IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
WP 2018-04. Executive Summary.
Since the dawn of the Industrial Revolution, countries around the world have seen a sustained increase in life expectancy, resulting in ever-increasing numbers of citizens in the 65+ age range. While longer lifespans are undoubtedly a huge social benefit, in this paper we question the effect of population aging on the size of government across countries.
Theoretically, the direction of the effect is ambiguous. Certainly, elderly populations desire spending on the programs which directly benefit themselves – particularly old age pensions and social insurance. As populations age and the median voter becomes older, this will militate towards more spending on these types of programs (Mello et al. 2017). At the same time, there is cross-country evidence that suggests the elderly prefer lower levels of spending on services like education (Sørensen 2013), which do not directly benefit them. Yet other studies suggest that the elderly prefer spending on both programs that benefit them directly and on those that do not (Sanz and Velazquez 2007).
By contrast, the fiscal burdens of supporting increased government expenditures might cause taxpayers to become less supportive of a large transfer state, creating political opposition. This attitude could result in a shrinkage in the size of government (Razin et al. 2002), or in inertial growth as a result of path dependency: politicians who deliver goods and services to their constituents tend to be more popular than those who promise to reduce government spending.
In this paper, we are not concerned about the particular mechanism behind the growth of government across countries, but rather the effect of aging populations on government growth. Our metric of government growth comes from the Economic Freedom of the World (EFW) index, published by the Fraser Institute. One of the five components that make up this index measures the size of government. We argue that this is a more comprehensive measure of government size than has been employed in previous studies of this sort. Not only is it a more inclusive and multifaceted measure, but it also allows us to evaluate the effect of demographic shifts on government as an institution, as opposed to examining particular spending flows.
We find a robust positive relationship between increases in elderly populations across countries and the size of government in those countries. Countries with larger numbers of people in the 65+ category do, in our model, have larger governments. However, by breaking down our measure of government size into its component parts, we find that the elderly do not prefer higher spending across the board, contrary to the findings of Sanz and Velazquez (2007). The elderly prefer spending on government consumption, and on transfers and subsidies. We find no evidence of elderly support for spending on government investment. This is likely due to the fact that the elderly directly benefit from the former types of spending, but not from the latter.
Currently, within OECD countries there are approximately four workers for every retiree. The OECD predicts that this ratio will fall by half by 2050 (OECD 2014). Continuing current spending policies indefinitely into the future will put considerable fiscal strain on these countries. This may over time lead countries to reduce spending, as taxpayers become less supportive of an ever-growing state. We can only hope politicians have the courage to reduce spending before their countries are plagued by serious fiscal crises.
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