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The aging of populations in countries around the world poses a challenge both to ensure the well-being of the elderly and to identify sustainable ways to expand pension systems. In few places is the challenge more pressing than the countries of the East Asia and Pacific region, where rising dependency ratios¡ªthe fraction of elderly relative to the working age population¡ªare forcing tough trade-offs for both families and policy makers.

At the November Policy Research Talk, John Giles, senior economist in the World Bank¡¯s research department, discussed what the latest research tells us about how these trade-offs are being made, how policy reforms are making an impact on the well-being of the elderly and incentives for work, and identified some potentially promising untapped areas of policy reform. The Policy Research Talks are a monthly event held by the research department to foster a dialogue between World Bank researchers and operational colleagues.

¡°Increased longevity often makes the formal pension systems unsustainable as fewer workers have to support a larger population of the elderly. For those in the informal sector, the challenge is equally large, as workers are often unable to formally retire, making the elderly dependent on their children,¡± said World Bank Research Director Asli Demirguc-Kunt, who hosted the event. ¡°So the big challenge for policy makers is how to design sustainable social protection systems that are not going to crowd out private support.¡±

Drawing on data from across the East Asia and Pacific region, Giles demonstrated the importance of private support to the well-being of the elderly¡ªespecially those who live in rural regions where workers are much more likely to be engaged in the informal sector, lack a formal pension, and live below the poverty line. In a range of countries from China to the Philippines and Thailand, private support to the incomes of the elderly help keep many above the poverty line. For example, in Thailand household survey data from 2011 indicate that the absence of private support¡ªall else equal¡ªwould nearly double the percentage of elderly living below the poverty line.

Giles also explored the potential impact of the demographic transition to smaller families on the role of private support. As he explained, ¡°you might think that there¡¯s some effect of the demographic transition on support to households, but we also see a very strong effect of years of education on transfers.¡± Consequently, ¡°if you look at these two effects together, the increasing human capital of smaller families suggests that the demographic transition itself isn¡¯t necessarily driving the elderly into poverty.¡±

The importance of private support raises a difficult question for policy makers keen on extending formal pension systems to rural and informal sector workers: will a formal pension system simply ¡°crowd out¡± the income support provided by families? Giles found little evidence to support this. In fact, in most cases formal pension systems might crowd out a third or less of existing private support¡ªin other words, an equivalent of one dollar provided by a pension system would lead to a drop in private support of less than 33 cents, and typically much less than this.

However, the impact on incentives for work poses a more significant challenge. Across the East Asia and Pacific region, patterns of retirement show sharp leaps around ages of mandatory retirement for formal sector workers. Initiatives to extend pensions might exacerbate this trend. China¡¯s New Rural Pension Program (NRPP)¡ªfirst rolled out in 2009 and made available across the country in 2012¡ªprovided a perfect opportunity to test out this hypothesis. Giles and his co-researchers found that while the NRPP did achieve its primary objective of reducing poverty among the elderly, it also induced many older workers to leave employment, even though many were still potentially productive members of the workforce.

A number of promising but untapped areas of policy reform could help developing countries meet the goal of creating inclusive and sustainable pension systems. Giles found evidence of a preference for spouses to retire at the same age, suggesting that bringing the retirement age of women in line with that of men might reduce disincentives to work. Giles also pointed out that a mandatory retirement age is a blunt policy instrument that leaves workers little flexibility. Instead, pensions could be made available at a threshold age but still allow workers¡ªespecially those who are productive and highly skilled¡ªto gradually exit the labor force over time.