The Consequences of Lower Fertility Rate

One of the major challenges that modern world has to face is the reduction of fertility rate. Lower fertility rate leads to demographic imbalances. Demographic pressure on public finance will be enormous since the share of population above the age of 65 is expected to rise rapidly. Western world is undergoing a massive aging of the population. In the 20th and 21sth century, birth rates in Western countries have fallen considerably. Consequently, the share of population 65+ and old-age dependency ratio have increased extensively.

One of the most notable consequences of aging population is an enormous pressure on the long term sustainability of entitlement spending. If public pension and health care systems will not adjust to changes in fertility rate and labor market entry and exit age, an ageing population might easely undermine the ability of public finance to cope with the burden of old-age dependency.

The economic pressure of ageing population will inevitably require the adjustment of tax and spending policies. A growing share of dependent population implies that tax burden disporportionately falls on the working population. The growth of net financial liabilities and current effective tax burden strongly distorts labor supply decisions. Higher implicit tax rate during the working age might easily reduce the fertility rate and keep replacement rates below the demographic equilibrium level. Higher tax burden would then reduce the incentives for having children since the loss of consumption in the working age would stream into prospective periods. In addition, Western countries will have to tackle the issue of early retirement. Empirical evidence suggests that early retirement costs Western countries from 5 percent to 10 percent of the GDP each year.

The growing share of population 65+ leads to changing political landscape. Pension spending would be difficult to reverse if age-dependent population represented a significant share of the voting body. This might trigger the incidence of pensioners' parties in national parliaments which could substantially halt the prospects of pension reform. In any case, age-dependent population would be able to subordinate the preferences of political parties. That would diminsh any plausible possibility of a much needed pension reform.

Unemployment rate and economic freedom

Does increasing economic freedom raise the unemployment rate? To answer the question, I collected data on the unemployment rate and Index of Economic Freedom in 2010. I randomly chose 26 countries from various income groups. In the sample are Hong Kong, New Zealand, Switzerland, Australia, Canada, U.S., Denmark, Chile, UK, Netherlands, Spain, Norway, Mexico, France, Turkey, Italy, Tunisia, Brazil, India, Indonesia, China, Russia, Syria, Bolivia, Venezuela and Zimbabwe. Based on the sample data, I estimated the rate of unemployment as a function of economic freedom as measured by the Heritage Foundation.

As it can be seen from the graph, economic freedom does affect the unemployment rate. In fact, the influence of economic freedom accounts for almost 37 percent of the variation in the unemployment rate. Partial regression coefficient suggests that a 1 point increase in the Index of Economic Freedom would reduce the rate of unemployment rate by 0.1452 percentage point. The coefficient is highly significant with p-value equal to 0.001. Thus, one could hardly blame greater economic freedom and labor market deregulation for the rise of the unemployment rate.

Economic Freedom and Unemployment Rate

Source: Index of Economic Freedom, 2010.