Population ageing over the next 50 years will be a significant challenge for Scotland and the rest of the UK (RUK). According to the Office for National Statistics (ONS) population projections, Scotland will age slightly faster than RUK (see Figure 1).
However, this difference should not be a major consideration when taking the decision about independence as the additional costs of supporting the ageing population as an independent state are much smaller than the costs of the population ageing itself. Scotland will have to bear these costs whether is stays part of the UK or becomes independent.
These are the main findings of the study, funded by the Economic and Social Research Council (ESRC) as part of the research programme of the Scottish Centre on Constitutional Change (SCCC), which was released yesterday in Edinburgh.
The study uses a macroeconomic model for Scotland, the rest of the UK (RUK) and the rest of the World (ROW). The model features free goods and capital mobility between all three regions. Government expenditures are divided into four categories: age-independent spending and expenditures on health, education, and pensions, which are sensitive to the age structure of the population. This model is capable of capturing behavioural responses of agents following changing circumstances. For example, economies increase their saving rates to provide for ageing populations, which leads to capital accumulation. This in return results in growing wages and falling interest rates. Also, faster ageing countries tend to benefit from positive terms of trade effects because the goods that they produce become relatively scarcer.
The study compares two scenarios:
The status quo scenario assumes that Scotland stays part of the UK and all government expenditures associated with an ageing population (mainly pensions and health) are funded on a UK-wide basis;
The independence scenario assumes that Scotland and RUK have to pay for the growing demands of their ageing populations independently.
In the status quo scenario
Population ageing has a strong impact on economic development in both regions. By 2060 output per person falls in Scotland and RUK by 10% and total government spending increases by 4 percentage points of GDP relative to the baseline without population ageing.
To achieve a government budget balance, the average labour income tax rate has to increase from about 13.0% to 21.5%.
Alternatively, to avoid increasing the level of taxation, keeping the budget balanced requires total factor productivity (TFP) growth of 0.6% per year, which would be equivalent to over a third of TFP growth observed in the recent past (Harris and Moffat, 2013).
Comparison of the status quo and independence scenarios shows that Scotland is worse off in the case of independence. Figure 2 shows the difference between the average labour income tax rates in the status quo and independence scenarios. The greatest difference is in 2035 and at this point the average labour income tax rate in Scotland is 1.4 percentage points higher in the independence scenario.
The difference is non-negligible, but is much smaller than the overall effect of population ageing itself. For comparison, by 2060 the average income tax rate increases by 8.5 percentage points in the status quo scenario.
The results are sensitive to population projections. So if Scottish demographic situation will deteriorate significantly compared with the situation in the rest of the UK then the additional burden of ageing under independence might become an important factor to consider.
Our conclusions differ from those presented in the IFS report released last month. We find smaller difference between the burden of ageing in Scotland and the rest of the UK. There are two broad reason for the difference:
Our model is different. We take into consideration the behavioural responses of economic agents, while IFS relies on the extrapolation of previous trends. We have a model of the whole economy that includes not only UK regions but also the rest of the world, while IFS only focuses on the public finance sector in the UK but models it in more detail.
Our assumptions are different. We use the most up to date ONS population projection for the UK (2012-based principal projection), while IFS uses the low migration variant of the 2010-based population projection (for main scenario). We do not assume a difference in labour productivity growth rates between Scotland and the UK. We do not consider the changes in the North Sea revenues because they are not related to the process of population ageing.
Dr. Katerina Lisenkova, a Senior Research Fellow at the National Institute of Economic and Social Research and one of the authors of the study said:
"The aim and scope of the study is to isolate the effects of population ageing in the context of potential Scottish independence. Many other factors might influence the future macroeconomic and fiscal performance of Scotland, including productivity growth, fiscal policy, North Sea oil revenues, changes in trade patterns, future cost of borrowing and the division of the UK's public debt. The level of uncertainty of any analysis looking 50 years into the future is very high. By isolating only one important factor – demographic change – we attempt to narrow the range of uncertainty of our results. The main conclusion is that looking from the perspective of demographic change, population ageing is a big challenge facing Scotland in the foreseeable future regardless of whether it stays within the UK or decides to go independent."