, they would close the other half of the gap in the benefit ratio. Financial sector and labor market policies could support such behavioral changes.

32. Balancing sustainability and equity considerations. The distributional consequences of pension system reform can be significant. While ongoing and planned reforms will improve pension system sustainability, average benefit ratios are projected to decline sharply in many countries. Thus, additional pension system reforms would need to be carefully calibrated to avoid undercutting the welfare of future retirees and fueling poverty among the elderly. One option would be to link additional increases in retirement age to longevity gains, with adequate provisions for the poor, whose life expectancy tends to be shorter than average. To minimize unintended negative consequences of such programs on aggregate saving (either through excessive fiscal costs or indirectly by crowding out private saving), antipoverty programs should be carefully designed and targeted.

33. Improving pension system adequacy to reduce precautionary saving. In China, for instance, the transition to a market-based economy that began in the 1980s resulted in a weakening of the social safety net, reducing pension spending and social transfers to very low levels. Lower income households now have a saving rate of 20–30 percent, compared with minus 20 percent in many peer countries (IMF 2017). Similarly, in Korea, the public pension system covers only about a third of the elderly, and replacement rates are low by international comparison, resulting in a saving rate of nearly 30 percent. These countries have room for fiscal maneuver; they could redirect resources to reduce old-age poverty by expanding coverage of the social security systems, raising social pensions, and enhancing targeted social transfers. These actions would reduce households’ need for precautionary saving while ameliorating inequality and old-age poverty.

34. Boosting private saving by improving pension system architecture. The presence of a DC scheme can support higher private saving rates, attenuating the negative effect of aging on national saving. Countries with an enabling environment might consider complementing the public pension scheme with a funded DC scheme.32 However, such reforms are not a panacea to deal with the aging challenge; for example, too few people may be covered or contribute to the system, or contributions over the working life of an individual may fall short of providing adequate pension benefits at retirement—many private pension funds are underfunded.33 In addition, future returns on savings (interest and investment rates) in an aging world could be lower, leading to lower-than-expected returns on the accumulated assets in such systems. In this case, governments might still have to make up for at least part of the gap. Country experiences also suggest that pension system transitions from PAYG to funded schemes can generate large and persistent fiscal costs (to fulfill the promises made to people who had contributed to the old systems) that reduce national saving.

35. Development of financial sector instruments to encourage voluntary saving. The ability of households to diversify retirement-related risks will depend on the availability of age-specific financial products (for example, annuities and long-term care insurance). Countries with underdeveloped financial sectors would benefit from boosting financial inclusion (for example, efforts to reduce the costs of bank account for individuals) and creating sound and resilient banking sectors that offer the right mix of long-term saving instruments. Financial literacy could foster a culture of saving and help people better plan for retirement. And government policies could focus on increasing voluntary private saving; for example, by providing tax-preferred saving vehicles related to pensions, such as the 401(K) plans in the United States. Tax-preferred general or education saving accounts could also be considered, but participation of middle-income households would be essential for these schemes to generate additional saving rather than displacing existing saving elsewhere (OECD 2007). Nudges to encouraging workers to save can also help; for example, by automatically enrolling them in pension schemes, as in the United Kingdom.

36. Counteracting the effect of aging on labor supply. On current demographic trends, many countries will face a declining labor force, which will drive down saving. Policies should focus on reforms that close gender gaps in labor force participation (as was done in Italy and Spain) and encourage people to lengthen their productive work lives, given their increased longevity. Policy actions could include ensuring equal remuneration for equal work and providing childcare services. Governments can make it easier for older people to remain in the workforce by reconsidering taxes and benefits that favor early retirement. Migration could also play a role in boosting the labor force in many advanced economies, but this is a politically contentious issue. In many emerging market economies, it is important to decrease the large share of young people who are neither participating in the labor market nor studying. Furthermore, reducing the large share of the labor force that does not work in the formal sector—and thus does not pay taxes or contribute to social security—could boost saving. Education and training policies could use some modifications to better align skills with rapid technological change, which will replace labor in some sectors but may be labor-augmenting in others (Manyika and others, 2017). Private (and to some extent public) saving will play a key role in helping individuals cope with these trends and changes.

The Future of Saving: The Role of Pension System Design in an Aging World
Author: Mr. David Amaglobeli, Hua Chai, Ms. Era Dabla-Norris, Mr. Kamil Dybczak, Mauricio Soto, and Alexander F. Tieman