DEMOGRAPHIC DEFICIT: HOW AGING WILL REDUCE GLOBAL WEALTH, THE

Accountancy SA,  Jul 2005  by Farrell, Diana,  Shavers, Tim,  Ghai, Sacha

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To fill the coming gap in global savings and financial wealth, households and governments will need to increase their savings rates and earn higher returns on the assets they already have.

The world's population is aging, and as it gets even grayer, bank balances will stop growing and living standards, which have improved steadily since the industrial revolution, could stagnate. The reason is that the populations of Japan, the United States, and Western Europe, where the vast majority of the world's wealth is created and held, are ageing rapidly (Exhibit 1). During the next two decades, the median age in Italy will rise to 51, from 42, and in Japan to 50, from 43. Since people save less after they retire and younger generations in their prime earning years are less frugal than their elders were, savings rates are set to fall dramatically.

In just 20 years, household financial wealth in the world's major economies will be roughly $31 trillion1 less than it would have been if historical trends had persisted, according to new research by the McKinsey Global Institute (Exhibit 2).2 If left unchecked, the slowdown in global-savings rates will reduce the amount of capital available for investment and impede economic growth.

No country will be immune. For the United States-with its relatively young population, higher birthrates, and steady influx of immigrants-the ageing trend will be relatively less severe. Still, its savings rate is already dismally low, even before the baby boomers have started to retire. To finance its massive current-account deficit, the United States relies on capital flows from Europe and Japan, but they too face rapidly ageing populations. Even fast-growing developing countries such as China will not be able to generate enough savings to make up the difference.

Finding solutions won't be easy. Raising the retirement age, easing restrictions on immigration, or encouraging families to have more children will have little impact. Boosting economic growth alone is not a solution, nor is the next productivity revolution or technological breakthrough. To fill the coming gap in global savings and financial wealth, households and governments will need to increase their savings rates and to earn higher returns on the assets they already have. These changes involve hard choices but can offer a brighter future.

Growing older, saving less

In just two decades, the proportion of people aged 80 and above will be more than 2.5 times higher than it is today, because women are having fewer children and people are living longer. In about a third of the world's countries, and in the vast majority of developed nations, the fertility rate is at, or below, the level needed to maintain the population. Women in Italy now average just 1.2 children. In the United Kingdom, the figure is 1.6; in Germany, 1.4; and in Japan, 1.3. Meanwhile, thanks to improvements in health care and living conditions,3 average life expectancy has increased from 46 years in 1950 to 66 years today.

As the elderly come to make up a larger share of the population, the total amount of savings available for investment and wealth accumulation will dwindle. The prime earning years for the average worker are roughly from age 30 to 50; thereafter, the savings rate falls. With the onset of retirement, households save even less and, in some cases, begin to spend accumulated assets.

The result is a decline in the prime savers ratio-the number of households in their prime saving years divided by the number of elderly households. This ratio has been falling in Japan and Italy for many years. In Japan, it dropped below one in the mid-1980s, meaning that elderly households now outnumber those in their highest earning and saving years. Japan is often thought to be a frugal nation of supersavers, but its savings rate actually has already fallen from nearly 25 percent in 1975 to less than 5 percent today. That figure is projected to hit 0.2 percent in 2024. In 2000, the prime savers ratios of Germany, the United Kingdom, and the United States either joined the declining trend or stabilised at very low levels. This unprecedented confluence of demographic patterns will have significant ramifications for global savings and wealth accumulation.

How the decline in prime savers will affect total savings depends on how these people's savings behaviour changes over the course of a household's life. Germany, Japan, and the United States have traditional hump-shaped life cycle savings patterns (Exhibit 3). In these countries, ageing populations will cause a dramatic slowdown in household savings and wealth. In contrast, Italy has a flatter savings curve, resulting in part from historical borrowing constraints that forced households led by people in their 20s and 30s to save more. Thus, an increase in the share of elderly households will have less impact on the country's financial wealth.

In some countries, the relatively lower savings rates of younger generations in their peak earning years will exacerbate the slowdown in savings and wealth. In the United States and Japan, where we analysed generation-specific savings data, several factors contribute to this pattern: a tendency to rely more on inheritance than past generations did, the good fortune to avoid the economic hardships that prompted earlier generations to be more frugal, and the availability of consumer credit and mortgages (which, in the case of Japan, have become more socially acceptable).