[Paleopsych] McKinsey: The demographic deficit: How aging will reduce global wealth

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The demographic deficit: How aging will reduce global wealth

To fill the coming gap in global savings and financial wealth, households
and governments will need to increase their savings rates and earn higher
returns on the assets they already have.

Diana Farrell, Sacha Ghai, and Tim Shavers

The McKinsey Quarterly, Web exclusive, March 2005

The world's population is aging, and as it gets even grayer, bank balances
will stop growing and living standards, which have improved steadily since
the industrial revolution, could stagnate. The reason is that the
populations of Japan, the United States, and Western Europe, where the vast
majority of the world's wealth is created and held, are aging rapidly
(Exhibit 1). During the next two decades, the median age in Italy will rise
to 51, from 42, and in Japan to 50, from 43. Since people save less after
they retire and younger generations in their prime earning years are less
frugal than their elders were, savings rates are set to fall dramatically.

In just 20 years, household financial wealth in the world's major economies
will be roughly $31 trillion1 less than it would have been if historical
trends had persisted, according to new research by the McKinsey Global
Institute (Exhibit 2).2 If left unchecked, the slowdown in global-savings
rates will reduce the amount of capital available for investment and impede
economic growth.

No country will be immune. For the United States?with its relatively young
population, higher birthrates, and steady influx of immigrants?the aging
trend will be relatively less severe. Still, its savings rate is already
dismally low, even before the baby boomers have started to retire. To
finance its massive current-account deficit, the United States relies on
capital flows from Europe and Japan, but they too face rapidly aging
populations. Even fast-growing developing countries such as China will not
be able to generate enough savings to make up the difference.

Finding solutions won't be easy. Raising the retirement age, easing
restrictions on immigration, or encouraging families to have more children
will have little impact. Boosting economic growth alone is not a solution,
nor is the next productivity revolution or technological breakthrough. To
fill the coming gap in global savings and financial wealth, households and
governments will need to increase their savings rates and to earn higher
returns on the assets they already have. These changes involve hard choices
but can offer a brighter future.

Growing older, saving less

In just two decades, the proportion of people aged 80 and above will be
more than 2.5 times higher than it is today, because women are having fewer
children and people are living longer. In about a third of the world's
countries, and in the vast majority of developed nations, the fertility
rate is at, or below, the level needed to maintain the population. Women in
Italy now average just 1.2 children. In the United Kingdom, the figure is
1.6; in Germany, 1.4; and in Japan, 1.3. Meanwhile, thanks to improvements
in health care and living conditions,3 average life expectancy has
increased from 46 years in 1950 to 66 years today.

As the elderly come to make up a larger share of the population, the total
amount of savings available for investment and wealth accumulation will
dwindle. The prime earning years for the average worker are roughly from
age 30 to 50; thereafter, the savings rate falls. With the onset of
retirement, households save even less and, in some cases, begin to spend
accumulated assets.

The result is a decline in the prime savers ratio?the number of households
in their prime saving years divided by the number of elderly households.
This ratio has been falling in Japan and Italy for many years. In Japan, it
dropped below one in the mid-1980s, meaning that elderly households now
outnumber those in their highest earning and saving years. Japan is often
thought to be a frugal nation of supersavers, but its savings rate actually
has already fallen from nearly 25 percent in 1975 to less than 5 percent
today. That figure is projected to hit 0.2 percent in 2024. In 2000, the
prime savers ratios of Germany, the United Kingdom, and the United States
either joined the declining trend or stabilized at very low levels. This
unprecedented confluence of demographic patterns will have significant
ramifications for global savings and wealth accumulation.

How the decline in prime savers will affect total savings depends on how
these people's savings behavior changes over the course of a household's
life. Germany, Japan, and the United States have traditional hump-shaped
life cycle savings patterns (Exhibit 3). In these countries, aging
populations will cause a dramatic slowdown in household savings and wealth.
In contrast, Italy has a flatter savings curve, resulting in part from
historical borrowing constraints that forced households led by people in
their 20s and 30s to save more. Thus an increase in the share of elderly
households will have less impact on the country's financial wealth.

In some countries, the relatively lower savings rates of younger
generations in their peak earning years will exacerbate the slowdown in
savings and wealth. In the United States and Japan, where we analyzed
generation-specific savings data, several factors contribute to this
pattern: a tendency to rely more on inheritance than past generations did,
the good fortune to avoid the economic hardships that prompted earlier
generations to be more frugal, and the availability of consumer credit and
mortgages (which, in the case of Japan, have become more socially

The coming shortfall in household wealth

Most of the public discussion on aging populations has focused on the
rapidly escalating cost of pensions and health care. Little attention has
been paid to the potentially far more damaging effect that this demographic
phenomenon will have on savings, wealth, and economic well being. As more
households retire, the decline in savings will slow the growth in household
financial wealth in the five countries we studied by more than
two-thirds?to 1.3 percent, from the historical level of 4.5 percent. By
2024, total household financial wealth will be 36 percent lower?a drop of
$31 trillion?than it would have been if the higher historical growth rates
had persisted.

Of course, changes in savings behavior by households and governments or
increases in the average rate of return earned on those savings could alter
this outcome. Without such changes, however, our analysis indicates that
the aging populations in the world's richest nations will exert severe
downward pressure on global savings and financial wealth during the next
two decades. The United States will experience the largest shortfall in
household financial wealth in absolute terms?$19 trillion by 2024?because
of the size of its economy. The growth rate of the country's household
financial wealth will decline to 1.6 percent, from 3.8 percent. Since the
aging trend is less severe in the United States, reduced savings rates
among younger generations are responsible for a large part of the decline.

In Japan, the situation is much more serious. Household financial wealth
will actually start declining during the next 20 years: by 2024 it will be
$9 trillion?47 percent lower than it would have been if historical growth
rates had persisted. Japan's demographic trends are severe: the median age
will increase to 50, from 43 (for the US population, it will rise to 38,
from 37), and the savings of elderly households fall off at a faster rate
in Japan than in the United States. Even more important, household
financial wealth in Japan is almost exclusively the result of new savings
from income rather than of asset appreciation; therefore, the falloff in
savings causes a bigger decline in wealth.

The outlook for Europe varies by country. Italy will experience a large
decline in the growth rate of its financial wealth?to just 0.9 percent,
from 3.4 percent?because of the rapid aging of its population. Its
relatively flat life cycle savings curve will mitigate the impact, however,
resulting in an absolute shortfall of about $1 trillion, or 39 percent. The
projected decline in the growth rate of financial wealth in other countries
will be less dramatic: to 2.4 percent, from 3.8 percent, in Germany
(because of its higher savings rates) and to a still-healthy 3.2 percent,
from 5.1 percent, in the United Kingdom (because of its stronger

Global ripple effects

This slowdown in household savings will have major implications for all
countries. In recent years the United States has absorbed more than half of
the world's capital flows while running a current-account deficit
approaching 6 percent of GDP. Japan has historically enjoyed a huge
current-account surplus, which has allowed it to be a major exporter of
capital to other countries, notably the United States. The expected drop in
Japan's household savings will make this arrangement increasingly untenable.

In all likelihood, the United States also won't be able to rely on European
nations, with their aging populations, to increase capital flows. Nor can
it expect rapidly industrializing nations, such as China, to fill the gap.
Even if China's economy continued to grow at its current breakneck pace, it
would need approximately 15 years to reach Japan's current GDP. In any
case, if China is to sustain this growth, the United States must continue
consuming at its current level?something it cannot do if capital flows from
abroad decrease. Even if China did have savings to export, it would have to
confront the obstacles posed by its current exchange rate and capital
controls regime.

Although an increase in global interest rates and the cost of capital may
seem inevitable, it is not. On the one hand, as global savings fall markets
can adjust through changes in asset prices and demand; which of these will
predominate is unclear. Some economists forecast less demand for capital:
fewer households will be taking out mortgages and borrowing for college,
governments will invest less in infrastructure to keep pace with population
growth, and businesses won't have to add as much capital equipment to
accommodate a labor force that will no longer be growing. On the other
hand, the demand for capital is likely to remain strong if emerging markets
and rich countries seek to boost their GDP and productivity growth by
increasing the amount of capital per worker. Likewise, while a drop in
global savings could drive up asset prices, opposing forces will also be at
work, as retirees begin selling their financial assets.4

One thing is certain: as household savings rates decline and the pool of
available capital dwindles, persistent government budget deficits will
likely push interest rates higher and crowd out private investment. The
rising cost of caring for an aging population in the years to come will
force national governments to exercise better fiscal discipline.
No easy solutions

Many policy changes suggested today, such as increasing immigration,
raising the retirement age, encouraging households to have more children,
and boosting economic growth, will do little to mitigate the coming
shortfall in global financial wealth (Exhibit 4).

Our analysis shows that an aggressive effort to increase immigration won't
solve the problem, simply because new arrivals represent only a tiny
proportion of any country's population. In Germany, for instance, a 50
percent increase in net immigration (to 100,000 people a year) would raise
total financial assets just 0.7 percent by 2024. In Japan, doubling
official projections of net immigration would have almost no impact on the
number of households or on the country's aggregate savings. The same is
true even in the United States, which had the highest historical levels of
immigration in our sample.

Since households don't reach their prime saving years until middle age,
promoting higher birthrates through policies such as child tax credits,
generous maternity-leave policies, and child care subsidies will also have
only a negligible effect by 2024. This approach could actually make the
situation worse by adding child dependents to a workforce already
supporting a larger number of elderly.

Similarly, raising the retirement age won't be particularly effective in
most countries. In Japan, efforts to expand the peak earning and saving
period by five years (a proxy for raising the retirement age) would close
25 percent of the projected wealth shortfall in that country. In Italy,
however, this approach would have little impact because households do not
greatly reduce their savings in retirement.

After the IT revolution and the jump in US productivity growth during the
late 1990s, it may be tempting to think that countries might grow
themselves out of the problem. Without changes in the relationship between
income and spending, however, an increase in economic growth won't generate
enough new savings to close the gap. The simple reason is that as incomes
and standards of living rise, so does consumption. For instance, raising
average income growth in the United States by one percentage point?a huge
increase?would narrow the projected wealth shortfall by only 10 percent.

Navigating the demographic transition

The only meaningful way to counteract the impending demographic pressure on
global financial wealth is for governments and households to increase their
savings rates and for economics to allocate capital more efficiently,
thereby boosting returns.
Boosting asset appreciation

The underlying performance of domestic capital markets varies widely across
countries, resulting in significantly different rates of return.5 Since
1975, the average rate of financial-asset appreciation in the United
Kingdom and the United States has been nearly 1 percent a year, after
adjusting for inflation. In contrast, financial assets in Japan have
depreciated by a real 1.8 percent annually over the same period (although
the ten-year moving average is now near zero). Real rates of asset
appreciation have been negative in Germany and Italy as well.

UK and US households compensate for their low savings rates by building
wealth through high rates of asset appreciation. Their counterparts in
Continental Europe and Japan save at much higher rates but ultimately
accumulate less wealth, since these savings generate low or negative
returns. From 1975 to 2003, unrealized capital gains increased the value of
the financial assets of US households by almost 30 percent. But in Japan
the value of such assets declined. European countries fell somewhere in

Raising the rates of return on the $56 trillion of household savings in the
five countries we studied could avert much of the impending wealth
shortfall. In Germany, increasing the appreciation of financial assets to 0
percent, from the historical average of -1.1 percent, would completely
eliminate the projected wealth shortfall. The opportunity is also large for
Italy, since its real rate of asset appreciation has averaged -1.6 percent
since 1992; raising returns to the levels in the United Kingdom and the
United States would fully close the gap. For the latter two countries, the
challenge could be more difficult because their rates of asset appreciation
are already high.

Achieving the required rates of return will call for improved financial
intermediation so that savings are funneled to the most productive
investments. To achieve this goal, policy makers must increase competition
and encourage innovation in the financial sector and in the economy as a
whole,6 enhance legal protections for investors and creditors, and end
preferential lending by banks to companies with political ties or
shareholder relationships.

For some countries, such as Japan, where households keep more than half of
their financial assets in cash equivalents, diversifying the range of
assets that individuals hold is an important means of increasing the
efficiency of capital allocation.7 To promote a better allocation of
assets, policy makers should remove investment restrictions for households,
improve investor education, and create tax incentives for well-diversified
portfolios. New research in behavioral economics has shown that offering a
balanced, prudent allocation as the default option for investors can
improve returns because they overwhelmingly stick with this option.8

Increasing savings rates

In many countries, today's younger generations earn more and save less than
their elders do. This discrepancy is an important driver of the wealth
shortfall in the United States and, more surprisingly, in Japan. If younger
generations saved as much as their parents did while continuing to earn
higher incomes, one-quarter of Japan's wealth shortfall and nearly a third
of the US gap would be closed by 2024.

Persuading young people to save more is difficult, however, and tax
incentives aimed at increasing household savings have yielded mixed
results.9 Contrary to conventional wisdom, too much borrowing is not the
culprit in most countries. Although household liabilities have grown
significantly faster than assets have across our sample since 1982, keeping
consumer borrowing in line with asset growth would close $2.3 trillion, or
just 7.5 percent, of the projected wealth shortfall.

The key to boosting household savings is overcoming inertia. When companies
automatically enroll their employees in voluntary savings plans (letting
them opt out if they choose) rather than requiring people to sign up
actively, participation rates rise dramatically.10 A study at one US
Fortune 500 company that instituted such a program found that enrollment in
its 401(k) retirement plan jumped to 80 percent, from 36 percent; the
increase among low-income workers was even greater.11 In addition, a
substantial fraction of the participants in the automatic-enrollment
program accepted the default for both the contribution rate and the
investment allocation?a combination chosen by few employees outside the

Of course, governments can also increase the savings rates of their
countries through the one mechanism directly under their control?reducing
fiscal budget deficits. Maintaining fiscal discipline now is vital if
governments are to cope with the escalating pension and health care costs
that aging populations will accrue.

If policy makers take no action, the coming slowdown in global savings and
the projected decline in financial wealth could depress investment,
economic growth, and living standards in the world's largest and wealthiest
countries. The future development of poor nations could also be in
jeopardy. A concerted, sustained effort to increase the efficiency of
capital allocation, boost savings rates, and close government budget
deficits can avert this outcome.
About the Authors

Diana Farrell is director of the McKinsey Global Institute, where Tim
Shavers is a consultant; Sacha Ghai is a consultant in McKinsey's Toronto

The authors wish to thank Ezra Greenberg, Piotr Kulczakowicz, Susan Lund,
Carlos Ocampo, and Yoav Zeif for their contributions to this article.


1All figures given in this article are valued in 2000 US dollars, and all
growth rates indicate real terms.

2This study examined the impact of demographic trends on household savings
and wealth in Germany, Italy, Japan, the United Kingdom, and the United
States. The full report, The Coming Demographic Deficit: How Aging
Populations Will Reduce Global Saving, is available for free online.

3The State of World Population, 1999 and 2004, United Nations Population

4Empirical analyses on the impact of demographic changes on financial-asset
prices and returns are inconclusive. See Barry P. Bosworth, Ralph C.
Bryant, and Gary Burtless, The Impact of Aging on Financial Markets and the
Economy: A Survey, Brookings Institution, July 2004; and James Poterba,
"The impact of population aging on financial markets," National Bureau of
Economic Research working paper W10851, October 2004.

5In this article, the terms "financial-asset appreciation" and "returns"
refer to the unrealized capital gains on financial assets, not to interest
and dividends paid. By convention, interest and dividends are treated as
household income, a portion of which may be saved.

6For a good synthesis of MGI's research, see William W. Lewis, The Power of
Productivity, Chicago: University of Chicago Press, 2004.

7Moving households closer to the efficient frontier of risk and returns
serves to make asset pricing more precise and forces companies to practice
greater capital market discipline.

8Brigitte C. Madrian and Dennis F. Shea, "The power of suggestion: Inertia
in 401(k) participation and savings behavior," Quarterly Journal of
Economics, November 2001, Volume 116, Number 4, pp. 1149?87.

9B. Douglas Bernheim, "Taxation and saving," Handbook of Public Economics,
Volume 3, Alan J. Auerbach and Martin Feldstein (eds.), New York: Elsevier
North-Holland, 2002.

10James J. Choi, David Laibson, Brigitte C. Madrian, and Andrew Metrick,
"Defined contribution pensions: Plan rules, participant decisions, and the
path of least resistance," National Bureau of Economic Research working
paper W8655, December 2001.

11Brigitte C. Madrian and Dennis F. Shea, "The power of suggestion: Inertia
in 401(k) participation and savings behavior," Quarterly Journal of
Economics, November 2001, Volume 116, Number 4, pp. 1149?87.

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