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Economic Outlook

Economic Outlook 2016-1st Half

Increase in Life Expectancy: Macroeconomic Impact and Policy Implications

  • Author KWON. Kyooho
  • Date 2016/05/12
SUMMARY ■ The rise in the savings rate caused by increased life expectancy could have ramifications for consumption in the short-run. But, in the long-run, it could help boost GDP growth by inducing capital accumulation and expanding the labor supply, eventually having a positive impact.

■ The above confirms that consumption-boosting measures should pay more attention to structural factors, even though private consumption has been relatively stagnant.
Report VOD
Private consumption in Korea continues to wane and households’ average propensity to consume continues to decline,
falling from 78% in 2003 to 72% in 2015.

An examination into the average propensity to consume by householder age reveals that although declines was witnessed across all age groups, it was especially marked for senior households.

For example, while the average propensity to consume for the 40s cohort dropped by 5%p in the past 12 years, that for the 50s, 60s and 70s cohorts tumbled by 7%p, 10%p and 22%p, respectively.

Life expectancy is rapidly increasing in Korea, which is considered a major force behind the declining average propensity to consume.

Since recording 75.5 years in 2000, the figure jumped 7 years to mark 82.4 years in 2014, essentially increasing half a year annually.

Assuming retirement is at 60, this implies that life expectancy after retirement increased a staggering 45%, surging from 15.5 years to 22.4 years, during the same period.

So, why is the propensity to consume declining on increased life expectancy?

Despite people living longer, pension payments are mediocre at best, and the labor force participation rate of the senior population remains at a standstill.

Accordingly, preparing for old age has become imperative,
and cutting back on spending during middle age has become the rational choice to do so.

[저자 인터뷰]
Korea’s average propensity to consume is exhibiting an overall decline and it is especially evident among senior households. As the cause, many speculate that it may be Korea’s rapid increase in life expectancy. However, despite prolonged longevity, the retirement age remains unchanged. As such, people are responding to the shock by lowering their propensity to consume to increase savings. Older generations have a shorter period to adjust their consumption, resulting in a larger decline in their propensity to consume.

This study analyzes the macroeconomic impact of the increase in life expectancy using an econometric model

Firstly, the countermeasures of economic agents with regards to consumption, savings and labor supply, for an increase of 0.5 year in life expectancy were estimated.

The results show that in the short-term, consumption contracts as savings rise due to increased life after retirement.

However, in the longer term, savings turn into investment which increases the accumulation of capital, and the labor supply expands as more people prepare for old age, all of which boost the economic growth rate.

Ultimately, consumption makes a rebound, and after a certain period, even surpasses past figures and the savings rate gradually declines.

Using the same model, estimations were obtained for the impact since 2000,

which show that as of 2015, increased life expectancy has caused the savings and growth rates to rise by 3.5%p and 0.4%p, respectively.

The results imply that if life expectancy does not increase, Korea’s potential growth may deteriorate rather quickly

[저자 인터뷰]
The diminishing effect of increased life expectancy on the average propensity to consume is having an negative impact on overall consumption. Yet, not all of the spillover from increased life expectancy is negative.
In the long-term, it will boost accumulation of capital and labor supply, which in turn, will promote both economic growth and consumption.
Accordingly, there have been increasing measures to counter the decline in consumption. From this study’s perspective, consumption-boosting measures should focus on structural factors.
In order to enable savings to lead to investment, polices that can increase the expected return on investments must be implemented through a rationalization of regulations and by creating a flexible labor market. Additionally, labor market reforms are needed to respond to the increasing number of middle-aged and senior workers in the market so that the demand corresponds with the supply.
Good examples of this include flexible management of working hours and a productivity-based wage peak system.
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