Demographic transition is, in general, a process of change where society passes through the stages of high fertility and high mortality to low fertility and low mortality. Before the start of the demographic transition, life was short, births were many, growth was slow and the population was young (Lee, 2003). The shift from high to low levels of fertility and mortality has been explained through the different stages in the demographic transition theory.

The modern transition theory is explained in four stages. In Stage I, the birth rate was very high and average longevity of life was short; therefore, population growth was relatively slow and the population was fairly young. Significant medical advances, better health care services, higher nutritional standards over the years have resulted in a drastic decline in mortality in almost all countries and a noticeable increase in the longevity of life. With this, the transition enters Stage II. With increase of exogenous survival rates, parents’ family-size decisions changed towards having fewer children. Besides, fertility rate is also influenced by how economic change influences the cost and benefits of childbearing. With the advancement of technology and rapid changes of family structure vis-à-vis the opportunity cost of child bearing and rearing, fertility decline follow subsequently and drift downwards until it stabilises at a much lower plane. This is technically Stage III of demographic transition. The fourth and final stage of demographic transition refers to low fertility and low mortality rates. While developed countries are already in Stage IV of demographic transition for more than three decades, Asian countries are passing through Stage II / Stage III as evident from their trends in total fertility rates. For example, presently while Pakistan is in Stage II, India is in Stage III.

Low fertility and increasing longevity cause a dramatic change in the population age distribution. An increase in the old-age dependency ratio indicates a situation in which an increasing number of potential beneficiaries of health and pension funds are supported by a relatively smaller number of potential contributors. This obviously imposes heavier demands on the working-age population in order to maintain a stable intergenerational flow of benefits to the older people. Given the existing social security arrangements and policies, the transition towards more elderly people relative to the number of workers will have pervasive effects on factor and product markets and will substantially impact on public finances, with important distributional implications, both between existing retirees and the working age population as well as between current and future generations (Visco, 2001).

The fiscal impact of ageing population is reflected through higher government spending on social security, health care and other welfare programs for the elderly. With public pension schemes coming under increasing pressure to raise contribution levels or cut the size of social safety benefits, the issue of fiscal sustainability is one of the principal challenges facing policymakers worldwide, particularly, in the context of intergenerational equity. In this regard, the literature on social security and pensions has assumed critical importance.

The principal rationale for mandatory social security programmes is that some individuals lack the foresight to save for their retirement years. Since the provision of social security benefits imposes real costs and acts as a fiscal burden on several generations, the optimal level of benefit requires balancing between the consideration of providing relief to the elderly and the deprived sections of society while minimizing the costs of distorted real resource allocation (Diamond, 1977). The issue has been compounded at the present juncture on account of a variety of factors, viz., (a) increasing proportion of old people, (b) higher degree of urbanisation and greater migration from rural to urban areas, (c) diminishing support for old people from families due to changes in family structure, (d) higher rearing cost of surviving children and (e) old people require greater resources and need support for a longer period. As such, the key issue is whether such support is provided by private or public funding. It may be noted that the inability of private provision implies greater reliance on public funding which is a burden on the fisc.

In the Asian context, this issue is of great relevance as ageing is occurring at lower income levels. The redistribution of resources from younger to older generations has to be concerned with the incentive for savings, keeping in view the need for higher investment in sustaining the growth process. In addition to the redistribution of resources from young to old, there also have to be some resource transfers from the affluent to the less well off. While the redistribution from young to old has been traditional and would continue as long as possible for those who cannot provide for themselves, the transfer of resources from rich to poor affects incentives. One critical difference between developed and developing countries is that in the case of the latter, as income growth is higher, pace of change in the standard of living is also high which may be difficult to maintain in old age on the basis of savings accumulated at a younger age. At the same time, since living standards are relatively low in developing countries, expectations about future standards of living are lower. Thus, more inter-generational resource transfers are warranted for developing countries.

In thinking about the fiscal challenges arising from ageing, the first question that arises is : why these problems now? It is true that longevity has increased tremendously in the past few decades, but some old have always been with us. What is different now?

In developing countries, and certainly in India, until recently, the provision for pensions and care for the old was essentially privately provided, and usually within the family. Why is this changing now?

• In rural areas, people essentially worked as long as they could. There was no retirement age and job content changed according to capacity to work as people aged.
• With urbanization, in the first instance, the old people get left behind, and remittances provide for pension equivalents, encompassing inter generational resource transfers.
• As urbanization proceeds, the issue of outside family provision arises, and is heightened by labour mobility.
• Earlier, when the retired were essentially expected to live until the age of 65 to 70, the issue of within family care arose for 5 to 10 years. This was a feasible burden for the family. Now with rising longevity, the within family care could extend to 20 or even 30 years, and with delayed marriage, perhaps throughout the son or daughter's full working life. This is difficult to sustain.

Thus, the problems of ageing are upon us in developing countries as well, and certainly in Asia. We can clearly expect a shift from private to public provision in the years to come. The issue for public policy in Asia is how fast this transition will take place and at what pace should public social security and pension provisions be made, with the consequent burdens on already stretched fiscal systems.

It has been argued that the provision of social security, particularly public pensions, reduces the inducement to save thereby having a damaging impact on a country’s long-term growth prospects. (Feldstein, 1977) This view has been countered by the multigenerational planning horizon theory of Barro (1978) which states that people making bequests is evidence enough that they derive some benefit from the well being of future generations. Current generations will therefore find that they need to save less to finance their own old age, but need to save more in order to increase their bequest sufficiently to compensate successive generations for their tax liabilities. These two effects should cancel each other leaving the savings rate unchanged. This issue is of particular importance for developing countries in Asia, which will continue to need high savings for investment and growth for quite some time.

Against the above background, let me now turn to the issues relating to ageing and the consequent fiscal challenges in the Asian context.

At present, the total fertility rate is below the replacement level in practically all industrialized countries. In the less developed regions, fertility decline started later but has proceeded faster than in the more developed regions. Over the last 50 years, the total fertility rate (TFR) declined globally by almost half, from 5.0 to 2.7 children per woman. Over the next half century, it expected to drop to the replacement level of 2.1 children per woman. In this context, it is important to note that Asia is roughly 50 years behind the developed nations. Within Asia, a great diversity in terms of demographic transition is noticeable.

As per global estimates, currently, the average annual growth of the older population (60+) is 1.9 per cent, which is noticeably higher than that of total population at 1.2 per cent (Table 1). More significantly, the average annual growth rate of persons aged 80 years and over (3.8 per cent) is currently twice as high as the growth rate of the population over 60 years of age (1.9 per cent). Projected figures clearly indicate a much higher growth rate of older people in 25 to 50 years ahead. In terms of percentage, the aged constituted 8.2 per cent of total population in 1950; this percentage rose slowly to 10 per cent of world’s population in 2000 and is projected to rise to 21.1 per cent in 2050 (Table 2). During that time, world population of the aged is expected to exceed the population of children in the age group 0-14 years (Table 3).

The Asian continent, with its large size, wide socio-economic and demographic disparities is better understood and interpreted when studied at country level. Accordingly, selected countries are categorised into three broad groups as indicated below.²

I: Indian Sub-Continent (India, Pakistan, Bangladesh, Sri Lanka)

II: China

III: East Asian Tigers (Indonesia, Malaysia, Philippines, Thailand)

The young-old balance of population is shifting throughout the world. The increasing proportion of aged people is accompanied by a falling proportion of young persons. In developed countries, the proportion of older persons already exceeds that of children, and by 2050, it is expected to be twice that of younger persons. What is notable, however, is that the proportion of working age people in developed countries has been roughly constant over the last 50 years at around 60 per cent (Table 4), and has in fact increased slightly with the float over baby boom. The overall dependency ratio has therefore not increased (Table 5). The issue of concern in developed countries is that the proportion of working age people is now expected to decline from these levels to about 50 per cent by 2050, with the corresponding rise in dependency ratios : hence the heightened concern with ageing in recent years in developed countries. What is most dramatic is the expected rise in old age dependency (i.e., those in the 65 years + age bracket as a proportion of the working age group 15-64 years). In developed countries it is around 21 per cent now, rising to 33 per cent by 2025 and as much as 46 per cent by 2050 (Table 6).

Source: United Nations, "World Population Ageing 1950-2050", Population Division, Department of Economic and Social Affairs, 2002

Note: The total dependency ratio is the number of persons under age 15 years plus persons aged 65 years or older per one hundred persons in the category of 15 to 64 years. It is the sum of the youth dependency ratio and the old-age dependency ratio.

Source: United Nations, "World Population Ageing 1950-2050", Population Division, Department of Economic and Social Affairs, 2002

Note: The old-age dependency ratio is the number of persons 65 years and over per one hundred persons 15 to 64 years.

The trends in Asia over the next 50 years will be more reflective of the past 50 years for developed countries, with significant variations across different countries. The proportion of old people in Asia (excluding Japan and Korea) today is around 8.8 per cent and will reach 22-23 per cent by 2050. However, similar to the developed country experience of the past 50 years, the working age population in Asia is about 60 per cent now; it will rise marginally by 2025 and then fall slightly by 2050. In the case of China it is now 65 per cent and will fall gradually to around 55 per cent by 2050. India, Indonesia and other Asian countries will remain between 60 and 65 per cent until around 2050. The expected increase in old age dependency is also dramatic : from about 9 per cent now to 15 per cent in 2025 and 26 per cent by 2050, which would be a little higher than that in developed countries now. The Chinese, however, are ageing faster with the old age dependency ratio rising from about 10 per cent now to an expected 19 per cent in 2025 and 37 per cent in 2050. For India and Indonesia, the rise will be much slower, whereas the situation in Sri Lanka and Thailand will be more like that in China (Table 6).

What is really different between developed countries and Asia is the expected trend in total dependency ratio (Table 7). The key fiscal problem of developed countries is the unprecedented rapid rise that is expected in the total dependency ratio (young + old as a proportion of the working age groups) from about 48 per cent now to 57 per cent in 2025 and 73 per cent in 2050. In 1950, incidentally, it was 54 per cent. For Asia as a whole it was 66 per cent in 1950, 56 now, falling to about 49 per cent by 2025 and then rising again to 57 per cent by 2050, with differences between countries as expected between China and other Asian countries. Countries such as India, Indonesia and others will continue to reap the demographic dividend for at least another 25 years.

Note: The youth dependency ratio is the number of persons 0 to 14 years per one hundred persons 15 to 64 years.

Source: United Nations, "World Population Ageing 1950-2050", Population Division, Department of Economic and Social Affairs, 2002

The total dependency ratio is a rough measure of potential social support needs. The expected decline is due to the fact that young-age dependency ratio of all these countries is likely to decrease very rapidly due to sharp decline in total fertility rate during this period. However, the decline of young-age dependency ratio during the next 25 years, i.e., 2025-2050 for most of the Asian nations is expected to be relatively small.

In view of the declining dependency ratio in Asia, there is greater room for maneuverability in public finances in terms of social security expenditure. A critical issue is the relative emphasis on expenditure related to the next generation viz., child rearing and education vis-à-vis expenditure on the earlier generation on account of medical and health care.

Old-age dependency ratio of China is likely to increase by almost four times during the next half century from 10.0 per cent in 2000 to 37.2 per cent in 2050 (Table 6). The other countries likely to have similar trends are Sri Lanka, Thailand and the Philippines. In the case of India, old-age dependency ratio during 2000-2025 is going to increase by almost 1.5 times (8.1 per cent in 2000 to 12.2 per cent in 2025); however next 25 years is likely to witness a sharper increase of around 2 times (from 12.2 per cent in 2025 to 22.6 per cent in 1950) (Table 7).

Globally, the ageing index is going to increase rapidly and will triple over the next half century. Higher increase in ageing index during 2000-2050 period is more significant for most of the Asian countries (see Table 8). This trend may lead to compelling demands for changes in the way a society’s resources are shared between generations. The median age of all the Asian countries is expected to increase by 12 years during the first half of the current century (see Table 9).

Note: The ageing index is calculated as the number of persons 60 years old or over per hundred persons under age of 15 years.

Labour force participation of the older people has declined worldwide over the last decades (see Table 10). In general, labour force participation of the older people of Asian countries is much higher than that of developed countries. However, disparity in labour force participation among Asian countries persists. Higher labour force participation of older ages in Asian countries clearly indicates that old-age support systems in the form of pension and retirement programmes are relatively less prevalent in these countries (as compared to developed countries).

Note: The labour force participation rate consists of the economically active population in a particular age group as a percentage of the total population of that same age group. The active population (or labour force) is defined as the sum of persons in employment and unemployed persons seeking employment.

Fertility decline has been the primary determinant of population ageing. Fertility of more developed countries with TFR is below replacement level since the last three decades. The TFR of less developed countries is twice than that of developed countries and this trend is expected to continue till 2030. The higher regional differences in fertility among Asian countries are expected to decrease (see Table 11). The projected fertility transition has been relatively smoother in India and Philippines. These countries are, therefore, in a favourable position (and thus may enjoy the fruits of ‘demographic dividend’ for a relatively longer period) as far as the inflow of working-age populations are concerned.

Note: The total fertility rate is the average number of children a woman would bear over the course of her lifetime if current age-specific fertility rates remained constant throughout her childbearing years (normally between the ages of 15 and 49). The current total fertility rate is usually taken as an indication of the number of children women are having at the present.

Along with fertility decline, reduction in death rate, especially at older ages, assumes an increasingly important role in population ageing. Over the last five decades, life expectancy at birth increased globally by almost 20 years, from 46.5 years in 1950-55 to 66.0 years in 2000-05 (Table 12). Among Asian countries, there exists a great degree of variation in life expectancy at birth. However, the extent of regional variations in life expectancy at birth among these countries is gradually narrowing down.

In the last decade, both the IMF (Heller et al., 1986; Chand and Jaeger, 1996) and OECD (1985, 1988, 1996 and 2001) have carried out a number of studies on the fiscal impact of ageing of major industrial countries. An important objective has been to assess, ex ante, the potential impact on public expenditure from the provision or financing of social services and transfers. Normally, the base line projections assume unchanged social insurance legislation and social sector policies by the government. Most studies have concluded that, although outlays on education will decline as a share of GDP, this will be offset by rapid growth of government outlays on pensions and medical care. For most industrial countries, the government social insurance commitments appear inadequately funded. Financial sustainability will be achieved only by a combination of cutbacks in benefits or an increase in contribution rates.

Many Asian countries suffer from the chronic malaise of fiscal imbalances: expenditures are much higher than government revenue. As a large section of the population survives at low-income levels, the tax base is weak and tax revenues grossly inadequate. Moreover, tax rates are distortionary and tax compliance is low. Current expenditures are high resulting in a paucity of resources for capital expenditure. Hence, deficits are an enduring feature of many Asian economies.

Based on the classification presented in Section II of select Asian countries, it may be noted that the average growth (over three years) in the Indian subcontinent was 4.2 per cent with India having the highest growth of 5.4 per cent (Table 13). Among all the countries under consideration, China has the highest growth of 7.8 per cent. Among the South East Asian Tigers, the average growth is 4.2 per cent with Indonesia recording the highest growth of 4.4 per cent and Philippines the least growth of 3.9 per cent.

In terms of domestic savings rates, it is noticed that among the four groups, the Indian subcontinent has the lowest savings rates on average of about 17.5 per cent. Among these countries, India has relatively higher savings rates of 23.8 per cent with Pakistan having the lowest rate of 13.7 per cent. Among all the countries, Malaysia has the highest savings rate of 45.3 per cent with China coming a close second with 41.0 per cent. The average savings rate of South East Asian countries is around 30.3 per cent with Philippines having the least rate of 21.0 per cent. Similarly, investment rates are very high for China and least for Pakistan.

On the fiscal side, the fiscal deficit of the Government on average seems to be the highest for the Indian subcontinent (Table 14). The situation in the South East Asian countries is relatively better with lower levels of deficit.

Table 14: Major Fiscal Indicators of Governments

(% of GDP)

Public expenditure on health and education as a percentage of GDP is among the lowest in the Indian subcontinent (Table 15). In this regard, it lags behind China and many of the South East Asian counties. Expenditure on education seems to account for a higher share in Malaysia and Thailand while expenditure on health draws greater attention in China. Although available information on pensions is dated, the pension burden seems to be quite high for Malaysia. All Asian countries in general have a low share of pension expenditure in GDP.

Table 15: Public Expenditure on Social Sector