Lower fertility is the major cause of an aging population. For at least the last fifty years, the burden of paying for elderly dependents in developed countries has fallen on governments.

Population Aging by David Weil summarizes the economics effects of aging populations. Populations in developing countries are aging due mainly due rapid decreases in fertility and partially to increasing life expectancy; population aging in developed countries is primarily the result of past declines of fertility. Weil mainly focuses on the impact of aging in developed countries, but he shows how these same factors will come to affect the rest of the world. As the population ages, the ratio of dependents to working age adults increases. Dependents are financed by a combination of personal saving, family help, and government transfers. In developed countries, government transfers derived from PAYGO (pay as you go such as Social Security) pensions provide the bulk of the support for the elderly dependents. Because practically all workers are part of such a system and their funds finance the prior generation, the major impact of aging on the economy is that these taxes which fund the PAYGO (pay as you go) system distort aggregate output.

Population aging is occurring throughout most of the world, but it is most advanced in the wealthiest countries. Among the countries currently classified by the United Nations as more developed, which totals 1.2 billion people in 2005, the median age rose from 29.0 in 1950 to 37.3 in 2000. It is forecasted to rise to 45.5 by 2050. According to Weil, most experts agree that the decline in fertility over the last half century is a larger contributor to aging than a rising life expectancy.

Weil creates a graphical representation of population aging. He demonstrates the concept demographers call stable populations. Stable populations occur when age-specific mortality and fertility rates have been constant for sufficient time so that the relative number of people of each age are constant. During times of transition, in and out of stable populations, economic distortions can occur. He demonstrates that falling fertility reduces the ratio of youths dependent on the working members of society immediately, and only raises the old age dependency ratio with a lag of several decades. For this reason, a country experiencing fertility transition will be able to move temporarily below the locus of stable populations.

Weil believes that it is difficult to determine how far along countries are in the transition caused by aging. It is believed that developed countries are further along this transition than developing countries. For example, Japan is likely relatively far along the transition from reduced fertility and, therefore, the number of dependent old people should increase. Previous literature shows that in Japan, it is estimated that the total dependency ratio (youth dependents plus old age dependents) will rise from 0.64 to 1.17 over the period 2005-2050. This increase in dependency translates to the GDP per capita growing 0.6% per year more slowly than GDP per worker ceteris paribus.

In contrast, because India had much a much higher fertility rate than Japan fifty years ago, India’s fertility rate is dropping at a much faster rate than Japan’s. Because of this, there are less children dependents and India is receiving a large “demographic dividend” from having less children. While the reduced number of child dependents due to reduced fertility is clearly beneficial for India in the short run, the number of Indian dependents will increase when the current children become old and retire because there will be less children who aged and became workers to balance them out.

Weil comes to 2 conclusions from his graphical analysis:

1. From the point of view of society as a whole, the period of rapid increase in old-age dependency that is in store for the world’s richest countries is to a large extent simply the passing of the transitory benefit derived from a decrease in fertility.
2. Any change in fertility that will in the long run undo the effects of population aging will, in the short run, lead to an increase in total dependency by moving a country out of a stable population.

The implication of these findings is that people must keep in mind the specifics of their country’s aging dynamics in order to minimize losses created by it. India should be aware that even though today they are enjoying the benefits of reduced fertility, they must plan for the additional expenses of an aging population down the road. They should accumulate extra capital during the period of low dependency in order to maintain a smooth path of consumption into the period of high dependency

In the developed countries that are aging most rapidly, the burden of paying for the elderly falls primarily on government transfer programs. For example, in Germany, government transfers and public health benefits comprise 65% of the income of people aged 65 and older. In 2005, the U.S. spent 58% of its money marked for transfers (or 6.5% of GDP) on the elderly. Per person, the elderly receive close to $8 in direct transfers for every dollar of transfers working-aged people receive. Children receive just 35 cents per dollar of transfers awarded to workers. Thus, assuming constant transfers per person by age group, a shift of 10% of the population out of the workforce and into retirement increases federal transfer outlays by 4.7% of GDP. This estimated 4.7% is likely under the actual percentage because the price of health care for the elderly is also rising. In addition to raising government spending on transfers, population aging also reduces government revenue on salary taxes. Adding these tax and spending effects together, previous literature calculates that the effect of population aging would raise the tax rate required to pay for government transfers on a PAYGO basis in from 16% in 2000 to 21% in 2030 in the U.S.

Besides raising taxes which cause a deadweight loss, transfer programs create an efficiency loss which does not exist in the other types of transfers to dependent age groups. People give money to their children and parents and save for their future because they care about themselves and their family members However, an efficiency loss occurs because few people are so altruistic that they value the taxes they must pay to finance elderly transfer programs as much as the money they give to family members directly or save for their own future. Because the worker does not perceive the benefit of the tax to be equal, his or her incentive to work decreases because work becomes relatively more expensive. This distortion is also increasing because the elderly are less likely to be supported by or living with their working children.

With this logic in mind, previous literature suggests that country’ differences in marginal tax rates may explain differences in labor supply across countries. For example, one author shows that because the French average marginal tax rate (inclusive of consumption taxes) is 48% greater than that in the U.S., French adults aged 15-64 work only 68% as many hours as their U.S. counterparts. This author concludes that the large elasticity of labor supply he estimates implies that deadweight losses will increase dramatically as populations age as long as government old-age pensions continue to be funded through taxes that are largely divorced from the benefits that the individuals paying them will receive.

Weil cites another author that finds that changes in policy will become more difficult because more old voters will demand that payments to the elderly are maintained or increased. Based on current voting participation rates, the fraction of voters aged 65 and over in the United States will rise from 20% to 31% between 2003 and 2030 and median voter age will rise five years to 52. Therefore, as fiscal strain from population aging becomes even more acute, it will be even more difficult for lawmakers to solve their problems by lowering transfers to the elderly.

Another interesting problem that Weil cites is the fact that while the burden of an elderly population falls on the government, families are enjoying relaxed budget constraints because they are having less children. Another important distinction between support for elderly dependents and support for child dependents is the fact that working adults can choose the number of children they raise but they cannot choose the number of elderly that must be supported through the government. Specifically, they cannot choose how many siblings they share the burden of supporting their parents with, or the size of the working age cohort relative to the elderly population (which determines the amount of taxation needed for the elderly transfer funds.) Weil is interested how population aging itself may feed back to affect fertility, which is controllable.

The best-known hypothesis for which population age structure affects fertility posits that members of large birth cohorts suffer from labor market crowding, consequently, earn wages that are low compared to the standard they grew up with, and therefore adjust fertility downward to partially restore their standard of living. Weil believes that the rise in taxes needed to fund transfers to the elderly that will be caused by population aging could have effects on after tax income that are at least as large as those from the aforementioned generational crowding. The implication is that “aging could lead to lower fertility and, down the road, even more aging.” (Page 13).