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1.06.2005 ANALÝZA: Long-term Impact of Population Aging on EU Fiscal Policy

Uveřejňujeme analýzu s názvem "Dlouhodobý vliv stárnutí obyvatel na fiskální politku EU"  jako příspěvek k dnes aktuálnímu společenskému tématu stárnutí populace.  Text je celý v anglickém jazyce, česky nabízíme pouze krátký abstrakt.  Autorka pracuje jako credit portfolio manager v ABN AMRO Bank N.V.  

Dlouhodobý vliv stárnutí obyvatel na fiskální politku EU
Druhý demografický přechod je charakterizován především stárnutím obyvatelstva, poklesem plodnosti a nárůstem střední délky života při narození. Mezi těmito demografickými změnami a sociálními výdaji pak existuje velmi úzký vztah, jak na straně výdajů, tak i na straně příjmů. Fiskální politiky evropských států čelí v posledních letech novým problémům a výzvám spojených s narůstajícími sociálními výdaji. Dlouhodobé projekce těchto výdajů jednoznačně ukazují, že pro další financování je nutná nejen penzijní reforma, ať již systematická či jen parametrická, ale i další kontinuální přizpůsobování celého veřejného sektoru novému populačnímu vývoji.

1. Demographic Introduction
1.1 Demographic Transition
All developed countries are facing many changes in demographic behavioral and age structure of the population. These demographic changes are called The Second Demographic Transition . This transition is characterized with the decrease of fertility under the replacement level. That means that the reproduction does not offset the mortality and the population decreases (only migration, which has increased in the last decades, can cause the population increase and will take the important role in population structure). Changing in mortality, for example better conditions and life style, better health care, prevention or treatment, almost reached its peak and does not have a big impact on the population structure any more. Changes in reproduction are usually connected to the increase in individualism and to the revaluation of life goals. The Second Demographic Transition started in the 1960's in North and West Europe and continued up until the 1980's. The exact timing and different behavioral patterns varied across countries and over time. The post-communist countries started twenty years later in the 1980's and these processes are still ongoing.

Aging of population is a gradual process in which the proportions of adults and elderly increase in a population, while the proportions of children and adolescents decrease. This results in a rise in the median age of the population. Aging occurs when fertility rates decline, while life expectancy remains constant or improves at the older ages.  Population aging has two dimensions: Not only will there be more elderly individuals in the future; in addition, healthier lifestyles and medical advances will create an expanding population of the oldest old.

The elderly dependency ratio is usually used for describing the changing in age structure. This ratio is computed as a quotient of the postreproduction part of population (P60+) and the children share in population (P0-14). Because the life expectancy at birth is still increasing, the oldest-old dependency ratio (the postreproduction part of the population is counted as P75+) is sometimes used for better distinction.

1.2 Demographic Changes in Long-run (Projections)
Demographic projections are usually created in three different scenarios (low, middle and high). The changes in age-structure of the population mainly depend on the following assumptions: fertility rates, life expectancy at births and migration (which is actually the most difficult part of the projection to estimate).

The average of the fertility rate in the European Union in 2000 stood at 1.5, but ranged from 1.2 in Spain and Italy to 1.8 and 1.9 in Denmark and Ireland respectively. Fertility rates are projected to converge upwards to an average of 1.7 for the EU by 2050, with most of the increase occurring in the coming two decades. However, even these fertility rates are too low to ensure a natural replacement of the population or to stabilize its age structure.

Migration inflows or outflows are difficult to project as I mentiond earlier. They are driven by economic developments both inside and outside the EU, and unlike fertility rates and life expectancy, they can be more directly influenced by policy choices. The baseline scenario of Eurostat assumes net migration to EU Member States of +/- 640.000 persons annually over the projection period, constituting of approximately 0.2% of the total population. All Member States are projected to have net inward migration throughout the projection period, including countries such as Spain, Ireland and Portugal which have experienced substantial emigration in the recent past. However, there are substantial differences with regards to the projected flows as a percentage of the total population, with annual immigration of more than 0.2% of the total population recorded for Germany, Greece, Luxembourg, Austria, Portugal and Sweden.

Life exptecancy at birth is projected to steadily increase over the projection period. Average life expectancy at birth for men is projected to rise from the level 75 years in 2000 to the level 80 by 2050. For women, it is also projected to rise but by a smaller amount due to the higher recent level - from 81 in 2000 to 85 by 2050.

The result of these assumption will be the increase in total size of the EU population. The population growth is estimated to be slow from 376 million in 2000 to 386 million in 2020. These assumptions are only on the whole. The timing and scale of the changes in population differs among the different states. Some of them will face population decline (i.e. Germany, Spain), some other will face slow population growth (i.e. France, UK) or faster growth (i.e. Luxembourgh, Ireland).

The demographic trends mentioned above are posing a serious challenge to the sustainability of current pension systems. The generations of working age are determined by past fertility rates. The number of future pensioners depends on the level of the life expectancy at birth. These values are relatively stable over time so the projections of population development are therefore seen reliable. The European population of working age (people between the age OF 15 and 64) will remain stable until the year 2015 at the level of 246 million. After this time there will be a faster decline to 203 million until the year 2050.

According to Eurostat projections, dependency ratios will more than double in European countries between 1995 and 2040, from around 23% to 48%. These figures describe only a general way and different trends will be across the different countries, regarding the initial levels of indicators and as well as the estimated country-specific developments.

Tab. 1: Projected dependency ratios in the euro area
(Population aged 65 and over as a percentage of the population aged between 15 and 64)
  
Source: Eurostat in Budgetary challenges posed by aging populations: the impact on public spending on pensions, health and long-term care for the elderly and possible indicators of the long-term sustainability of public finances

2. Fiscal Policy Issues
Population aging influences the fiscal policy in different ways and on the side of revenues as well as on the side of expenditures. With the decreasing number of working age people come decreasing revenues from income taxes, while on the other side, increasing number of older people are increasing the social expenditures. Also expenditure of education will be affected by the anticipated consequences of longer life expectancy and lower fertility.

2.1 Pension System
There are four main factors driving the increase in public spending on pensions. A population aging effect which measures the changes over the future period in the ratio of persons aged 55 and over to the population aged 15 to 54. The second is an employment effect which measures changes in the share of the population of working age (15 to 64) that are employed. The third is an eligibility effect which measures the share of the population aged 55 and over that receive a pension and the last benefit effect which captures changes in the average pension relative to output per worker. The dependency ratio rises very substantially in all countries placing a strong upward pressure on public pensions spending. The aging of populations emerge as the dominant force driving public pensions expenditure upwards.

The social security system differs across the different states in the European Union; each is based on some certain similar characteristic. They are usually financed by taxes on the pay-as-you-go basis, although some schemes are also financed through transfers from the state budget. The possible benefits are generally computed as a share of the lifetime earnings and on the number of years that individual has worked. The problem caused by aging of the population is the increasing number of retirees and therefore the rising cost of pensions. If the pay-as-you-go system stayed unchanged the requirements for the tax revenues would have to rise by about 50 per cent in most countries. 

Public pension schemes in most Euro area countries also include some redistributive elements, i. e. providing pensions for the disabled, widows or orphans. The pensions are paid out from the contribution of the current population at the working age, therefore the relationship between current revenues and current pension payments and the structure of the population is very important.

2.2 Pension Reforms
Population aging problems brought an idea of changing the structure of the public transfer's schemes, which is already implemented in some countries. But the better estimates of the demographic indicators and also better projections based on new assumptions call for further systematic pension system adjustments coupled with reforms in other areas of public finances. If the pension system did not change we would observe a huge increase in the government debt or substantial cuts in benefits; also, problems concerning intergeneral equity would arise.

There are two possible general pension reforms. The first one would include only adjustments of existing public pension schemes and would be regarding the structure of the benefits and contributions (often referred to as "parametric reforms"). The second one would change the current pension system much more and the future benefits would be counted on accumulated assets (this is referred to as "systemic reforms"). The combination between these two schemes is also possible.

The reform is necessary to help financing the sharp medium-term increases in pensions even now, when the demographic shifts, changes in age structure and population aging do not have such a big influence as it will have in the future. It is also easier for countries to fight with incoming demographic problems ahead and adapt social transfer reforms with the fiscal norms established among EU Member States.

Parametric reforms seem to be more feasible to politicians. During the last decade, the small increase in contributions was normally enough to balance the public finance, but the incoming population aging problems will require more structural and deeper changes in pension system. The main idea of the pension parametric reform is in the different variants of the lowering benefits, implemented gradually and mainly influent future recipients. Possibilities for lowering benefits are increases in the effective average retirement age, a reduction in replacement rates and a change in the indexation rules for pensions.

Due to growing life expectancy at birth and better health conditions, it is possible to increase the age at which an employee becomes eligible to receive a pension. Also, the contemporary average retirement age was set many years ago, when the life expectancy at birth was much lower than it currently is. The key elements of the pay-as-you-go system are the individual's work history, as well as the factor determining the accrual of pension rights in relation to annual assessed income. Therefore, average replacement ratios could be adjusted by extending the number of years of income taken into account, or by changing the accrual factors. Although the parametric reforms could help to finance public social transfers, there are unsustainable and systematic reforms that should be used for greater funding of future under the estimated demographic projections.

Defined contribution systems are systems with more fundamental changes in the structure of contributing and receiving pensions. Contributions here are predetermined, normally as a proportion of the wage income, while pension benefits equal an annuity paid for the assets plus interest accumulated on individual accounts. Contribution rates to a funded system are fixed at a level, which balances the present value of all future receipts, and the present value of future benefits, the number of future retirees and contributors and wage growth. 

This is the main advantage compared to the pay-as-you-go system. Some countries operate notionally funded systems, where contribution rates are fixed in line with the requirements of a funded system; i.e. above the level needed to finance current pension payments. Contributions also are not actually invested in assets, but they accrue to the government, which may use positive balances in the pension system's budget to lower outstanding debt. Some possible administrative or economic problems could arise, but the examples of Sweden and Italy show that the change forms the traditional pay-as-you-go system to this notional defined contribution system is possible and efficient.

2.3 Pension Expenditure Projections
Projections for public expenditures on pensions are in a long run heavily influenced by assumptions on labor market developments. Participation rates for men are estimated to remain constant, but participation rates for women will increase, mainly in countries with well-developed child-care facilities. Unemployment rates are assumed to fall to their structural level by 2005 and to stay constant thereafter: for the EU, this resulted in unemployment falling to 8%. The increase in participation and the decline in unemployment rates can offset some of the impact of demographic developments on the size of the working age population. The key determinant is the balance between economically active and inactive persons who must be supported.

Tab. 2: Public Pension Expenditures as a % of GDP
 
Notes: (1) For Denmark, the results include the semi-funded labour market pension (ATP). Excluding the ATP, the peak increase would be 2.7% of GDP.
(2) Results for Ireland are expressed as a % of GNP and not GDP.
(3) For the Netherlands the second tier is quite well developed. Such characteristics have a direct positive effect on the public pension scheme by reducing the burden of aging populations on first tier pensions. However, there is also an important indirect implication: taxes on future pension benefits (which are drawn from the private funds) are expected to be quite high and may partially counterbalance the rise in public pension benefits.
Source: EPC working group on aging populations in Budgetary challenges posed by aging populations: the impact on public spending on pensions, health and long-term care for the elderly and possible indicators of the long-term sustainability of public finances

The projections show an increase of public pension expenditure between 3% and 5% of GDP in most of the states of the European Union over the upcoming time periods. Only the UK actually projects a decrease in public pension spending as a percentage of GDP that is due to the indexation of pension benefits after retirement to inflation. On the other side, the countries with the highest pension expenditure increase are Portugal, Spain and Greece; countries where public pension financed entirely on a pay-as-you-go system. Hence, these projected results support the necessity of the pension reforms.

3. Conclusions
In this paper I tried to discusse some of the factors affecting the relationship between population aging and social expenditures. The role of the first demographic transition is in influencing the shift from a predominant use of intra-family transfers and support. The role of the second demographic transition is in the population aging, in the fertility rates decline and in the growing life expectancy at birth.

Fiscal policies are facing newly established problems and challenges, especially in the large share of pension spending in government budgets. Therefore, the pension reform and broader adjustments of the public sector are urgently needed in order to meet future financing needs. Careful planning will be required to deal with the changing composition of social expenditure, and this changing composition is in many ways the most interesting and challenging aspect arising from population aging. Social insurance arrangements will experience, as they have done over their short history, a continual process of transition.

Notes:
1)  The First Demographic Transition started in developed European countries during the second half of the 18. century and finished after one hundred years later and was a part of the Global Transition of the Modern Era. The main changes in demographic transition were increase in life expectancy at birth due to better mortality condition and decrease of the total fertility, and also the change in age structure.
2)  Raffelhüschen, Bernd (1998): Aging, Fiscal Policy and Social Insurances: A European Perspective, Burch Center Working Paper Series University of California, Berkeley Department of Economics: Albert-Ludwigs-University of Freiburg, Germany, University of Bergen, Norway, Burch Working Paper No. B98-8
3)  All assumptions abut the future demographic development are taken from Economic Policy Committee Brussels (2001): Budgetary challenges posed by aging populations: the impact on public spending on pensions, health and long-term care for the elderly and possible indicators of the long-term sustainability of public finances
4)  European Central Bank (2000): ECB Monthly Buletin July 2000 (Population aging and fiscal policy in the Euro area)
5)  Economic Policy Committee Brussels (2001): Budgetary challenges posed by aging populations: the impact on public spending on pensions, health and long-term care for the elderly and possible indicators of the long-term sustainability of public finances
6)  Feldstein, Martin (2001): The future of Social Security Pensions in Europe, national bureau of Economic research, cambridge, Working paper 8487
7)  Tosun, Mehmet Serkan (2001): Assymetric Population Aging, Open Economy, and Fiscal Policy, Bureau of Business and Economic Research, College of Business and Economics, West Virginia University, Morgantown, WV 26506-6025 U.S.A.
8)  European Central Bank (2000): ECB Monthly Buletin July 2000 (Population aging and fiscal policy in the Euro area
10)  Feldstein, Martin (2001): The future of Social Security Pensions in Europe, national bureau of Economic research, cambridge, Working paper 8487
11)  Feldstein, Martin (2001): The future of Social Security Pensions in Europe, national bureau of Economic research, cambridge, Working paper 8487

Bibliography
1) Centre for Strategic International Studies and Watson Wyatt Worldwide (1999): Global Aging, the Challenge of the New Millennium
2) Davis, Nick & Fabling, Richard (2002): Population Aging and the Efficiency of Fiscal Policy in New Zealand
3) European Central Bank (2000, June): ECB Monthly Buletin July 2000 (Population Aging and Fiscal Policy in the Euro Area)
4) European Central Bank (2002, August): ECB Monthly Buletin August 2000 (Fiscal Policies and Economic Growth)
5) Economic Policy Committee Brussels (2001): Budgetary challenges posed by aging populations: the impact on public spending on pensions, health and long-term care for the elderly and possible indicators of the long-term sustainability of public finances
6) Feldstein, Martin (2001): The future of Social Security Pensions in Europe, national bureau of Economic research, cambridge, Working paper 8487
7) Raffelhüschen, Bernd (1998): Aging, Fiscal Policy and Social Insurances: A European Perspective, Burch Center Working Paper Series University of California, Berkeley Department of Economics: Albert-Ludwigs-University of Freiburg, Germany, University of Bergen, Norway, Burch Working Paper No. B98-8
8) Tosun, Mehmet Serkan (2001): Assymetric Population Aging, Open Economy, and Fiscal Policy, Bureau of Business and Economic Research, College of Business and Economics, West Virginia University, Morgantown, WV 26506-6025 U.S.A.
9) Tosun, Mehmet Serkan (2000): Worldwide population Aging: Endogenous policy Formation and Capital Market Transmission in the Presence of Symmetric Demographic Shocks, Center for Policy Research, Maxwell School of Citizenship and Public Affairs, Syracuse University
 

Anna Pilařová
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