Ageing Europe: A Mixed Blessing

Paolo Belardinelli, Research Fellow at Instituto Bruni Leoni // 2.11.2016

Pension Systems and Politicians’ Temptations

 

It is common knowledge that Europeans are in their best physical shape ever. On average, in the European Union, we expect to live 62 years in a healthy condition at birth. This is the result of different dynamics, such as better living conditions, the development of new healthcare technologies, and the change of lifestyles.

 

Besides being healthier, we also live longer.

 

The 2015 Ageing Report from the European Commission reveals that 18.4 percent of the European Union population is 65 or over. In the Euro area this elderly cohort accounts for 19.2 percent of its population. According to the projections included in the report, in 2020 these percentages will be 20.5 and 21.3 respectively, rising to 28.2 and 29.2 in 2050. The demographic old-age dependency ratio (people aged 65 or above in proportion to those aged 15-64) is 28 percent in the EU and 29 percent in the EA. In 2020, these would be 32 and 33 respectively, increasing to 50 and 52 in 2050.

 

In other words, today there are almost four working-age individuals for every person aged over 65 years. In the medium term, not least due to low fertility rates, they are slated to decrease to two. These numbers are even more impressive if we look back at 1950, when there were seven working-age people for every elderly person.

 

Of course, these projections depend on assumptions that become increasingly less reliable as we look further into the future. At any rate, a number of official sources (e.g. World Bank, European Commission, OECD) have suggested a similar trend. We should be aware of the consequences of these developments, starting from the jeopardised sustainability of welfare systems.

 

Retirement systems are the most likely to be affected by population ageing. In particular, a changing population structure directly affects the financing of pay-as-you-go pension schemes, as a decreasing number of working-age people needs to support pension levels for an increasing number of elderly. Contribution-based schemes do not escape this problem. Moreover, even those national systems that today appear to be the most stable assume migration flows which, due to political opposition, may not come to pass.

 

The Italian system, for instance, after the 2011 reform that raised the retirement age to 66 and established a contribution-based scheme, is judged as a pretty stable one.

 

Nonetheless, the current system’s sustainability is predicated upon inflows of about 200,000 immigrants a year, while there are several political parties—in Italy as elsewhere—advancing policies of severe restrictions to immigration flows.

 

In addition, there is the temptation for politicians to look for votes in exchange for other peoples’ money. Italy will vote on a constitutional referendum next December 4. The fate of Prime Minister Matteo Renzi is closely tied to the referendum result. It is not by chance that with the 2017 budget law, the Government is proposing that workers be allowed to retire three years earlier than provided for by current regulations. Ostensibly, the benefits to be accrued in these additional years of pension age will take the form of a loan, to be issued by a bank or insurance company. After three years, the beneficiaries would start repaying these loans through deductions taken out of their pension checks over the course of the subsequent 20 years, resulting in lower monthly average payments. Thus, the Italian Treasury should only be minimally affected. In particular, this would obtain in case a pensioner should die before having fully repaid the loan to the bank, in which case the Government would take on the remaining interest payments. Another potential impact would appear in case a tax deduction is needed to offset lower pension benefits. Anyhow, this only goes to shows at an advantage the vulnerability of pay-as-you-go systems to the ambitions of politicians.

 

Only a fully-funded system that pays all benefits from accumulated funds instead of current contributions, can  really be effective in facing the challenges brought about by the change of population structure. Notwithstanding the troubles the transition from a pay-as-you-go to a fully-funded scheme would entail—among which financing the pensions accrued in the old scheme is probably the most problematic—the Chilean experience shows that such a move is possible. Starting from 1980, Chile introduced a fully-funded system, that is now judged among the most sustainable in the world.

 

 

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