Paying for ourselves as we get older: rethinking resource allocation



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Paying for ourselves as we get older: rethinking resource allocation




Donald Hirsch, Institute of Actuaries/Oxford Institute of Ageing conference “Ageing population”, 8 September 2005

The population pyramid is on its way out. By the middle of this century, for the first time in human history, there will be no systematic decline in the population in successively higher age-groups, for the first eight decades of life. As shown in Figure 1, the classic age pyramid of a century ago has been getting steadily less pronounced over a long period. Today, there remain significantly fewer 60-80 year olds than people in younger age-bands, but by 2041, according to current projections, this will no longer be true. There will for example be as many people aged 78 as there are starting school at age 5.


We have only just begun to consider the implications of this huge structural change in the population for the ways in which resources are allocated in our society, by governments, households and markets. A central change will be a completely new balance among three categories of people, who tend to access resources in very different ways: those aged under 20, those aged 20-64 and those aged 65 and over.


As shown in Figure 2, the group who are most likely to access resources directly by earning money and spending it – those approximately of “working age” – will decline as a percentage of the population. But this change will be relatively minor, when compared to a second change: the change in the balance between those younger than and older than traditional working age. In 1960, there were two and a half times as many young as old; by 2050 there will be a quarter more old than young.1


Both of these changes matter greatly for the ways in which resources are generated and distributed in our society. This is sometimes seen primarily in terms of rising “dependency levels”, with a focus on the declining ratio of “working age” to “pension age” people. As the Turner Commission has pointed out, this decline (from over 4:1 to barely 2:1 in terms of the measures in Figure 2) requires us either to put aside more in taxes and savings during our working lives or to work longer, if we do not want relative incomes in retirement to fall.


Yet the challenge is much wider than one of adjusting the rates at which we retire, save and tax ourselves in order to sustain the pensions system. Figure 2 shows that the overwhelming challenge is not the rise in the overall dependency rate but a likely shift in the non-earning periods of our lives, from occurring primarily in childhood and youth to occurring more commonly in old age. Today’s family structures and social and economic policies were not established to cope with this coming demographic reality. In particular, the most effective existing private mechanism for redistributing income from earning to non-earning members of society – the modern nuclear family – is less well adapted to allocating resources to post-earning than to pre-earning age-groups.
This paper does not to attempt to give a comprehensive account of the many implications of ageing societies for economic decision-making and sustainable systems of social support. Rather, it identifies as examples six issues about how we allocate resources that may require radically new approaches in the light of demographic change. In exploring these examples, it suggests that while ageing creates new constraints that can be seen negatively, as a “limitation”, the chance to rethink priorities also represents an opportunity. It forces us to re-examine existing patterns of resource allocation, and the values that underpin them.

Issue 1) Distributing the fruits of growth across the lifespan
Is one paradox of human progress that prosperity will keep us alive for so long as to impoverish us? This is not a wholly implausible scenario in the very long term, since during the present century it may be possible to eliminate many of the diseases that shorten human life without eliminating frailties associated with old age that can limit the scope for remaining economically active. Even if worker productivity continues to grow and make working people more comfortable, it may be difficult to preserve the high living standards to which people grow accustomed during a 40-year period of earning, through say a 30 year average period of retirement. Much will depend on the extent to which working lives start to lengthen.
The Turner report helps us understand this issue by reminding us of a mathematical truism. This is that over the long term, lengthening life expectancy means that in order to maintain a constant ratio of pensions to working-life incomes, we will either have to put more working income aside through taxes and/or savings, or extend our working lives, or a combination of both.
At an immediate political level, this message looks extremely painful. Most people feel much too financially hard-pressed to imagine putting a much higher percentage of their earnings than at present into taxes and savings. Resistance to working into one’s late 60s and 70s may be easier to overcome with time and a gradual change in expectations, but as the Commission points out, this is highly unlikely to be enough on its own. One reason is because it means putting a long-term social trend into reverse. For most of the past century the average age of workforce exit has been falling, and this trend has profoundly affected cultural expectations. This leaves a central question for the future: can we find some way of putting more aside during our working years, or are we condemned to face steeper declines in income during retirement than we have grown used to?
To those who believe that the rational answer lies in the first option – distributing money more effectively across the lifespan – one particular factor gives succour. This factor is time. To doomsters who warn that in 50 years time we will not be able to support older generations, time is the great enemy. The longer we project present trends into the future, the less favourable are the relevant demographic ratios. Yet time also gives us the opportunity to adjust.
To illustrate this point, consider two interpretations of the Turner Commission’s calculation that twenty years from now we will all need to be putting much more of our working incomes into pensions, other things being equal. One way of picturing this is to imagine giving up say 5-10% of one’s income today, to pay in extra taxes or pension contributions This sounds a painful and politically unrealistic change. But a sudden change of this magnitude is not being proposed. Imagine, alternatively, that productivity growth is sufficient to raise every worker’s earnings in real terms by 2% a year over that 20 years, a modest assumption on recent trends. That means a growth in real earnings by 49% over the whole period. If in 20 years time, each worker had to forego an extra 10% of their earnings to pay for old age, this would not mean having lower living standards than at present, but rather living standards only one-third higher than at present, rather than nearly 50% higher.
Ten per cent of everyone’s earnings represents a huge sum, which would be more than adequate to pay for tomorrow’s pensions. Of course, there are likely to be many other new calls on earnings, which could further erode any rise in living standards despite earnings growth, including the growing cost of both long-term care and health care in an ageing society. Yet it is hard to imagine that a gradual and evenly distributed shift in the deployment of earnings to pay for these things would cause a fall in living standards, as long as the economy continues to grow at somewhere near its long-term trend. Rather, it would require working-age people to accept that the benefits of wage increases feed only partly into a higher standard of living, with a substantial share being reallocated to paying for longer rather than more prosperous lives.
This requires a new mind-set in a (developed) world that in the twentieth century grew accustomed to the concept that each generation enjoys vastly better material standards than its parents. In moving in this direction, we may do well to consider some fundamental questions about our values as a society. For many people, a wage rise means being able to afford an extra holiday, to spend more at Christmas or to buy a wider-screen television. If across-the-board we accept limits to the growth in such aspirations, in exchange for stronger guarantees of preserving our living standards, health and social care through longer lives, we may start to feel happier as a society. If there were a clear enough trade-off between dignity in old age and credit-card spending in our working years, would not most of us accept limits to growth in consumption?

Issue 2) Allocating resources for human development
One of the biggest resource investments that we make as a society is in the development of human beings. In particular, we allocate a large part of our national resources to bringing up and educating the young. At present in the UK, about £5 of every £100 in national income is spent on educational institutions primarily enrolling young people between age 5 and 21. In addition, a large but harder to estimate amount is devoted to supporting young people in the course of their education. For children, this can be regarded as a fixed social cost. But for young adults who may otherwise be economically productive, participation in education represents an opportunity cost in the sense that they are absent from the labour market, as well as a tangible cost to families or the state to the extent that they subsidise these students’ subsistence. Between them, these costs represent a major investment by society.
We have so far been willing to increase, over the long term, the share of national resources devoted to educating young people at the same time as their share of the population has declined, for two main reasons. One concerns economic development and its link to human capital. In what have been described as increasingly “knowledge-based” economies we want more people to be well educated and to know how to think. Another imperative concerns the role that education plays in achieving social justice. Traditionally, advanced levels of education have been available mainly to social elites, and the relative life chances of disadvantaged groups may be improved by expanding access to education. (Note however that this has not always been the case, the most notable counter-effect being the tendency for expanded access to higher education to be more widely taken up by middle-class than by poorer groups.) Moreover, we have also been putting increasing emphasis on training, work experience and career guidance activity that helps young people integrate into the workforce – and thus we conceive young people’s development needs as being more than just attaining a given level of education.

It seems unlikely, given these priorities, that education and training will make reduced demands on resource allocation as the relative size of the youth population shrinks. However, while there may not be a case for reallocating resources away from education and human development, there may be a case for spreading this funding more evenly across the lifespan. For all the talk of lifelong learning, the bulk of educational resources are still spent on the young (see Figure 3). Yet both in terms of economic development and in terms of social justice, learning at later stages of life can be immensely important. It is widely acknowledged that people will need recurrent learning opportunities to adapt continuously to change during their working lives. Adults will need to learn and to develop new skills and roles. Many will also need good guidance later in working life, especially if the incidence of premature withdrawal from the workforce is to fall, reversing the recent trend of earlier retirement despite greater life expectancy. It is highly likely that changing demography will increase overall demand for older workers purely through market forces, but the unpreparedness of some groups disadvantaged in the labour market to take advantage of this change in demand could well contribute to widening inequalities.




In this illustrative diagram, the approximate amount spent on each age-group is shown by the volume of the blocks. Although spending per student (height) is greater in preschool and higher education than in primary and secondary, differences in participation rates (depth) means that the bulk of money is spent on schoolchildren. Even though the UK has one of the highest mature student rates in the OECD, the proportion of adults studying at any one time remains low (source: OECD).

How could an education, training and guidance system adjust to these demographic changes and become less skewed towards the young?


One set of issues concerns the accessibility of learning and other forms of development including guidance to adults of all ages. To some extent formal age conditions on study are breaking down, although some programmes/subsidies are still available on an age-restricted basis. Often a more important factor is whether the type of education/training/guidance on offer is adapted to the needs of mature adults, in terms for example of the time and place where it occurs and the style of teaching employed/
But perhaps the most important resourcing issue for adult learning is how to replace lost income during the time one spends learning. This indirect cost is particularly great if someone wants to study full time, but part-timers too can face difficult trade-offs between work, family and learning commitments. Here, there is a huge disparity between the extent to which we as a society have been willing to subsidise the time of young people in “initial” education and mature adults. In higher education, traditionally, student grants have been limited by age, and today, one of the biggest sources of maintenance payments for students – the support of parents – remain skewed to the young. However, age restrictions on student loans are relatively generous, with an upper age limit of 55, and even this is being abolished from 2006 (although the maintenance element of the loans will not available for pensioners). Nevertheless, many adults will find it hard to afford to study, especially if they do not want to do so through a higher education route eligible for the loan scheme. Another option that has been mooted and tried in some Canadian provinces is a system that helps people save for sabbaticals through their employers.
In the long term, there may be radical ways of restructuring employment and income flows to move away from the assumption that non-earning periods occur only before the beginning and after the end of working life. If as a result working lives are lengthened, this need not carry a net cost. Are there then feasible trade-offs between mid-career learning and non-working time at either end of working lives? With respect to the end of working life, mid-career learning may well reduce premature workforce exit by refreshing some workers’ skills and energies. A trickier question is whether around the start of working life, pre-entry periods of education may not need to be as long if mid-career education becomes more common. There is certainly a case for thinking about the expansion of educational participation less in terms of ever-more young adults taking degrees before starting work, and more in terms of making a range of post-secondary learning opportunities available at different points in people’s careers. This has the attraction of ensuring that learning is well-focused on identified needs, rather than being part of an ever-extended general initiation into the adult world whose purposes for many may be vague.


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