The aging of the developed world is creating a demographic deficit that could radically transform the financial wealth of households, and therefore, the capital available to businesses and governments. There are no easy choices, but fiscal discipline today can yield healthier balance sheets tomorrow.
The long-term solvency of pension plans—both public and private—is a growing concern across the developed world as policy-makers wrestle with the fiscal consequences of aging, and business leaders and investors seek to understand how aging will affect global markets for goods, capital and labor. The answer to all these issues depends largely on a fundamental question that is often overlooked: How will aging affect future levels of household wealth and economic well-being? New research by the McKinsey Global Institute (MGI) sheds light on this question, drawing its conclusions from in-depth analyses of five countries—the US, Japan, Germany, Italy, and the UK—which together account for two-thirds of global financial assets.
Birth rates will fall and lifespans will continue to lengthen over the next two decades, driving up the median ages in many countries. In Japan, for example, the median age will rise from 43 to 50, and from 42 to 51 in Italy. MGI’s new report reveals that the aging of the developed world is creating a demographic deficit that could radically transform the financial wealth of households, and therefore, the capital available to businesses and government.
MGI’s key finding is that over the next two decades, absent dramatic changes in saving behavior or returns earned on financial assets, growth in household financial wealth will slow by more than two-thirds, from 4.5 percent historically to 1.3 percent going forward. This slowdown will cause the level of household financial wealth to fall some 36 percent, or approximately $31 trillion, below what it would have been had the higher historical growth rates persisted.
The US will be by far the largest source of the global shortfall ($19 trillion) because of the US dominant share of global financial wealth. Japan stands out as the second-largest source ($8 trillion) of the global shortfall, because its demographic trends are so severe. MGI projects that Japan’s household financial wealth will stop growing and enter an absolute decline over the next two decades, driving a 47 percent shortfall in wealth.
Unfortunately, there are no easy ways to counterbalance the coming decline in wealth. MGI found that no country outside the developed world can generate enough new financial wealth over the next two decades to meaningfully address the projected shortfall. While China’s stock of financial assets, for example, have been growing at a remarkable 14.5 percent compounded annual rate over the past decade, its share of financial assets remains just 4 percent, less than one-third that of Japan. Other commonly discussed solutions, including encouraging families to have more children or increasing immigration, do little or nothing to counteract the projected wealth shortfall either. It is unlikely that nations will be able to simply grow their way out of the problem either. Increasing economic growth without changing the relationship between income and spending will not by itself change the amount of savings enough to materially alter the rate of wealth accumulation.
MGI found that achieving higher rates of real financial asset appreciation is the most powerful adjustment, and examines options to achieve them. Other changes that could also mitigate the downward demographic pressure on savings to some degree include extending peak earning years—chiefly by increasing the retirement age, and raising the savings rate of younger generations.
The future global capital shortfall
Over the next two decades, demographic trends will create significant downward pressure on household savings and financial wealth accumulation. The demographic transition is occurring throughout the developed world, albeit with different timing and severity across countries. Demographic pressures on wealth accumulation can be counteracted through policy adjustments, but it will not be easy.
US: From boom to bust?
In the next 20 years the US baby boomers will enter retirement, creating a significant economic "headwind“ for the nation. If the US is to navigate smoothly through this demographic transition, US households and their government will need to increase savings, reduce borrowing, and work to further improve the returns on savings.
Japan: The world’s savers retire
Japan is the only developed nation facing an absolute decline, rather than a slowdown, in financial wealth because of demographic trends. To reverse, or even moderate, the projected slowdown, Japan needs to institute broad reforms that generate increased domestic competition and better productivity.
Germany: Storm clouds gathering
Demographic trends are expected to exert significant pressure on the growth of German household savings and net financial wealth accumulation, with potentially substantial implications for economic growth. German households and their government will need to take actions to halt the decrease in saving and to improve the returns that households obtain on their portfolios.
Italy: Aging but saving
Italy’s situation is particularly difficult because of its surging aging population. For example, by 2024, it will already have more than 1 million people over the age of 90. Mitigating the demographic forces already at work in Italy will require sustained, coordinated efforts by the public and private sector.
UK: Counting on the market
Over the next two decades, demographic trends are expected to have a limited impact on UK household savings and financial wealth accumulation because of impressive returns on savings ratios and other characteristics unique to the UK.