Aging Population and Rising Debt: The Urgent Need for Pension Reforms in Korea

The IMF paper explores the fiscal challenges posed by Korea's aging population on its pension system, projecting a sharp rise in public debt by 2070. It recommends a mix of reforms, including raising the retirement age, increasing social security contributions, and lowering pension benefits to ensure long-term sustainability.

The IMF working paper authored by Daniel Baksa, Boele Bonthuis, Si Guo, and Zsuzsa Munkacsi from the Asia Pacific Department of the International Monetary Fund, explores the significant fiscal challenges that Korea's public pension system will face as the country undergoes rapid demographic changes. Korea is on the brink of one of the fastest aging transitions among advanced economies, driven by plummeting fertility rates and rising life expectancy. Fertility rates have drastically declined from nearly six children per woman in the 1950s to less than one child in 2023, while life expectancy has significantly increased, particularly at age 65, where it rose from 15 years in 1990 to over 20 years by 2020. These trends are expected to continue, placing immense pressure on Korea’s public pension system, as the proportion of the elderly population increases and the old-age dependency ratio the number of elderly compared to the working-age population soars.

The public pension system in Korea, especially the National Pension Scheme (NPS), is still relatively young, having been introduced in 1988. The NPS operates on a pay-as-you-go defined benefit basis, funded by contributions from current workers, with a sizable reserve fund. However, despite recent annual surpluses due to its immaturity, the NPS is projected to run into a deficit by 2041, and its reserve assets are expected to be fully depleted by 2055. This is despite previous reforms aimed at reducing the replacement rate the percentage of pre-retirement income replaced by pensions and increasing the retirement age. The growing elderly population, coupled with slower economic growth resulting from a shrinking labor force, is expected to drive pension expenditures significantly higher. Pension spending, which accounted for 1.8% of GDP in 2009, has already risen to 4% of GDP in 2022 and is projected to increase by an additional 4 percentage points by 2070.

A Looming Fiscal Crisis for Korea’s Pension System

The paper examines several options for pension reform to prevent the unsustainable rise in public debt that would result if no further changes are made. Under current policies, Korea’s public debt is expected to rise by nearly 180% of GDP by 2070 due to the pressure from pension expenditures. The authors consider three primary policy levers to address this looming fiscal crisis: raising the retirement age, increasing social security contributions, and reducing the pension replacement rate. They argue that while each of these measures could, in theory, stabilize the pension system, the magnitude of change required would be politically and socially challenging if done in isolation. For example, to fully offset the projected increase in pension spending, the retirement age would need to rise by six years, social security contributions would need to increase by 13.8 percentage points, or the replacement rate would have to be cut by 10 percentage points. Any of these options alone would place a considerable burden on either workers or retirees, making them difficult to implement.

Balanced Reforms: A Path to Sustainability

Instead, the authors propose a more balanced approach, combining smaller adjustments across multiple areas. For instance, a mix of policies that includes raising the retirement age by two years, increasing contribution rates by 4.6 percentage points, and reducing the replacement rate by 3.3 percentage points could achieve similar fiscal outcomes without placing excessive strain on any single group. This would allow Korea to stabilize its public debt while minimizing the negative impacts on economic growth and workers’ livelihoods. The authors emphasize that Korea’s contribution rates and retirement age are currently among the lowest in the OECD, and modest increases would bring them more in line with international standards. They also highlight that while further reductions in the replacement rate may be inevitable, these should be accompanied by increases in the Basic Pension, which provides a minimum income to retirees, to protect against elderly poverty.

The Economic Cost of Inaction

In the absence of reforms, Korea’s rapidly aging population will lead to severe macroeconomic consequences. As the working-age population shrinks, labor markets will tighten, leading to lower unemployment but also slower capital accumulation and declining GDP growth. By the 2050s, GDP growth rates are expected to turn negative, exacerbating the fiscal strain. The paper warns that without action, the demographic transition will result in a significant shift in consumption patterns, with a greater share of resources going to the elderly, further depressing investment and growth. The model used in the paper projects that under current policies, real GDP per capita will decline as the population ages, and public debt will skyrocket.

Timely Action is Critical

The authors conclude by stressing the importance of early and carefully calibrated reforms to prevent Korea’s pension system from becoming fiscally unsustainable. They argue that a combination of measures, reflecting a balance between social preferences and fiscal necessity, is essential. While increasing the retirement age and contribution rates would bring Korea closer to OECD averages, these changes must be made with sensitivity to the country’s specific demographic and economic conditions. A comprehensive and consultative approach is needed to avoid reform fatigue or reversals, which could undermine the long-term sustainability of Korea’s public pension system.

A Call for Comprehensive Pension Reform in Korea

The IMF's study thus calls for urgent and decisive action to address the pension challenge in a way that maintains intergenerational fairness and economic stability. The demographic trends, if unaddressed, will lead to skyrocketing debt and declining GDP, potentially destabilizing the economy. Only through a balanced and phased reform can Korea ensure the sustainability of its pension system while protecting the financial security of future generations.