Asia Caught Off Guard by Its Aging Population

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There are significant changes under way in the global economy. The continuing rise of emerging markets is one. Aging populations is another. The latter is gripping not just developed markets, such as Japan and Europe, with possibly dire consequences for financial stability and growth.

In parts of emerging Asia, populations are graying rapidly as well. These countries are equally ill-prepared to face the challenge.

Asia Caught Off Guard by Its Aging Population
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China is probably the most worrying. Partly as a result of the country's one-child policy — initiated in 1977 and rolled out nationwide two years later — its demographic turn will be abrupt. By some estimates, the labor force will start to contract in 2015. After years of expanding rapidly, which goes a long way toward explaining the economy's breath-taking growth over the last three decades, this will amount to an outright jolt.

The numbers speak for themselves. Currently, China has approximately 137 million people aged 65 or above. In 12 short years, this will balloon by another 100 million. The ratio of retirees to income earners will jump from 49 percent currently to 69 percent in 2030, assuming that the retirement age remains the same. By 2035, the median age in China will have increased from 35 to 45 years — equal to Japan's median age currently.

But China is not alone. South Korea's working-age population will also begin to shrink in 2015. Taiwan has already seen a sharp rise in the ratio of retirees to income earners, while the country's median age is projected to climb from 37 currently to 56 in 2050, which will make it the oldest population in Asia. Hong Kong and Singapore face similarly daunting demographics — although, in both cases, immigration could yet help mitigate the problem. Even Thailand is past its demographic prime, with the labor force expected to start contracting within the next 10 years.

(Read More: Hong Kong's Rich-Poor Divide Widens as Population Ages)

Diminishing Demographic Returns

There are a number of ways in which aging affects growth. First, a declining labor force throttles economic dynamism. This is particularly true in Asia, where the demographic dividend has for years been a potent driver of economic expansion. For these economies to maintain their accustomed speed, every remaining worker would have to become a lot more productive.

Second, consumption patterns tend to change. People consume the most between ages 20 and 40. As populations age, therefore, household spending tends to cool as well, a situation that poses a challenge to countries trying to rebalance their economies away from exports and investment. Sharply rising incomes can go a long way toward delaying the slowdown in consumption that aging inevitably entails. But that brings its own set of problems, including rising inflation pressures, especially if productivity fails to accelerate.

Third, demographics can have a powerful impact on savings. People tend to accumulate a nest egg over their working lives. Particularly between the ages of 40 and 65, saving rates peak in anticipation of retirement. But, thereafter, it swiftly begins to drop, with savings being drawn down. Japan is already well into this process: its household saving rate has fallen from solid double digits in the 1990s to a rate below that of the United States. In South Korea, too, the saving rate has already started to plummet. With fewer savings available, investment ultimately becomes more costly, making it harder still to maintain economic growth.

(Read More: Countries With Aging Populations)

Fourth, rapidly aging populations put significant strain on the public finances. Healthcare costs soar and, if not sufficiently accrued in prior years, so does spending on pensions. This can mean an ever higher tax burden on the working population, dampening growth. The IMF, for example, estimates that aging-related public sector costs will climb on average by 4.1 percent of GDP in China and by 7.8 percent in South Korea over the next 10 years, some of the highest such adjustments required in the world.

Act Now or…

Policymakers will need to act, fast, to prepare for Asia's demographic turn. Provisions will have to rise, financed through taxes and direct contributions. Every effort, too, must be made to spur productivity growth to wean the economies off labor force growth as a driver of economic expansion. Debt should be held in check as well, if only because the cost of capital will inevitably begin to rise. Higher interest rates will make even existing, let alone new, borrowing far harder to finance.

(Read More: China's Aging Population Threatens Its Manufacturing Might)

Investors, too, should be mindful. It is easy to be gripped by the vagaries of economic numbers released from one month to the next. But something far larger is going on. Parts of Asia face similar aging problems as Europe and Japan. So far, no economy has succeeded in maintaining rapid growth when populations grow old. If this process is managed well, it need not spell doom. But the right tracks will need to be laid at once. Fortunately, there are other countries still waiting in the wings with young and hungry populations. India and the Philippines, for instance, will not have to grapple with such challenges for decades to come.

Frederic Neumann is co-head of Asian Economics at HSBC's Global Research and has been covering regional economies for the past 7 years. He is a regular guest on CNBC TV.