Andrew Coleman on the effects of the world’s population-centre moving towards the Indian Ocean

Gather around and listen to a story! It’s a tale, that if told better, might be worthy of Scheherazade herself … It involves life and death, great threats and missed opportunities, difficult problems and difficult solutions, and an ending that could be happy or sad. It might even be the story of the 21st Century – the Sinbad Century.

THE DEATH OF DEATH

The story begins with the greatest success story of the last 200 years: the decline of death. Globally, average life expectancy at birth has increased from just 20-30 years in 1800 to 70 now.

This increase in life expectancy is not just due to reduced infant mortality, for age-specific death rates have fallen at all ages. One measure of this is life expectancy at age 20, which has increased from 55 in most pre-industrial countries to 85 in most rich countries.

Another measure is the additional life expectancy conditional on reaching 65 years. This is still increasing: in England, where the big increase in life expectancy first took place, male life expectancy conditional on reaching 65 years has increased from 14 extra years in 1988 to 18 extra years now, and female life expectancy has increased from an extra 18 years to an extra 21 years over the same period. Similar improvements are occurring in Japan, where life expectancy at birth should soon be 90, the highest in the world.

The decline of death has led to a huge increase in the world’s population, from 1 billion in 1800 to 7.5 billion today. In recent years, the fastest increase in the population occurred among those over 65 years old. When the world population reached 7 billion in 2012, 570 million people (or 8% of the population) were over 65. By 2030 there will be 1 billion people over 65. In 2050 the number will increase to 1.5 billion, or 16% of the world’s estimated 9.5 billion people.

NZ’s population is not ageing particularly quickly, due to rapid inward migration. Currently 15% of NZ’s population, or 750,000 people are over 65. By 2050 this fraction should increase to 24-26%, depending on migration. This fraction will be slightly higher than Australia and similar to the US, but lower than most of Europe and East Asia.

THE DEATH OF BIRTH AND THE SINBAD CENTURY

Population ageing also reflects the decline of birth. If all countries had birth rates at long-run replacement levels (2.1 babies per woman), and if all countries had developed-country age-specific mortality rates, approximately 25% of people would be aged over 65.

Countries such as Japan that had a very short baby boom in the 1950s followed by decades of fertility rates lower than 2.1 will not only have very large fractions of old people but they will also have declining populations because of the low birth rate. Indeed, Japan is only expected to have 100 million people in 2050, down from 125 million now, and South Korea, Germany and Russia are all expected to lose 10% of their populations by then. Even China is likely to have 60 million fewer people by 2050.

Current trends mean birth rates in most countries should be equal to or lower than replacement levels by 2050. There are three major exceptions: most countries in Africa, the Middle East, and parts of South Asia, particularly Bangladesh and Pakistan.

Even though Africa will have many more older people, in 2050 it will still have a young and expanding population because of a very high fertility rate, at around 4.4 births per women. Africa’s population should increase from 1.1 billion now to 2.4 billion in 2050, accounting for more than half of the world’s projected increase.

Nigeria may be as populous as the US by 2050; Ethiopia may increase from 100 million to 230 million; Tanzania and Uganda from 50 million to nearly 115 million; and even Mozambique will more than double to 60 million. The agricultural and medical advances that see the number of old people in Africa sharply increase will not create a significantly ageing population in Africa in our lifetimes, because of the high birth rates.

Given these population trends, it seems reasonable to describe our century as the Sinbad Century – because what should be the last great human population increase is centred around the Indian Ocean.

POPULATION AGEING AND ECONOMICS

Economists focus on the following four population ageing issues.

(1) What happens to the number of people working in the economy as a fraction of the population?

(2) What happens to health care and long-term care costs?

(3) What happens to savings and the supply of capital, and how will this affect the productivity of workers?

(4) What happens to government finances, particularly the costs of pensions and health care?

The rest of this article is about the last two issues. Globally, the big story is whether capital assets can be accumulated by ageing countries and sent to the workers in the Sinbad countries, to raise their productivity levels. If this can be achieved, it will help both young and old have prosperous futures. What’s more, it may be the key to solving global warming.

CAPITAL INVESTMENT AND GLOBAL WARMING

The interplay of declining birth rates and declining death rates that causes population ageing can also create a temporary saving bonus. When workers increase their savings as they approach older age, there can be a large increase in the supply of capital resources.

This phenomenon was very noticeable in countries that passed through their demographic transitions in fast motion: countries such as Japan, the Asian tigers and now China all had large increases in saving ratios and current account surpluses. These savings can be valuable. Properly invested, they can enhance the productivity of the workforce and allow the substitution of capital for the slowly diminishing size of the labour pool as the population ages.

When the savings of people approaching older ages are invested in the education of the young, in machinery and infrastructure, and in firms’ research programmes, there is considerable potential to ease some of the cost pressures associated with ageing. Japan has specialised in this; a lot of their private savings are directed towards machines that reduce the number of carers needed to look after older people.

The savings associated with population ageing may be the solution to the world’s most awkward issue. The burgeoning populations of the Sinbad countries are the poorest on earth. Naturally these countries want to develop, but this has always taken vast quantities of capital and energy, and in the past this has always meant coal, gas, or oil – and CO2 (see Ayres and Warr, 2009).

So, how do we let half of the world’s population develop without massively increasing the amount of CO2 in the atmosphere?

There may be a way. Technological breakthroughs in renewable energy and storage technologies mean the lifetime costs of renewable electricity are now competitive with gas-fired electricity and cheaper than coal (Heal, 2018). This means Sinbad countries could develop without a massive increase in carbon usage.

One of the difficulties, however, is that renewable electricity has much higher up-front costs than carbon-based electricity, even though it has much lower ongoing costs. It is expensive to build renewable energy plants, an expense most developing countries will struggle to meet because they are capital poor.

Even though it is cheaper in the long run to build renewable energy than coal-fired generators, this won’t happen because the capital doesn’t exist in these countries now. It could exist if capital were transferred from currently rich countries, whose ageing populations wish to accumulate capital for their retirements. Recycling this capital from ageing countries to young countries to enable green development is possibly the greatest opportunity of our time.

There are two major constraints. The first is ensuring the recipient countries have the appropriate political and institutional structures that encourage investment without expropriation. This is no small task. No one wants to invest in an undeveloped country if they believe the country is too corrupt to operate properly, or is likely to take the proceeds of their investment.

The second constraint is to ensure the potential population ageing dividend – the savings of middle-aged people planning to retire – is productively invested.

RETIREMENT SAVINGS AND TAX

Here there are two problems: (1) tax, and (2) the design of retirement saving programmes. The tax issue is conceptually straightforward, but very important in NZ.

To take advantage of the demographic saving bonus, savings need to be productively invested. This means the tax system shouldn’t artificially encourage investment in one sector or another (unless it is to solve some externality problem such as pollution).

Investment opportunities should be equally taxed – or equally not taxed. Unfortunately, NZ does this particularly poorly; more than most rich OECD countries, NZ has a tax regime that encourages investment in housing and property rather than other assets.

The problem is not really the way NZ owner-occupied housing is taxed, for it is taxed in a similar fashion to many other countries (Coleman, 2017). The problem is the way other assets, particularly retirement savings accounts, are taxed.

EET VERSUS TTE

Without getting into the technical details here, most OECD countries tax dedicated savings accounts in an Exempt-Exempt Taxed (EET) basis: money placed in the account is not taxed when it is earned and deposited in the account, the returns are not taxed as they accumulate, but the whole sum is taxed when it is withdrawn in retirement.

The EET system provides a broadly similar approach to the way housing is taxed, because neither the return to assets nor the return to housing (the rent you save by owning your own house) are taxed. Consequently, there is no artificial incentive to invest in housing.

In contrast, NZ taxes retirement savings on a Tax-Tax-Exempt (TTE) basis: money earned is taxed before it is deposited in the account, the returns are taxed as they accumulate, but the whole sum is exempt from tax when it is withdrawn in retirement.

The TTE system significantly raises the tax paid on retirement savings and provides an incentive to invest in housing. It is not a policy designed to finance green-energy technologies around the world. From a global perspective it is fortunate that NZ’s approach to the taxation of retirement savings has not been copied by any other countries.

PAYGO VERSUS SAYGO

The second problem is the design of government retirement savings schemes. The structure of these schemes makes a big difference to the way capital resources are accumulated because some schemes, such as New Zealand Superannuation, do not accumulate capital at all.

NZ Superannuation is primarily funded on a pay-as-you-go (PAYGO) basis, which means tax is collected from one group of people and given to over-65 year olds. No money is saved; no investments are made.

The alternative approach is to fund NZ Superannuation or other retirement schemes on a save-as-you-go (SAYGO) basis, in which the taxes are collected and saved and invested and used to pay pensions in the future. SAYGO financing can lead to a significant accumulation of assets, as we observe from the private sector. The NZ Superannuation Fund is a step in this direction.

YUP, r > g … SO WHAT?

This is not the place to discuss all of the differences between PAYGO and SAYGO pension schemes, even though this is the most important fiscal topic facing young New Zealanders. The economics was worked out more than 60 years ago by several high profile economists including Nobel prize winners Paul Samuelson (in 1970), Edmund Phelps (2006)11 and Peter Diamond (2010).

Suffice it to say that when the returns to capital investments (r) exceed the growth rate of the economy (g) – i.e. r > g – it is more efficient to accumulate savings and capital to finance old age rather than use a PAYGO transfer system. This is why private payas-you-go finance systems, where you provide your parents with their retirement incomes and get your own retirement incomes from your children, have fallen out of favour in the western world.

However, PAYGO systems are widely used by governments – not because they are efficient, but because once you have adopted them you can’t get out of them without one generation being hurt. Politicians are reluctant to reduce the benefits to middle-aged and older voters, and so they continue the PAYGO system.

Unfortunately, this pushes the inefficiency of the system on to current and future generations of young people. All those taxes that could have been saved and used to invest in green technologies or other investments are simply passed to older people and spent.

WHAT’S THE DIFFERENCE?

Economists like to describe the difference between an efficient way of doing things and an inefficient way of doing them as an opportunity cost. The opportunity cost of having a PAYGO pension scheme depends on ‘r − g’, i.e. the difference between the rate of return to capital investments and the growth rate of the economy.

This difference (r − g) is a big number, especially when the population growth rate, a part of ‘g’, is falling. NZ currently collects $13 billion in taxes each year to pay for NZ Superannuation. To a first approximation, only half of this sum would be necessary to pay the pensions of future generations if it were invested. And all of this sum would be available to finance investment.

SOMEONE’S GOTTA PAY

It would be great if we could simply make the transition to a more efficient SAYGO system and take advantage of the ageing saving bonus. But we can’t.

We could make the transition by cutting transfers to currently older people and investing the taxes instead. But the income distribution implications of this don’t bear considering.

Alternatively, we could make currently working-age people pay taxes to pay current pensions and then pay more taxes or privately save to pay for their own retirements. Their children would thank them – as would all future generations – but the “double-pay” generation would be worse off than under the current system.

Unfortunately, there is no way around this. And there lies the political paralysis that prevents reform. The easiest way would be to make everyone a bit worse off now to make everyone better off in the future by increasing taxes and saving the extra in the NZ Superannuation Fund, but even this step has yet to garner consensus political support.

THE SINBAD CENTURY AND THE LAND OF OZ

The coming Sinbad Century is big news for Australia. Australia is the richest English-speaking country on the Indian Ocean; the new Sinbad cities should be built with minerals from Western Australia or minerals dug up by Australian mining companies; and it might be the destination of choice for young Sinbad citizens.

If things go well, Australia’s focus is likely to move towards the Indian Ocean, where the population is rapidly increasing, where there is surplus labour relative to the rest of the world, and where the demand for capital will be high. Perth may well be the Los Angeles of the 21st Century, a sun-blessed eye on the Indian Ocean, a city expected to have nearly 5 million people by 2050.

Of course, things might not go well in the Sinbad countries: young and restless populations, poor democratic traditions and weak political institutions, and an uncertain and volatile climate may produce other outcomes. Either way, birth-rate and death-rate dynamics will make Australia and especially Perth increasingly important and increasingly less interested in the globally irrelevant country to their south-east.

How young New Zealanders and NZ firms respond to the burgeoning opportunities to the west is one of the key issues facing NZ in the next 50 years. The echo of Horace Greely, “Go west young man”, may yet be the rallying call for young NZ men and women of the 21st Century.

HOW WILL THIS TALE END?

We can be pretty sure that the decline of death and the decline of birth will lead to a realignment of the world’s population-centre towards the Indian Ocean – the Sinbad Century countries. We can be pretty sure these countries will want to use a lot more energy, and that there will be scope for this energy to be primarily renewable.

What we can’t be sure about is whether the world will find a way to finance these investments by recycling the savings of middle-aged countries into the energy plants of young countries. And, locally, we can’t be confident that NZ will reform its tax and retirement systems to better participate in this process.

Fortunately, however, the future belongs to the young. And they, much more than the old, have an incentive to undertake these reforms.

*Andrew Coleman is a senior lecturer in the economics department at the University of Otago. He's also a principal advisor and economics lecturer at Treasury.

This article was published in the EcoNZ@Otago magazine and has been re-published by interest.co.nz with permission.