Speech

Fiscal Policy under Demographic Change and Radical Uncertainties in Asia

June 4, 2017

As prepared for delivery

On behalf of my colleagues at the IMF, it is my honor and pleasure to welcome you to the third Tokyo Fiscal Forum. I would like to thank the Policy Research Institute of Japan’s Ministry of Finance, and the Asian Development Bank Institute for organizing this conference.

The Tokyo Fiscal Forum aims to facilitate exchanges among policymakers on key fiscal policy issues in Asian economies. This year, we focus on the challenge for fiscal policy under demographic change and radical uncertainties.

To consider these issues in this context, let me start with an overview of the global and Asian economic outlook, and several risks to that outlook. I will then discuss the challenges to achieving inclusive growth arising from inequality and demographic change, and the role of fiscal policy in addressing them.

Growth outlook in Asia

The good news is that the global economy is finally gaining momentum. Our projection for growth in 2017 is 3.5 percent—higher than last year, 3.4 percent. This improvement largely comes from expectations of higher growth in the U.S., and stronger indicators in Europe and Asia.

In fact, Asia continues to be the world leader in growth helped by stronger demand and accommodative policies. The region’s growth is projected to reach 5.5 percent in 2017 and 5.4 percent in 2018. Nonetheless, the near-term outlook is clouded with significant uncertainties and risks.

Uncertainties surrounding Asia

A key uncertainty is the lack of clarity about U.S. economic policy, including the size and composition of an expected fiscal stimulus. A faster than expected increase in interest rates and significant appreciation of the U.S. dollar could exacerbate public debt vulnerabilities in Asia’s emerging and developing countries. China’s rebalancing process continues; but growth remains reliant on rapid domestic credit growth that could cause problems down the road.

Politics presents another set of uncertainties, including more upcoming elections in Europe, and this autumn’s party congress in China. In addition, geopolitical tensions have increased in Asia.

There are also important medium-term challenges. One is rising income inequality in most Asian countries—a trend we are seeing in other parts of the world. There is a growing consensus that high levels of inequality can hamper the pace and sustainability of growth. It may also create a more challenging political climate.

Another very important challenge for Asia is demographic change. This is marked by slowing population growth and aging. Asia’s population growth is projected to fall to zero by 2050, and the ratio of the elderly to working age people will reach 2½ times its current level. This puts many Asian countries at risk of growing old before becoming rich.

Clearly, this demographic transition could have a significant impact on growth prospects and future fiscal burdens for governments. Experience shows that it is important to adapt fiscal policies before aging sets in. This should occur at a gradual pace in order to spread the burden across generations and to avoid policy reversals.

Role of Fiscal Policy for Inclusive Growth

So, what is the role of fiscal policy to address these challenges?

Let’s first focus on the role of fiscal policy in fostering inclusive growth.

It is essential that in all economies, the benefits of growth are shared by all.

Fiscal policy is a powerful tool to promote inclusive growth in two main ways.

First, it can facilitate income redistribution through improved transfers and more progressive tax instruments. Expansion of cash transfers and broadening the tax base of the personal income tax could increase equity in emerging market and developing economies.

For example, the Philippines expanded its conditional cash transfer programs targeting to eligible, poor households. This was subject to their compliance with conditions about educational enrollment and health statutes.

Second, fiscal policy can promote equality of opportunity by helping people adapt to a changing economy through investment in human capital and protection against risk.

In our fast-changing global economy—with rapid technological change and economic integration— there is a rising demand for public policies to cushion the effect on those who cannot keep up.

These policies include job counseling and re-training, wage insurance for workers displaced into lower-paying jobs, and wage subsidies for employers to hire displaced workers.

Australia has developed active labor market policies assisting jobseekers, supported by private provision of employment services. This approach achieved more labor participation with less unemployment benefits.

Fiscal Policy under Demographic Change

Now we turn to fiscal policy under demographic change.

Achieving sustainable and inclusive growth in Asia in the coming decades will only be possible if policy makers address the implications of demographic change.

Under current policies, age-related public expenditures, pensions and health care in Asia are projected to increase by up to 10 percentage points of GDP by 2050, depending on the country. (Korea at 10 percentage points) Such spending increases could lead to unsustainable public debt. That, in turn, could require sharp cuts in other spending or large tax increases.

So, what can policy makers do to tackle these challenges?

They need to adopt policies that include:

• first, entitlement reforms to contain the growth of age-related spending, mostly in health care and pension systems;

• second, better tax systems to offset some of the impact of demographic change—such as shifting the tax base from wages to consumption and assets;

• third, providing affordable childcare and tax incentives to raise labor force participation, especially for women and the elderly;

• and fourth, credible medium-term fiscal frameworks to ensure debt sustainability.

Concluding remarks

Let me conclude by underscoring that fiscal policy has an important role to play to promote inclusive growth and address the challenges of an aging population.

Today’s Tokyo Fiscal Forum is a timely and valuable opportunity to share recent experiences of Asian countries in this arena.

I look forward to a discussion of how policymakers could develop better policy strategies, and effectively communicate with the public and financial markets on these issues.

The IMF is committed to continue supporting member countries’ efforts in this area through policy advice and technical assistance.

I would like to thank you again for your participation, and wish you two productive days in Tokyo.