VIEWPOINT : Some Nations Are Obsessed With Aging : Fears About Pension Costs Holding Back Economic Growth

You would think that international economic policy-makers would be more or less preoccupied with trying to enhance the prospects for the world economy this year and next--perhaps with just enough time left over to cast the occasional glance into the early 1990s.

But the focus of policy debate among leading industrial countries is now stretching not simply into the next decade but into the next century. And, encouraged by international organizations such as the Paris-based Organization for Economic Cooperation and Development, some governments are using concern about potential economic dislocation in the year 2000 and beyond as a spurious justification for their present policies.

The argument centers on how the inevitable aging of the populations in many Western nations will affect public finances over the next 25 years or so and, more specifically, on the possibility that the greatly increased pension burden could lead to a rapid deterioration in the ratio of those countries’ public debt to their gross national product.

Policy-makers in Tokyo, Bonn and several smaller European countries have found in these demographic trends a convenient excuse to resist demands by the United States that, after several years of retrenchment, they should now begin to relax their fiscal policies in order to maintain the momentum of economic growth.

View of Pessimists

The pessimists put it like this: In nations such as Japan, West Germany and Italy, the proportion of pensioners in the overall population will soon begin to rise sharply because of the failure of birth rates since World War II to keep up with the number of people moving out of the labor force into retirement.

Unless governments continue to reduce public debt as a proportion of GNP by cutting back on budget deficits now, their successors will be forced to implement massive rises in tax and social security payments in order to meet the increased pension bill and higher debt-servicing costs early in the next century.

In contrast, the argument runs, the United States, with a different demographic profile and a labor force constantly replenished by young immigrants, will see little relative change in the size of its elderly population over the next 25 years and so will not face anything like the same problems.

The OECD’s latest half-yearly economic report gives the pessimists some useful ammunition. The organization forecasts that in Japan, for example, the number of people receiving pensions will rise from just over 18% of the labor force last year to 40% by the year 2010. In West Germany, the figures are even more alarming--an increase from 29% in 1985 to more than 40% in 2010 and to a startling 63% two decades later.

Against that, in the United States, the percentage should remain fairly constant at about 25% to 2010 before rising steadily in the succeeding two decades.

Cast-Iron Justification

The OECD then factors in these demographic trends to its projection of public sector debt-to-GNP ratios in the main industrial countries and comes up with what at first sight appears a cast-iron justification for the United States’ trading partners to stick with their present austere approach to fiscal policy. In Japan, it says, the government’s pension obligations could push up the ratio of public debt to GNP from about 25% now to more than 100% in the year 2010. In West Germany, the progression might be from just over 20% to 85%.

And if those countries allowed their budget deficits to widen now, the figures would be even worse.

The message to Bonn and Tokyo, then, is that they should stick with present policies and ignore calls from the United States to relax policy to at least partly counterbalance the contractionary impact on world economic growth of reductions in its own budget deficit.

The problem is that several of the premises underpinning the OECD’s argument are doubtful, and its central thesis misses the point.

To take two of the premises first. The calculations on debt-to-GNP ratio are made on two key assumptions: first, that economic growth throughout the industrialized world remains at the fairly depressed levels seen over the past few years; and second, that interest rates will continue to remain higher than growth rates in the period to 2010, further worsening public finances.

Both of those assumptions are highly likely to prove too pessimistic. The growth rates seen over the past few years are atypical rather than typical of the experience since World War II, and most economies are currently expanding at a pace well below their productive potential. Faster growth would significantly reduce the prospective ratio of debt to GNP.

There is also no reason to suppose that interest rates--which still reflect the inflationary traumas of the 1970s--will inevitably remain at their current high inflation-adjusted levels indefinitely.

But there is also a much more fundamental objection to the OECD’s reasoning.

The argument that governments should opt for austerity now to cope with higher pensions in the future focuses on the division of an apparently predetermined “national cake” (GNP) between the productive and unproductive sections of the population.

The real issue that governments should be confronting is how they can maximize the size of that overall cake to ensure that there is enough for everybody.

In other words, they should be promoting higher productivity and faster growth in GNP, which in turn would act as a natural brake on public debt ratios.

If that process can be helped along by tax cuts or increases in public investment--even at the expense of slightly higher budget deficits now--then those policies, not austerity, represent the prudent course. It used to be called investing in the future.