Growth imperative for aging Asia

Asia has aged dramatically over the last few decades, and the changes in the age structure of the population are already having a strong effect on government expenditure, revenues and fiscal balances. If not managed carefully, the fiscal impacts of aging populations could pose risks for many Asian economies.

During the 1950s and 1960s, most Asian populations were relatively young, on average, but the proportion of children has declined rapidly since 1970, raising the relative sizes of two other groups - people of working age (between 15 and 59) and those over the age of 60.

Changing Asia
These effects have been noticeable in many countries, most notably Japan. But Asia is now entering a third phase, in which the proportion of older people is increasing dramatically. By 2030, 20 Asian countries will have reached this final phase of the demographic transition.

This transition will have an important impact on government spending, and on public policy more generally. The beneficiaries of public programs are primarily children, through spending on education, and the elderly, through state pensions, while most of the fiscal burden is borne by the shrinking working age population.

As the proportion of older people grows, countries across Asia should be prepared for significant increases in government spending. Rapid economic growth, which further increases demand for public services across all age groups, will add to the pressure for further government expenditure.
In a recent working paper entitled “Demographic Change and Fiscal Sustainability in Asia,” my colleagues and I simulated the impact of population aging and economic growth on the public finances of Asian countries.

Demographic change in developing Asia
We found that developing Asian countries face an average increase in public expenditure amounting to 2.2 percentage points of gross domestic product over 40 years. Put another way, average public expenditure in developing Asian countries will increase from 25.4 percent of GDP in 2010 to 27.6 percent in 2050.

The rise in public expenditure is particularly dramatic in East Asia, with the average share of GDP rising from 16.9 percent in 2010 to 27.5 percent in 2050. In China, the projected rise is yet more dramatic -- moving from 22.4 percent to 33.9 percent of GDP, a projected increase of 51 percent.
This sharp increase reflects rapid aging combined with relatively high rates of economic growth. In South Korea, public spending will increase from 19.8 percent in 2010 to 32.4 percent in 2050, in large part due to the aging of the population. In a number of other countries outside East Asia, public expenditure will also grow quite rapidly. For a few countries, only a small increase is projected because forecast population aging is limited. Government expenditure in Bangladesh, India, and the Philippines is projected to reach 12.6 percent, 16.5 percent and 16.9 percent of GDP, respectively, in 2050.

Clawing money back
The corollary of increased expenditure is that economic growth will be the main driver of increased government revenues. Tax revenues averaged 15.1 percent of GDP in Asia in 2010, but this figure is projected to increase to 19 percent of GDP by 2050.

The projected increase in revenue is driven by an increase in income levels, and in some developing economies by an increase in the working age population as well. Very large increases are projected for China, where tax revenue as a share of GDP soared from 9.9 percent in 1995 to 18.2 percent in 2010, and is projected to reach 37.3 percent by 2050. That is an increase of 105 percent over a 40-year period. But for South Korea and [Taipei,China] tax revenues will increase very little, since the negative effect of population aging partially offsets the positive effects of growth. Only Japan will experience a decline in tax revenues as a share of GDP, due to its shrinking working age population.

However, tax revenues are only part of government revenues, and the relative importance of tax revenue and non-tax revenue varies considerably from country to country. In some Asian countries, non-tax revenue is more important than tax revenue.

Importance of government revenues
East Timor is an extreme case, where tax revenues accounted for only 1.5 percent of GDP in 2010, even though government revenue was 22 percent of GDP in the same year. This is because foreign aid makes up the lion’s share of the government budget.

Another extreme case is Brunei, due to a large part of its revenues coming from petroleum and natural gas sales. For developing Asia as a whole, government revenues averaged 21 percent of GDP in 2010, and this figure is projected to rise to 24.1 percent in 2050.

With government expenditure expected to rise to an average of 27.6 percent of GDP across the region, but revenues rising only to 24.1 percent, governments in Asia should be paying close attention to fiscal sustainability. A rough, first-order indicator of this is the fiscal balance, which refers to the government’s income from tax and non-tax revenues minus government spending.

Interestingly, China shows the most dramatic improvement in fiscal balance between 2010 and 2050, from a deficit of 1.7 percent  of GDP to a surplus of 6 percent, even though population aging is well under way. On the other hand, South Korea’s surplus of 1.3 percent of GDP will turn into a deficit of 9.7 percent and [Taipei,China]’s deficit of 2.8 percent will widen to 15.1 percent. For Asia as a whole, a deficit of 1.5 percentof GDP will shrink slightly to 1.1 percent.

Addressing Asia’s policymakers
At first sight, the findings of this research might seem reassuring to Asian policymakers concerned about the effect of population aging on fiscal sustainability. The primary cause for optimism is Asia’s continued rapid growth, notwithstanding its slowdown since the global financial crisis. This explains China’s fiscal improvement.

At the same time, however, population aging -- which has already begun in most of the region -- will adversely affect fiscal sustainability. The drastic deterioration of projected fiscal balances in South Korea and [Taipei,China] should serve as a stark and sobering reminder for younger Asian countries that are following in their demographic footsteps.

Nevertheless, Asia is far from powerless in mitigating the negative fiscal impact of less favorable demographics. Public policymakers will have to make wise decisions as they move to shore up public pensions systems and increase medical coverage for the elderly. Above all, sustaining healthy growth will help to reduce the impact.

(Donghyun Park is principal economist in the economic research and regional integration department of the Asian Development Bank)