Dependency Ratio
The number of dependent individuals to the total population
What is the Dependency Ratio?
The dependency ratio compares the number of dependent individuals by age to the total population. Specifically, it measures people between the ages of 0 to 14 and above 65 to those who are 15 to 64. By doing so, it separates those who can and cannot work, which can indicate how unemployment levels create an economic burden.
Summary
- The dependency ratio compares the number of dependent individuals to the total population.
- The ratio indicates the level of economic burden that the employed in a population takes on to support the unemployed.
- To account for various limitations and discrepancies in the calculation, it is recommended to tailor the assumptions of the dependency ratio to ensure it fits the demographic profile of the population.
Utilizing the Dependency Ratio
The formula for the dependency ratio is the following:
Where:
- No. of Dependents – Those aged 15 and under + 64 and over
- Working Population – Those aged between 16 and 63
When the dependency ratio percentage is large, it indicates that the working population faces a greater burden supporting the dependent population.
The groups are separated into those that can work and those that cannot. Individuals who are less than 15 years old are unlikely to receive personal income due to employment regulations (child labor laws). Individuals who are above 64 are considered to be of retirement age, where they are not expected to be part of the workforce. Thus, for both groups, the assumption is that those that are of legal working age will be the ones to support their living needs.
Understanding the Dependency Ratio
As the dependency ratio compares the working to the non-working population, it is used to track shifts in employment. As the non-working group increases, the working population will shoulder a greater tax burden as there are fewer people to spread it out to.
Often, the dependency ratio will be re-adjusted for people who are nearing the age of 65. As those who are seniors require more government assistance relative to those below the age of 15, the ratio must be shifted to more accurately reflect the aging population.
Dependency Ratio Example
Assume that in an economy, there are 800 children under the age of 15 and 2,000 individuals at or above the age of 65. The working population consists of 1,500 individuals. Using the formula given above, the dependency ratio is calculated as follows:
Dependency Ratio = (2,800/1,500) * 100 = 187%
Downsides of the Dependency Ratio
It is important to be aware that because the dependency ratio factors are purely based on age, those groupings may not accurately reflect the economic burden the working population faces. For example, even though individuals are considered dependents above the age of 65, it does not necessarily mean that older people do not continue to work.
In order to retrieve a more reliable estimate, the labor force participation rate for each age group should be considered within the calculation. The U.S. Bureau of Labor Statistics calculates the figure on a 5-year increment for ages 16 and up. As of currently, it can be perceived that the labor force participation rate (LFPR) is dropping.
It is evident in the U.S., as younger individuals are choosing to go to school and obtain an education rather than entering the labor market immediately after high school. Due to such reasoning, governments will shift the tax burden to other working-age groups to support the higher dependency levels.
The dependency ratio also does not account for longevity. Those above the age of 80 likely have more health issues than younger seniors, as their frail bodies are more prone to illnesses. For example, approximately 80% of women who are above the age of 75 have some type of sickness. Overall, this situation increases the cost burden on workers.
To mitigate the discrepancy, it is important to simply not rely on a single dependency ratio based on the criteria mentioned in the beginning. Rather, another age dependency ratio should be calculated to account for those within their 80s. Based on the U.N.’s historical data, 11.9 million seniors in their 80s were supported by 211.6 million workers.
More Resources
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
Financial Analyst Certification
Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes!
