Economic Growth and Fiscal Sustainability in the EU: The Impact of an Ageing Population

Abstract

This paper presents an assessment of the budgetary impact of ageing for the EU Member States. It draws upon the macroeconomic assumptions developed jointly by the Ageing Working Group of the Economic Policy Committee and the European Commission-Directorate General for Economic and Financial Affairs for the purpose of making age-related expenditure projections. The paper presents and analyses projections of the impact of ageing populations on the main age-related public expenditure items. The projections are not forecasts, but nonetheless provide an indication of the potential timing and scale of budgetary changes that could result from ageing populations in a no-policy change scenario. The projections show where, (in which countries), when and to what extent ageing pressures will accelerate as the baby-boom generation retires. In doing so, the projections are helpful in highlighting the immediate and future challenges for governments posed by demographic trends. The projections point to pressing economic policy challenges for the EU. From an economic perspective, potential growth rates are projected to fall to levels below those observed in recent decades. Fiscal challenges will come from a higher share of the total population in older age cohorts and a decline in the share of the population that is economically active. The fiscal impact of ageing is projected to be substantial in almost all Member States, with the effects accelerating as of 2010. Overall, on the basis of current policies, age-related public expenditures are projected to increase on average by almost 4 percentage points of GDP by 2050 in the EU and rise considerably more in several Member States, especially through pension, health care and long-term care. Ageing populations are expected to lead to a substantial increase in public pension expenditure in some countries. In eleven EU Member States the increase is projected to be over 5 percentage points of GDP. However, reforms implemented in recent years in some other Member States are having visible positive impacts. They have sharply reduced the projected increase in expenditures, diminishing the budgetary impact of ageing. Nonetheless, in some countries, the scale of reforms has been insufficient and they need to be pursued further to cope with the budgetary challenge. At the same time, implementing other measures, for instance promoting higher employment rates of older workers that contribute to adequate retirement incomes in the future might be required in order to ensure the lasting success of the pension reforms. In the EU as a whole, the current fiscal positions coupled with the projected cost of ageing would lead to government debt being on an explosive path and it would reach some 130% of GDP in 2050. The required fiscal adjustment to set the public finances on a sustainable path, the so-called sustainability gap, is estimated to be about 2½ per cent of GDP. The situation however varies greatly among EU member states, as a result of the diversity and degree of maturity of their public pension arrangements and the effects of pension reforms enacted so far. Nearly all countries have sustainability gaps. This implies that based on the current budgetary position (in 2007) and with no changes in fiscal policies, an adjustment is necessary so as to render the public finances sustainable over the long term for most EU countries.In some EU Member States, there is a risk of unsustainable public finances even before the long-term budgetary impact of ageing populations is considered. Indeed, the current budgetary position, in addition to the long-term budgetary impact of ageing, affects the sustainability of public finances. However, for the EU as a whole and for several Member States, the current budgetary position contributes in part to cover the longer term budgetary impact of ageing. This clearly shows that the fiscal consolidation in recent year's bear fruit and that fiscal policy can affect strongly the sustainability position. As regards policy conclusions, the paper underlines the critical need for ensuring that retirement behaviour takes due account of future increases in life expectancy and the need for more efficient and cost-effective service provision, in particular in health care and long-term care, in order to reduce the main sources of potential fiscal pressure. Nonetheless, containing the observed trend increase in health-care spending above that motivated by ageing is likely to be challenging. Moreover, it shows that progress has been made in recent years in terms of consolidating the public finances, with a visible impact on the sustainability positions in the EU Member States. However, it also reveals that several Member States still have a long way to go. First, they need to reach the medium-term budgetary targets (the MTOs) that have been set; and second, seriously consider pursuing more ambitious fiscal policies so as to put the public finances on a more sustainable footing, for the benefit of enabling both the people currently working and especially for those who will do so tomorrow to embrace the future with greater confidence.