Economic Policy Committee reports on state pension systems
Published: 27 November 2000
In February 2000, the Economic and Financial Affairs Council of Ministers (Ecofin) requested that the Economic Policy Committee (EPC) prepare by December 2000 a preliminary report on the impact of the ageing population on state pension systems. This report was published on 26 October 2000 and is entitled /Progress report to the Ecofin Council on the impact of ageing population on public pension systems/. It aims to illustrate the development of long-term public expenditure on state pension systems. The EPC, set up in 1974, provides assistance and advice to the Council. It is composed of up to four members from each Member State, generally senior officials from national ministries of finance or economics and from national central banks. The European Commission and the European Central Bank also nominate up to four members each.
In November 2000, the EU Economic and Financial Affairs Council discussed a report drawn up at its request by the advisory Economic Policy Committee, investigating the impact of the ageing population on public pension systems across the EU. The report highlights the characteristics of current state pension systems and provides an assessment of current and future pension provisions.
In February 2000, the Economic and Financial Affairs Council of Ministers (Ecofin) requested that the Economic Policy Committee (EPC) prepare by December 2000 a preliminary report on the impact of the ageing population on state pension systems. This report was published on 26 October 2000 and is entitled Progress report to the Ecofin Council on the impact of ageing population on public pension systems. It aims to illustrate the development of long-term public expenditure on state pension systems. The EPC, set up in 1974, provides assistance and advice to the Council. It is composed of up to four members from each Member State, generally senior officials from national ministries of finance or economics and from national central banks. The European Commission and the European Central Bank also nominate up to four members each.
The publication of this report forms part of a wider agenda to study pension provision in the future - the Council of Ministers has launched a long-term investigation into the future development of social protection and the sustainability of pension systems up to 2020 and beyond. Within this context, the European Council held in Lisbon in March 2000 (EU0004241F) gave a mandate to the High-Level Working Party on Social Protection to study the evolution of public pension systems. It also asked the Council and the European Commission to present a report by spring 2001 to assess whether adequate measures are being taken to ensure the long-term sustainability of public finances in view of the ageing population.
Characteristics of state pension systems
The report from the EPC states that the pension systems across the EU are characterised by a strong state component and in only three Member States - Denmark, the Netherlands and the UK- are private sector elements of the pension systems well developed. According to the report, some 50% of state pension systems offer a universal scheme, which is usually means-tested, and all Member States, except the Netherlands, have comprehensive public pension systems which cover workers in the private and public sectors as well as self-employed workers.
Member States' public pension systems are financed mostly by means of a combination of "pay-as-you-go" arrangements and transfers from state budgets. However, in Denmark, Sweden and Finland, the financing system is partly pre-funded, with contributions invested in funds for repayment to individuals after retirement.
In terms of eligibility requirements, the report states that 65 will be the most common pension age requirement for men and women after 2004, while the requirements in terms of contributions levels vary from country to country and are not expected to change in the future. All Member States, apart from the UK, offer early retirement schemes which can be more generous in terms of eligibility criteria, with the average eligible retirement age for such schemes as low as 56. However, the report states that as a result of the take-up of early retirement schemes, the labour market participation rates of people aged between 55 and 64 is low compared with international standards for high-income countries. The report also highlights that the indexation of pension benefits is sometimes based on inflation and sometimes on wages, but for the most part it is a mixture of both.
Calculating spending forecasts
In the report, the EPC makes spending forecasts for public pension systems based on two macroeconomic scenarios: the "current policy" and the "Lisbon" scenarios.
In the "current policy" scenario, the report states that macroeconomic assumptions agreed at meetings of the Organisation for Economic Cooperation and Development (OECD) and at EU level imply convergence of productivity growth in Member States to between 1.7%-1.8% by the period 2020-30. They also predict convergence of unemployment rates and an increase in labour market participation rates in most countries, especially for women.
In the "Lisbon scenario", macroeconomic assumptions are adjusted to achieve consistency with the Lisbon European Council conclusions. The Lisbon Council set targets for 2010 which are predicated on the belief that male and female labour market participation rates and unemployment rates will converge to values achieved by the current best-performing EU Member States by 2050. The Lisbon scenario also supposes an average increase in the employment rate of 10 percentage points - from 70% to 80% - across the EU. In addition, it is assumed that between now and 2050, productivity rates in European countries will converge with those of the most competitive countries in the world.
In terms of demographic analysis, in the current policy scenario, the EU population is expected to fall from around 2020 onwards, primarily as a result of low fertility rates. By 2050 the population could be more than 3% lower than the current level. As the so-called "baby-boomer" generation starts to retire, the old-age dependency ratio - the population over 65 as a ratio of working age population - is expected to increase from the current level of almost 27% to over 53% by 2050 - as illustrated by the table below.
| 2000 | 2010 | 2020 | 2030 | 2040 | 2050 | |
|---|---|---|---|---|---|---|
| Austria | 25.1% | 28.8% | 32.4% | 43.6% | 54.5% | 55.0% |
| Belgium | 28.1% | 29.4% | 35.6% | 45.8% | 51.3% | 49.7% |
| Denmark | 24.1% | 27.2% | 33.7% | 39.2% | 44.5% | 41.9% |
| Finland | 24.5% | 27.5% | 38.9% | 46.9% | 47.4% | 48.1% |
| France | 27.2% | 28.1% | 35.9% | 44.0% | 50.0% | 50.8% |
| Germany | 26.0% | 32.9% | 36.3% | 46.7% | 54.7% | 53.3% |
| Greece | 28.3% | 31.6% | 35.8% | 41.7% | 51.4% | 58.7% |
| Ireland | 19.4% | 19.1% | 24.5% | 30.3% | 36.0% | 44.2% |
| Italy | 28.8% | 33.8% | 39.7% | 49.2% | 63.9% | 66.8% |
| Luxembourg | 23.4% | 26.2% | 31.0% | 39.8% | 45.4% | 41.8% |
| Netherlands | 21.9% | 24.6% | 32.6% | 41.5% | 48.1% | 44.9% |
| Portugal | 25.1% | 26.7% | 30.3% | 35.0% | 43.1% | 48.7% |
| Spain | 27.1% | 28.9% | 33.1% | 41.7% | 55.7% | 65.7% |
| Sweden | 29.6% | 31.4% | 37.6% | 42.7% | 46.7% | 46.1% |
| UK | 26.4% | 26.9% | 32.0% | 40.2% | 47.0% | 46.1% |
| EU-15 | 26.7% | 29.8% | 35.1% | 43.8% | 52.4% | 53.4% |
Source: Economic Policy Committee.
In the "Lisbon scenario", the EU population is expected to increase by around 17% by 2050, assuming higher fertility rates, higher life expectancy and higher general mobility rates. However, the report underlines that for many countries this demographic projection does not necessarily result in lower old-age dependency ratios because increased numbers of young people tend to be compensated for by an increase in the numbers of old people.
Future public spending on pensions
On the basis of the macroeconomic and demographic scenarios above, Member States have provided simulations for public pension expenditure as a percentage of gross domestic product (GDP), which are contained in the report.
Current policy scenario
In the current policy scenario, spending on state pensions as a percentage of GDP is forecast to increase in 14 Member States over the next few decades, although it is predicted to fall in the UK. The report states that in the majority of cases pension expenditure as a percentage of GDP is predicted to rise by between 3%-5%, as follows:
in Belgium, by 3.7% by 2040;
in Denmark, by 4.5% by 2030;
in Germany, by 4.3% by 2050 or after;
in France, by 3.9% by 2030;
in Ireland, by 4.4% by 2050 or after;
in Austria, by 3.1% by 2030; and
in Finland, by 4.7% by 2040.
In some Member States, spending pressures are forecast to rise slightly. For example, in Italy and Sweden pensions spending as a percentage of GDP is set to increase by 1.7% by 2030. However, in some countries the pressure on spending is expected to be more acute. In Spain, spending on pensions as a percentage of GDP could increase by 8.3% by 2050 or after and in the Netherlands and Portugal it could amount to an additional 6.2% of GDP by 2040 and 2030 respectively.
Lisbon scenario
In the Lisbon scenario, forecasts show a lower rise of pension expenditure as a percentage of GDP for all countries. The improvement is most pronounced in:
Portugal. Here, pension expenditure as a percentage of GDP between 2000 and 2040 is expected to increase by 4.1%, compared with 6.2% under the current policy scenario;
Belgium. Here, pension expenditure as a percentage of GDP between 2000 and 2040 is expected to increase by 1.6%, compared with 3.7% under the current policy scenario; and
Germany. Here, pension expenditure as a percentage of GDP between 2000 and 2050 or after is expected to increase by 2.3%, compared with 4.3% under the current policy scenario.
Under the Lisbon scenario, pension spending as a percentage of GDP is forecast almost to stabilise at 2000 levels for Sweden and Italy. However, the report underlines that even under "this very favourable scenario", the increase in pension spending as a percentage of GDP is expected to remain high for most EU Member States.
Impact of increased spending on public finances
The report also states that the necessary increased spending will have a further significant impact on public debt, forecasting that an increase in public expenditures on pensions of some four to five percentage points of GDP represents "a considerable challenge for the sustainability of public finances and the debt burden".
It also highlights the fact that the pressure on public finances could be even greater if healthcare is taken into account - the impact of healthcare and other age-related expenditures will be studied in a future report by the EPC.
Recommendations
The EPC suggests that the increased size of the older population will soon result in pressures on public pension expenditure to a varying degree across Member States. The report therefore recommends that Member States should adopt appropriate measures to ensure that such pressures do not undermine the long-term sustainability of their public finances. These measures include:
restricting access to retirement. In order to contain the rise in spending, the report suggests that some of the parameters characterising current eligibility requirements, indexation and benefit calculation for public pensions should be tightened. In particular, increases in the retirement age, especially in early retirement schemes, should be seen as a priority;
improving labour market participation rates. The report suggests that measures to improve labour market participation rates, especially among women, would have significant positive effects. It contends that higher participation rates would help reduce public debt and help to offset the need for public spending cuts or higher tax rates. Further, the EPC proposes that measures aimed at improving the labour market participation of older workers aged over 50 will help to improve Member States' fiscal position. Such workers would increase tax contributions to public finances and lower claims on public expenditure as a result of fewer public pensions and unemployment benefit payments; and
restricting long-term debt accumulation. This would improve the fiscal position in the immediate future before the costs of ageing populations start to have an impact. Budgetary surpluses and the resulting decrease in debt and related interest payments would balance the expected increase in pension expenditure.
Next stage
The EPC has stated that it plans to study the merits of different pension systems in the next stage of its work. Additional work will be undertaken out to assess possible reforms of "pay-as-you-go" systems and the extent to which the development of complementary funded systems might be advisable.
The Ecofin Council discussed the report at its meeting on 7 November 2000. Ministers paid particular attention to the "problems of financing public pension schemes, which would be encountered relatively soon, even in a favourable economic climate". The Council instructed the EPC to continue its work on the subject and broaden the scope to include the impact of ageing on healthcare expenditure, tax schemes and possible alternatives for adjusting various systems.
Commentary
The debate regarding how governments intend to finance their public pension systems in the context of an ageing population has been running for some years. This report marks the beginning of a concrete and concerted approach to tackling this issue.
Some governments have already taken action to try to curb the impact of the so-called pensions time bomb. Reforms aimed at restricting early retirement (TN0010201S) have been put in place in Austria (AT0008228F), Denmark (DK9902111N), Finland (FI9908114F), the Netherlands (NL9912176F) and Spain (ES9708216N). In France, the government has proposed a reform of state pensions that would increase the retirement age (FR0004159F), while in Germany new reforms have been recently unveiled to encourage private sector pensions (DE0008276F). In Italy, new rules have taken effect to encourage supplementary pensions (IT0001141N) and a debate on further pension reform is expected to take place in 2001. In Greece, the debate on pension reform at an early stage (GR9909150F).
The active debate on the pensions issue at EU and Member State level reveals the level of concern among policy-makers about the potential impact of the ageing population on public finances over the next 50 years. However, it remains to be seen whether action taken thus far by Member States and the current proposals of the EPC report will help cushion the impact of the ageing population on public finances (Neil Bentley, IRS).
Eurofound recommends citing this publication in the following way.
Eurofound (2000), Economic Policy Committee reports on state pension systems, article.
