Pension Reform in the European Union: Pension Reform in the European Union: How to Cope with Ageing PopulationsHow to Cope with Ageing Populations

Per EckefeldtPer Eckefeldt

European CommissionEuropean Commission – DG ECFIN– DG ECFIN

Cicero Foundation Great Debates seminar: Pension Reform in the European Union – Comparing Different National Approaches

Paris, 15-16 May 2008

OutlineOutline

European Commission

• Why reform? Why reform?

• demographic changes and economic demographic changes and economic and budgetary implicationsand budgetary implications

• Scale and composition of the fiscal Scale and composition of the fiscal sustainability challenge in the EUsustainability challenge in the EU

• Policy implicationsPolicy implications

Fiscal sustainability a core policy Fiscal sustainability a core policy objectiveobjective

European Commission

• Ensuring sustainable public finances in view Ensuring sustainable public finances in view population ageing is a key challenge for population ageing is a key challenge for policy-makers in the EUpolicy-makers in the EU

• Consistency between medium-term budgetary Consistency between medium-term budgetary targets and long-term fiscal sustainability targets and long-term fiscal sustainability emphasized in the EUs fiscal framework, the emphasized in the EUs fiscal framework, the Stability and Growth PactStability and Growth Pact

Population2004-2050

Labour force - Participation- Employment- Unemployment

Labour productivity

Real interest rate

GDP

Pensions

National models

Health care

Long-term care

Education

Unemployment benefits

Total age-

relatedspending

Measuring the ‘cost of ageing’: common long-term budgetary projections

Source: 2006 EPC/Commission report on ageing.

Main demographic indicatorsMain demographic indicators

The consequences of ageing populations The consequences of ageing populations on employment and growthon employment and growth

EU15 EU10

  2004 2050   2004 2050  

Fertility rate 1,5 1,6 +0.1 1,2 1,6 +0.4

Life expectancy at birth - men 76,4 82,1 +6 70,1 78,7 +8.6

Life expectancy at birth - women 82,2 87 +5 78,2 84,1 +6

Net migration flows (thousands) 1347 778 -3 101

Net migration flows (as % of population) 0,4 0,2 0 0,1

2004 2050

A much older population structure in the EU25

Source: 2006 EPC/Commission report on ageing.

4000 3000 2000 1000 0 1000 2000 30004000

1

59

13

1721

25

2933

37

41

4549

53

5761

65

6973

77

8185

89

Males Females

4000 3000 2000 1000 0 1000 2000 3000 4000

1

59

13

1721

25

2933

37

41

4549

53

5761

65

6973

77

8185

89

Males Females

• Total population: Total population: 457457 mill. in 2004, mill. in 2004, 471471 mill. in 2030, mill. in 2030, 454454 mill. in 2050 mill. in 2050• Most numerous age cohorts: Most numerous age cohorts: age age 3636 in 2004, age in 2004, age 57-5957-59 in 2050 in 2050 • Population aged 65+ doubles until 2050 Population aged 65+ doubles until 2050 (from (from 7575 to to 133133 millions in 2050) millions in 2050)• Old age dependency ratio (65+/15-64): Old age dependency ratio (65+/15-64): doubles from doubles from 2626 to to 5252

Participation rate projections:

the cohort approach Three main features of the methodology

1) Use of entry rates and exit rates

2) Participation rates are projected for

each single year of age and gender

3) Incorporate the impact of pension

reforms

DE - Male

0%

5%

10%

15%

20%

50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70

AGE

2003

2025

DE - Male

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70

AGE

2003

2025

Probability of retirement Cumulative probability of retire at or before a given age

Impact of recent pension reforms

Impact of recent pension reforms(2003 - 2025)

Increase in the average exit age

0

0.5

1

1.5

2

2.5

3

3.5

4

SK HU FR CZ FI PL SL AT BE DE LT UK IT LV ES EE SE

year

s

Males Female

• Unemployment rate assumed to converge to EU15 average -7% for those with higher UR)

• Employment rate for the EU25 :

from 63% in 2003 to 71% in 2050 mainly due to: - women’s employment: from 55% to 65% - older workers (aged 55-64): from 40% to 59%

58

60

62

64

66

68

70

72

2003 2010 2020 2030 2050

Pension reforms effectsCohort effectFixed Participation Rate for each age and gender group

Ageing or retirement problem?Ageing or retirement problem? Adult life spent in retirementAdult life spent in retirement

EU25EU25

Men2003 2050

Employment rate of older workers

50.0 64.8

Average exit age 61.9 62.9Life expectancy at the time of withdrawal

19.0 22.1

% of adult life spent in retirement

28.8 31.6

Requested exit postponement,in years (to keep % life spent in retirement constant)

1.9

Women

2003 2050

30.4 53.0

61.1 61.9

23.3 26.6

33.6 36.2

1.9

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

2005 Austria, Cyprus

2006 Portugal

2007 Finland2009 Ireland

2010 Germany2011 Latvia

2013 Estonia

2014 Lithuania

2018 Spain

2023 Slovenia

TARGET NOT REACHED IN 2050 (7MSs)

Belgium FranceHungaryITALY LuxembourgMalta Poland

Projected time frame for meeting the Lisbon employment target 70%

TARGET ALREADY REACHED IN 2004 Denmark Netherlands Sweden UK

2035 EU12

2015 EU15, Czech Republic

2020 EU25, Slovakia

The consequences of ageing populations on employment and growth

EU10

2015 EU15

2020 EU25

Phase 1: A “window of opportunity” : both working-age population and employment increasing –but closing fast

The consequences of ageing populations on employment

Source: 2006 EPC/Commission report on ageing.

180

200

220

240

260

280

300

320

2003 2008 2013 2018 2023 2028 2033 2038 2043 2048

total employment

working-age population

Phase 1 Phase 2 Phase 3

Between 2018-2050:Employed persons: - 30 millions (14%)Working-age population: - 45 mill. (15%)

Impact of ageing on economic growth

Moving from Employment to GDP growth assumptions: the Production function approach

based on the projections of the main components:

L

KTFP

POP

L

POP

POPPOPGDP )1(

6415

6415

Productivity growthEmployment growth

GDP growth = Δ labour input (Δ population + population + Δ Active ageing population+ Active ageing population+ Δ employment rate) employment rate) + Δ labour productivity (TFP growth + contribution from capital deepening)

- long run equilibrium in Solow model: Δ Y/L = Δ K/L= Δ TFP/a (=labour augmenting technical progress)

Productivity Δ labour productivity :

- convergence to 1.7 in 2030 (EU15) & 2040 (EU10)

=• Δ TFP assumptions is key : - convergence to 1.1% in 2030

+ • Contr. from capital deepening: 0.6% in 2030 = (1- α)* Δ K/L or Δ TFP(1-α)/ α (α=labour share = 0.65)

- long run capital rule: capital/labour ratio in efficiency units constant Δ capital stock = Δ L +labour augmenting technical progress (or TFP/ α ),

The consequences of ageing populations The consequences of ageing populations on employment and growthon employment and growth

Projected Growth : EU15 & EU10Projected Growth : EU15 & EU10EU15

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2004-10 2011-30 2031-50-1.0

0.0

1.0

2.0

3.0

4.0

5.0

GDP growth

Employment growth

Productivity

growth

EU10

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2004-10 2011-30 2031-50-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2.21.8 1.3

4.5

3.0

0.9

Population2004-2050

Labour force

- Participation- Employment- Unemployment

Labour productivity

Real interest rate

GDP

Pensions

National models

Health care

Long-term care

Education

Unemployment benefits

Total age-

relatedspending

Results of the budgetary projections

Projected changes in public pension expenditure

2004-2050 (% of GDP)

-10

-5

0

5

10

15

PL

EE LV

AT

MT IT SE

DE

SK LT

FR

UK FI

DK

NL

BE

CZ IE HU

ES SI

LU

PT

CY

From – 6pp in Poland to + 13 pp in CyprusFrom – 6pp in Poland to + 13 pp in Cyprus

Decomposition of the increase in pension expenditure

Dep. effect Empl. effect

PensExp = Pop>65 x Pop (15-64)

GDP Pop(15-64) EmplNo

Take-up eff. Benefit effect

x PensNo x PensExp/PensNo

Pop>65 GDP/EmplNo

Factors contributing to pension expenditure changes, EU15 and EU10 (% of GDP)

8,2

-1,0-1,7

-2,8

2,3

9,9

-1,7

-3,8 -3,5

0,3

-8

-6

-4

-2

0

2

4

6

8

10

Dependencyratio

Employmentrate

Take up ratio Benefit ratio Total

EU15 EU10

2004-20502004-2050

Large reductions in the benefit ratio in several countries (2050 in percent of 2004)

-100,0

-80,0

-60,0

-40,0

-20,0

0,0

PL EE MT LV SK IT AT DE SE FR EU25

Mainly resulting from:

shift towards private funded schemes,

pension inversely linked to life expectancy gains;

shift towards indexation to prices

… and leading to possible adequacy challenges…

Budgetary projection results, EU15

EU15

0

5

10

15

20

25

30

pensions health care long-term care education unemploymentbenefits

total

% o

f GD

P 2004

2050

+3.7

-0.2

-0.6+0.7

+1.6

+2.3

Budgetary projection results, EU10

EU10

0

5

10

15

20

25

30

pensions health care long-term care education unemploymentbenefits

total

% of

GDP

2004

2050

+0.2

-0.2

-1.3

+0.2

+1.3

+0.3

Budgetary projection results, EU9 (excluding Poland)

EU9 (EU10 - PL)

0

5

10

15

20

25

30

pensions health care long-term care education unemploymentbenefits

total

% o

f G

DP

2004

2050

+5.4

-0.1

-0.9

+0.3

+1.3

+4.8

Fiscal sustainability analysis at the EU levelFiscal sustainability analysis at the EU level

European Commission

• Ensuring sustainable public finances in view Ensuring sustainable public finances in view population ageing is a key challenge for population ageing is a key challenge for policy-makers in the EUpolicy-makers in the EU

• Consistency between medium-term budgetary Consistency between medium-term budgetary targets and long-term fiscal sustainability targets and long-term fiscal sustainability emphasized in the EUs fiscal framework, the emphasized in the EUs fiscal framework, the Stability and Growth PactStability and Growth Pact

• Sustaining the European welfare model(s) Sustaining the European welfare model(s) central policy issue in view of ageing and central policy issue in view of ageing and globalisation; Lisbon strategy, Integrated globalisation; Lisbon strategy, Integrated guidelines, Open method of co-ordination,… guidelines, Open method of co-ordination,…

What should be done? What should be done?

A three-pronged strategy to ensure sustainabilityA three-pronged strategy to ensure sustainability

European Commission

Ensuring sustainabilityEnsuring sustainability

Reducing debt Reducing debt at a fast paceat a fast pace

Raising employment Raising employment and productivityand productivity

Reforming pension, Reforming pension, health-care and health-care and long-term carelong-term care

systemssystems

What are the policy implications?What are the policy implications? (1)

European Commission

• Ambitious fiscal policies contribute Ambitious fiscal policies contribute significantly to fiscal sustainability; significantly to fiscal sustainability; the planned budgetary positions in the planned budgetary positions in the Member States need to be the Member States need to be reachedreached

• If attained, the debt ratio in the EU If attained, the debt ratio in the EU would almost remain below the 60% would almost remain below the 60% threshold up to 2050threshold up to 2050

What are the policy implications? (2)What are the policy implications? (2)

European Commission

• Adapting Europe’s social models and enhancing its Adapting Europe’s social models and enhancing its growth potential is paramount: growth potential is paramount:

• the Lisbon strategy, by fostering employment creation and enhancing productivity, give rise to double benefits: higher future living standards and, importantly a contribution to fiscal sustainability

• structural reforms, notably in the field of pensions, are crucial to improve fiscal sustainability; there are several examples showing that reforms do pay off

What are the policy implications? (3)What are the policy implications? (3)

European Commission

• Adapting Europe’s social models and enhancing its Adapting Europe’s social models and enhancing its growth potential is paramount: growth potential is paramount:

• measures that extend working lives and provide incentives for private pension provision contribute to adequate retirement income and are necessary to ensure the lasting success of several major implemented pension reforms

• improving the quality of public finances will involve prioritization of public expenditure – and its financing - in view of competing budgetary pressures, such as education and healthcare

Reports on ageing and sustainabilityReports on ageing and sustainability

• The 2005 EPC projections of age-related expenditure (2004-2050) for the EU25 Member States: underlying assumptions and projection methodologies

http://ec.europa.eu/economy_finance/epc/documents/2005/ageing2005en.pdf

• The impact of ageing on public expenditure: projections for the EU25 Member States on pensions, long-term care, education and unemployment transfers (2004-2050)

http://ec.europa.eu/economy_finance/epc/documents/2006/ageingreport_en.pdf

• The long-term sustainability of public finances in the European Union

http://ec.europa.eu/economy_finance/publications/publication_summary7907_en.htm

European Commission

Thank you for your attention!Thank you for your attention!