Looking ahead, Asian countries face a "double imperative" in considering their appropriate macroeconomic policy stance.

The challenges faced by industrial countries in the West and Japan with the prospective retirement of the "baby-boom" generation are well recognized. Governments face a growing financial burden from pension costs, medical care, and possibly long-term care, implying either sharp increases in taxes or a reneging on the promised level of benefits. But less appreciated is the fact that many Asian countries also face their own demographic "time bomb." Although they lag two decades or so behind the industrial countries, the sharp decline in fertility rates and rising longevity will result in a growing proportion of elderly people, relative to both the overall population and the number of working-age people, by 2020–30.

Asian countries sit astride the "demographic transition" at various points. Some, such as Korea and Singapore, are much more advanced in the process, with the elderly dependency rate (EDR)—the ratio of elderly to the working-age population—converging to industrial country levels by 2030 and with further dramatic increases forecast in subsequent years. Korea, for example, is said to have the fastest rate of aging in the world. China and Thailand follow, with the so-called demographic dividend period (when there is a large share of working-age population) lasting through about 2035–40, but with the proportion of elderly rising quickly thereafter. Malaysia is close behind, with its demographic dividend period lasting through 2045. India, Indonesia, and the Philippines will see a high EDR beginning to emerge only sometime after 2050.

China's situation is unusual in several respects. Its elderly population already dwarfs those of many industrial countries. But, more important, the pace of aging in its urban centers (where about a third of the population lives) has been far greater than in the rural areas, reflecting both sustained lower fertility and higher longevity. Even with migrants to the urban areas included in the urban population, the end of the demographic dividend period may emerge much earlier in urban China (say in 2025–30) and much later in rural China (2035–40). Many critical policy issues will rest on how urban-rural differentials are addressed (across and within provinces), at both the family and the policy level. The oft-mentioned gender gap—the shortage of women relative to men (because of differences in the birth and survival rates of boys and girls)—will also be an important issue to be reckoned with in China.

A higher EDR poses important challenges. Unless the elderly are prepared to work longer, they will either need to have accumulated retirement assets or receive financial support. In Asia, this is becoming increasingly relevant, with the gradual weakening of the traditional role of the family as caregivers for multigenerational support. The elderly will also require more access to medical care and, for many, long-term care services. How Asian countries are positioned to face these future challenges is a bit of a mixed bag. Certainly, decisions taken now could have a major impact on the scale of the problems to be faced later on. This article examines the state of readiness of Asian countries and discusses the issues they need to address to successfully cope with the demands of an aging population.

Several Asian countries (for example, Hong Kong SAR, Korea, Malaysia, and Singapore) have successfully pursued a development strategy built on exploiting their demographic dividend. China, coming from much further behind in economic terms and despite its extraordinarily rapid growth and high savings and investment rates, is still challenged to create productive jobs for its large labor pool in coming years.

Virtually all the Asian countries under discussion have wrestled with the issues involved in developing social insurance systems to manage the risks associated with retirement income and medical care.

Looking ahead, Asian countries face a "double imperative" in considering their appropriate macroeconomic policy stance. Policies should continue to support rapid economic growth, given that growth rates will fall with a slowing, if not declining, labor force in the later stages of the demographic transition. Labor market pressures, reflected in higher real wages, will require new strategies to maintain external competitiveness. Policies should also be framed by the recognition that governments will eventually have to address the pension, medical treatment, and long-term care challenges associated with a substantial increase in the EDR. This underscores the importance of having a sound fiscal position, with low public debt levels, at the time the potential demands of an elderly population become particularly acute. The relative importance of each of these imperatives depends both on how close a country is to the time when its EDR rises and on the extent of its convergence to industrial PCI levels.

But there is also a microeconomic dimension to the aging problem. When a society ages, how will it meet the financial needs of its elderly? Will the elderly be dependent on their own accumulated savings, on the support of individual family members, on the general taxpayer, or on payroll contributions from the workforce through government social insurance schemes (as in the industrial countries)? Or will they be forced to work longer? How will the needs of the very elderly be met, since they frequently require either long-term care or substantial medical or social support?

Virtually all the Asian countries under discussion have wrestled with the issues involved in developing social insurance systems to manage the risks associated with retirement income and medical care. The variety in the observed strategies principally reflects differences in national perspective. Only three—Korea, Singapore, and perhaps Malaysia—can be said to have social insurance systems whose coverage is broad enough that their design features can be evaluated in terms of their robustness or adequacy in addressing the needs of a future aged population.

For the DB schemes, the coverage of the labor force ranges from very low (India), to 30 percent (Thailand), to largely universal (Korea). Replacement rates for covered workers—the ratio of average pension benefits to wages—range from 30 percent in Thailand to 50–60 percent in the Philippines and Korea. Because most of the DB systems are pay-as-you-go (PAYG)—with pension benefits financed from current contributions—they rely heavily on their capacity to raise workers' contribution rates in the event of future operational deficits. They may thus be prone to the same financial pressures as industrial countries once the EDR rises.

The CPF approach essentially prefunds certain large expenditure obligations before retirement (for housing, education, and, in some cases, medical care), as well as income needs during retirement, with commensurately higher national saving rates implied. High mandatory saving rates in the CPF schemes (in the mid-30 percent range up to a wage ceiling), coupled with investment strategies for the accumulated assets, provide for a lump-sum payment at retirement (where the eligible age ranges from 55 to 62). However, the income stream that can be realized by purchasing an annuity with this lump sum is not generous, ranging from 20 to 40 percent of average wages. Such systems entail the potential risk for households of using funds too soon after retirement.

Relative to the others, China's pension system is very much in a state of flux. In the urban areas, the government is replacing the fragmented system of pension system responsibilities of state enterprises and the government (as employer) with a three-pillar system involving a mandatory DB/PAYG first pillar, a mandatory funded DC second pillar, and a voluntary third-pillar savings scheme. The government is largely responsible for the pension liabilities of existing retirees and those with vested rights. However, the new schemes cover less than half the urban workforce. Pooling of the contributions and payments of the schemes rarely extends beyond the municipal level, rather than being at a provincial or national level. Noncompliance is rife among employers (particularly in the private sector). The funds associated with the DC system have largely been used by municipalities to finance pension payments to existing retirees. Indeed, the pension system appears in deficit. Optimistic estimates of the implicit "legacy debt" associated with the earlier urban pension system range from 50 to 150 percent of GDP. In China's rural areas, the commune system, which previously provided retirement benefits to its members, has fallen apart, being replaced, if at all, by minimal social safety net transfers.

In effect, fewer than one-fourth of China's workers are covered by the new pension scheme. High individual saving rates by Chinese workers may thus, in part, reflect the limitations of the still-evolving pension system. China's authorities are well aware of the challenges posed by an aging population. Yet, for the bulk of China's population, a coherent national strategy for addressing the retirement needs of the future large group of elderly remains to be put in place.

In sum, most Asian countries are still far from establishing a financially sustainable pension system that will provide a basic level of retirement income for the bulk of the elderly when the EDR rises. The three-pillar system remains the most viable approach for framing a strategy for retirement income. For most Asian countries, what will be critical is to ensure that the system is realistic in terms of the promises that can be financed. This underscores the importance of a first pillar to address the needs of the elderly destitute and a third pillar to promote individual and household savings. It also points to the importance of strengthening the functioning of the financial system both to absorb an increasing volume of household saving and to channel it effectively to high-quality investments and loans.

Health care systems are particularly difficult to categorize. Some countries are heavily reliant on public systems (Hong Kong SAR, Indonesia, and Malaysia), with universal access to care in principle, but with the quality of effectively available services varying widely according to a household's income and place of residence. Even where care may be formally available in terms of public facilities, in some cases, the fact that most costs must be borne out of pocket effectively limits access. China's once-vaunted universal medical care system collapsed in the 1980s with the introduction of the market economy and, as with pensions, the cost, availability, and system of financing differ dramatically between and within urban and rural areas.

In some countries, the private sector may also be a key provider—this might reflect the inadequacies of the public health care system (India), or it might be an intrinsic element in the design of the medical care system (Thailand). In other cases, the private sector caters largely to a narrow segment of the population. Korea is currently debating the prospective role of the private sector in medical care.

Singapore, Malaysia, and China provide useful cautionary lessons on the medical care issues that will emerge as the demand for treatment and care management increases. Malaysia, like several other Asian countries, still has a largely budget-financed medical care system, one that has been relatively effective. It is now considering allowing a greater role for private health insurance. The existing system allows for considerable government control in determining the quality and quantity of available services and technology. But budget-financed systems can also be subject to administrative challenges and political economy pressures in setting budgetary aggregates, leaving many households dissatisfied with the standard of care available in public medical facilities. The opening up of the system to private insurance may give rise to considerable cost-push pressures. Indeed, Malaysia already has experienced significant brain drain from the public to the private sector, with adverse effects on the quality of care in the public system.

Similar pressures are emerging in Singapore's largely private system. The key operative assumption is that restrictions on supply, coupled with demand restraint by households (which are required to bear a significant proportion of costs out of pocket), will limit cost inflation and demand pressures. By mandating savings for medical care, the government has forced individuals to prefund, to a limited extent, some of the cost of catastrophic incidents. But medical cost pressures are nevertheless emerging in Singapore as well. These have not been reflected in a rising medical expenditure share yet only because of Singapore's rapid economic growth.

In China, medical spending has risen rapidly in the past two decades, fueled almost entirely by uncontrolled, largely supply-induced spending in both public and private urban sector units. This has involved the acquisition of high technologies, financed largely by the out-of-pocket spending of households. There is a network of public hospitals and clinics in both the urban and rural areas, but because they are dramatically underfunded, effective access to most medical services for much of the population is contingent on an individual's ability to pay. In urban areas, a basic employee medical insurance scheme has been introduced that involves a combination of a medical savings account system, limited risk pooling, and health insurance. But coverage is only gradually being extended to the private sector, there is little coverage of urban migrant workers, the benefit coverage remains limited, and there is costly cross-subsidization of many elderly retirees. In the rural sector, government medical units provide care, but most of the costs must be borne directly by households. A new rural cooperative medical scheme is now being developed and aggressively expanded, but it is poorly funded and is likely to cover only an additional 20 percent of the rural population.

Looking ahead, the challenge remains as to how to ensure that the elderly in China will have adequate basic treatment and long-term care in the absence of the assets or income to afford the current requirements for large out-of-pocket payments. The growing gender gap may result in a shortage of caregivers for the very elderly.

It is in the sphere of social insurance and welfare schemes that much effort is still needed to lay down a policy framework that can accommodate the challenges of an aging population. Since most of the social insurance systems that have emerged in Asia have not been designed with the anticipation of a relatively aged population, there is a need not only to extend coverage, over time, to existing social insurance systems but, more important, to ensure that the expanded systems are affordable. This argues for an emphasis on reforming the key policy provisions of existing systems, with affordability as a key concern.

Pension reforms should include a gradual deferral in the age of eligibility for retirement benefits, lower replacement rates, actuarial neutrality in linking benefit levels to the length of the prospective retirement period, a move to payout methods that provide for income rather than lump-sum payments, and restrictions on the use of funds before retirement. Some minimal social safety net scheme is needed to address the potential problem of the indigent elderly.

In the medical sphere, the challenge will be to facilitate provision and access to a basic level of care for all elderly at reasonable co-payment rates while avoiding the potential cost pressures and significant inequalities that can arise in a medical care system that lacks the regulatory or budgetary capacity to impose a global budget ceiling.

The contrast between India and China as they consider policy alternatives is worth noting. India's social insurance system is minimal, whether in its still-limited coverage of the population for pensions or in the dominance of a largely private medical care system. Because its population is aging more slowly, India has an enormous window of opportunity in terms of the amount of time available before the population becomes aged. China has far less time to develop a solution to its aging problem. Perhaps because of the collapse of its previous social insurance system, and the acute awareness of the rapidity of its aging process, it is in China that one sees most clearly the effort to grapple with these issues. And yet China also highlights how difficult this can be and the looming deficiencies that need to be addressed.

In closing, it is also worth remarking on two final strategic policy options for confronting an aging population. First, some industrial countries are seeking a more pronatalist policy framework in their labor market policies, facilitating earnings replacement for mothers after childbirth, and subsequent child care arrangements. Singapore, Malaysia, and Korea are notable among the Asian countries for introducing some incentives to promote marriage and a larger family size.

Second, industrial countries are now recognizing that the fiscal sustainability of social insurance systems will require a longer working life commensurate with increased longevity. With the exception of Singapore, there is little evidence in Asia of policies to create incentives for a longer participation in the labor force. (Singapore is seeking to provide incentives to employers to hire the elderly, including policies to reduce wages for workers above age 60.) Indeed, in China, the overwhelming priority to address unemployment pressures has led to pressures for workers to retire early (with the retirement at age 55 for women and 60 for men). Asian countries cannot be faulted too seriously for this neglect since Western industrial countries themselves are only slowly removing the disincentives for working longer. But Asian countries should now be moving early to ensure that social insurance systems, the labor market policy framework, and the health care delivery system support incentives for workers who choose to work longer and for enterprises to take advantage of the skills of elderly workers. Increasing female labor force participation or encouraging immigration are additional policies to be encouraged.