Relative importance of fertility and mortality in the economic impacts of ageing in Finland

Finland has already entered the stage of demographic transition where the share of the working-age population is declining because of the population ageing. This is expected to continue at an accelerating rate during the next two decades. Impacts of this pattern are intensified by the fact that the baby-boom generations are exceptionally large. Our particular attention lies in the rapid deterioration of the old-age dependency ratio and the relative importance of earnings-related pensions for the sustainability of public finances. The public sector in Fin-land has positive net financial wealth, unlike most of the OECD countries. This is because of partially-funded statutory employment pension insurance, compulsory for all employers and employees as well as for the self-employed. However, population aging and rising dependency ratio are putting pressure on public finances also in Finland. In this paper we draw attention to different economic implications of changes in fertility and mortality. They both affect old- age dependency ratio, which is important determinant of expenditures in age related public programs. In an economy without migration aging results from two sources: an increase in the age at which people die, and a decrease in the birth rate. An increase in longevity rises the average age of the population by increasing the number of years in which each individual is old relative to the number in which he is young A decrease in fertility rises the average age of the population by changing the relative numbers of young and old people. Reduced fertility also lowers the rate at which the population grows. Even rapid aging is a slow process compared to most macroeconomic phenomena. For the effects of ageing it takes decades to materialize completely. It is difficult to disentangle empirically the effects of aging from the effects of other, contemporaneous changes. In this study we rely on a computable macroeconomic model to isolate the effects of aging by simulating the impacts of changes in birth and death rates to consumption, wages, public pensions, and saving. The macroeconomic framework we use in our study is Auerbach-Kotlikoff type numerical overlapping generations (OLG) model that describes the population by its generational structure. In the model each generation is represented by an economic agent who has specific age-related consumption and saving patterns and who maximizes utility over her entire lifetime. The model enables to us to analyze dynamics of demographic developments with inter-generational feedback effects. In calibrating the model we use Finnish National Transfers Accounts as a main source of information. National Transfers Accounts (NTA) is a methodology and a framework for collecting, combining and analyzing cross-sections of inter-generational and life cycle reallocation variables that is consistent with the System of National Accounts. The essence of NTA is to estimate private as well as public consumption and labor income by age, and to calculate the difference of the two, called life-cycle deficit (LCD). Using the data on age-specific information of public and private asset income savings and transfers, the sources of financing the life cycle deficit can be derived. If necessary, the variables are adjusted so that corresponding economy-wide aggregates in the National Accounts are satisfied. In 20 years’ time frame the modeled pattern of fertility shock is expected to be more important driver of ageing. Within next 20-years old age dependency ratio is expected to deteriorate by 27 percentage points. Almost two third of the change is caused by decline in the past fertility rates. Annual decline in output per capita for next twenty years is about 0.7% relative to alternative scenario with a stable age structure. The size of capital stock needed to equip employed labour force in the future is expected to decline. This gives room for increased consumption relative to GDP. Increase in the expected lifetime on the other hand works in the other direction. Longer expected life-time gives consumers incentive to save in order to smooth consumption over longer retirement period. Prefunding of pension constitutes a buffer that absorbs the pressure of fertility shock to the pension finances. Pension accrual has also life-expectancy adjustment that in its part eases the financial pressure. Other age-related public expenditures like health and social care lack both of these elements and are expected to create, in the near future, the main economic burden of ageing in Finland.