Global ageing is pushing much of the developed world towards fiscal and economic crisis, Richard Jackson of the Center for Strategic and International Studies (CSIS), told a Brussels conference last month: “There is still time to change course, but it is running short. And the problem is worse than is generally supposed.”
At the conference on ‘The economic and budgetary implications of global ageing’, run jointly by the European Commission and CSIS, a Washington-based think tank, Jackson announced the ‘Ageing vulnerability index’*. “This assesses the ‘vulnerability’ of 12 developed countries to rising old-age dependency costs,” he said. This assumed the continuation of historical trends regarding fertility, mortality, immigration, employment participation rates, productivity and healthcare costs.
Four basic indicators were used to see how countries are likely to be affected by 2040. Public burden indicators track size of the public spending burden; fiscal-room indicators track governments ability to accommodate the benefits growth; the benefits dependence indicator looks at how dependent the elderly are on public benefits, and the elder affluence indicator tracks the relative affluence of the old versus the young.
Each of the 12 countries were ranked and scored to arrive at the index for the 12 countries. “The 12 countries fall into three clear groups, a low medium and high vulnerability group,” said Jackson (see table). The three countries, France, Italy and Spain face a “daunting fiscal and economic future”, according to the study.
The challenges Europe faces demographically were spelt out by Pedro Solbes, European Commissioner for economic and monetary affairs.
“Our population in the EU is ageing for three reasons,” he told delegates. “The fertility rate is below replacement level, an increased life expectancy at the rate of an additional year per decade and increasing immigration. But not enough to make an impact on the ageing population.”
The active working population in the European Union countries would fall by 40m in the next 50 years, he said.
“The same number of elderly people will retire,” and the old age dependency ratio will change from four workers to every retiree to a two to one ratio by 2040. Italy and Spain would have the biggest increases in old age dependency rates – reaching 60%.
The budgetary implications of this for countries in the single currency area on the average-age related public spending could increase by 5-8 percentage points by 2040 with much larger amounts in certain countries.
For some, age related expenditures could lead to unsustainable budget deficits. “This could complicate the implementation of the single monetary policy and lead to higher interest rates than otherwise.”
He added that budget stability meant keeping the tax burden at “reasonable levels”. Under current policies the risks of unsustainable budgets, he reckoned, existed in half the EU states.
When the “baby boomers” retired from the EU workforce from 2010 onwards this would reduce the potential economic growth rate by 1%-1.25% per annum. The “ultimate effect would be a per capita GDP some 20% less than otherwise could be expected in the absence of demographic change”.
Solbes pointed to a pension shortfall, as most entitlements to pensions are based on growth rate in the economy.
He believed the solutions lay first in reducing the amount of debt and secondly in increasing employment rates – but he pointed to the big gap between reality and the objective as a number of member states have underlying budget deficits above 60% of GDP.
Measures to increase employment of older workers were lagging still, he said. More reform on the pension side was required.
He was concerned with the inability to deal with these challenges, the cost of which would be borne long term. The temptation was to adopt a “wait and see” attitude and to defer difficult decisions. “Uncertainty is no excuse for inaction,” he maintained.
Potential economic growth rates in the US were expected to remain robust at around 2.5% per annum in the period to 2040, this compared with the reduction to 1.25% expected in Europe, Klaus Regling, director general for theEconomic and Financial Affairs DG, told the conference.
“The difference in economic performance between the EU and the US can largely be attributed to the projected continuous increase in the population of working age in the US over the projected period.”
The main policy challenges for sustainable public finances were being faced by Greece and Spain for large increases on spending on public pensions; Germany, France, Portugal and Austria were at risk from age related expenditure, low employment especially among older workers and slow debt reduction; Belgium and Italy with high debt will have to run “high primary surpluses over the very long run”.
Those with sustainable finances, in his view, include Denmark, Ireland, Luxembourg, the Netherlands, Finland, Sweden and the UK. But they could face budgetary challenges posed by ageing populations.
What mattered more for growth and for pension systems was not demographics but the balance between economically active people in employment and inactive people, who must be supported,” Henri Bogaert, chairman of the Economic Policy Committee Working Group on Ageing Population.
The EPC’s work showed that EU states’ spending on public pensions will increase by between three and five percentage points of GDP between 2000 and 2050, with the largest increases of eight to 12 points predicted for Spain and Greece. Health-care spend was also projected to rise by around two to three percentage points.
“There is now a large consensus for accepting that the first pillar PAYGO system is perhaps not the best performing system, but for various reasons, it is better to continue with a structure of three pillars.” Reforms in EU states were concentrating altering the “parameters of the system” to control costs. The EPC had crried out a number of simulations of changing the pension rules, he pointed out.
By reducing the indexation of pensions by half a percentage point a year, in an earnings related system could offset a 0.5 to 2 percentage points of expected increase in spending by 2050, equivalent to a third of the overall increase in spending. The effect of increasing effective retirement age by one year, with workers working an additional year before retiring, would be to reduce projected spending by 0.6 to 1% of GDP to 2050 corresponding to 10 to 30% of the expected increase.
The third EPC exercise was to look at adjusting benefits to the expected increase in life expectancy, which will account for half of the likely rise in pension spending. By having an actuarially neutral approach, expenditure by 0.4 to 1.9 percentage points.
Bogaert said further reforms of pension and early retirement schemes were inevitable. “The most appropriate route seems to be to increase the actuarial fairness of the system across ages of retirement.” A possible ingredient in several countries is to change the indexation rules. Raising employment rates “is a critical element in strategies required to meet the budgetary cost of ageing”.
Countries should look at successful reforms elsewhere, he suggested and referred to Sweden’s as “best practice”.
The focus of the debate about ageing, pensions and demographics needed to be shifted, said Pat Cox, president of the European Parliament. “We should not always be talking about pension timebombs and disastrous exponential healthcare costs,” Cox said.
The increase in life expectancy along with better health prospects is “an achievement worth celebrating and not to be oppressed by the fiscal challenges,” he told the conference.
“You can’t have deliberate attitude changes in society by constantly harping on to people about the benefits of longevity and good health and say that these are a burden on the society that has achieved them.”
The terms of reference of the debate needed some balancing out in his view. Now is the time to go to war on shifting European leaders from rhetoric to delivering reform, he said. “The gap between the two is a large one.”
“We must emphasise the need for growth in Europe. If we don’t go for growth the political adjustment mechanisms inter-generationally will become impossible to operate in terms of scale of the cost.” Growth was one factor that could help ease adjustments.
*The 2003 Ageing Vulnerability Index’ published by Center for Strategic and International Studies (www.csis.org) and Watson Wyatt Worldwide (www.watsonwyatt.com).