2.4.1. Growing EU involvement in ageing related policies
There is a growing recognition that there are benefits to addressing issues related to ageing populations at EU level, with the result that the issue has featured promi- nently on the agendas of several recent European Councils (Stockholm of March 2001, Nice of December 2000 and Lisbon of March 2000). A comprehensive approach has been taken drawing upon the report ‘Maintaining pros- perity in an ageing society’ (OECD, 1998), which policies through which societies can transfer resources to a rapidly growing number of retired persons without creating major economic and social strains. Such an approach recognises that budgetary sustainability in light of ageing popula- tions must be accompanied with social sustainability. To this end, a committee on social protection, comprising officials from social affairs Ministries, was established in 2000 with a view to upgrading cooperation on the modernisation of social protection systems (Council of the European Union, 2000). The need for ageing policies to satisfy both budgetary and social objectives was made clear in a Commission communication that identified a number of principles for pension reform which include adequacy of income provision, solidarity, transparency, predictability of benefits and fairness both within and between the generations (European Commission, 2000b). This led to a report being submitted to the European Council of Göteborg (15 and 16 June 2001) entitled ‘Ade- quate and sustainable pensions’ (1).
While the EU has clear competences enshrined in the Treaty as regards budgetary surveillance to ensure sound public finances, involvement in other aspects of ageing on public policies is guided by the subsidiarity principle. This is because the main impact of ageing will be on public policies that are the responsibility of Member States, i.e. pensions and healthcare. Nonetheless, Member States can learn a great deal from the experiences of other countries and benchmark their progress against their peers. The introduction of difficult reforms can be facilitated if it is possible to present concrete examples of successful reforms in other countries. The recent Stockholm Euro- pean Council of March 2001 therefore agreed that the so-called ‘open method of coordination’ be extended to include pensions. It also called for the Barcelona Euro- pean Council of March 2002 to examine a detailed report on the quality and sustainability of pension systems, with a interim report due by December 2001.
Community level action in ageing-related policies is also required to ensure the smooth functioning of the single market. To date, measures have been taken to remove impediments resulting from pension systems to the free movement of workers and capital, and to companies oper-
ating in various countries (2). In October 2000, the Com-
mission made a proposal for a directive on the activities of institutions for occupational retirement provision (COM(2000)507). The main provisions include rules con- cerning the establishment of minimum prudential stan- dards and the role and responsibilities of supervisory authorities, and a qualitative approach to investment rules, according to which investment portfolio management should comply with principles (diversification, security, quality) and not uniform quantitative requirements. The proposal is also designed to allow cross-border manage- ment of occupational pension schemes — an institution in one Member State would be able to manage company pension schemes in other Member States. This initiative is an important step in the direction of creating a single market for occupational pension provision. Finally, the Commission has in April 2001 adopted a communication on the elimination of tax obstacles to the cross-border provision of occupational pensions (COM(20001)214).
(1) Adequate and sustainable pensions: a report by the Social
Protection Committee on the future evolution of social protection: Council of the EU (2001), Document 8792/01 of 30 May 2001.
(2) The most relevant question for social security pensions is the cross-
border recognition of legal social security claims: it was dealt with in Regulation (EEC) No 1408/71 (amended 118/97) which regulates the application of social security schemes to employed persons, to self-employed persons and to members of their families moving within the Community. A directive on the supplementary pensions of workers posted in another country has been adopted in 1998, and allow these workers, as of 25 July 2001, to remain within the scheme of their home State.
P a r t I V
2.4.2. A three-pronged strategy to address the budgetary consequence of ageing
It is beyond the scope of this chapter to consider all aspects of EU involvement in age-related policies, and instead the focus is on measures to address the budgetary consequences of ageing. The need to address the bud- getary consequences of ageing populations at EU level in a more systematic and comprehensive manner, going beyond the medium-term time horizon of the stability and convergence programmes, was recognised by the Ecofin Council in December 1999. In its report to the Helsinki European Council on the coordination of economic poli- cies, the Ecofin Council called for ‘a broadening of the scope of public finance issues covered in the stability and convergence programmes and more emphasis on medium to longer-term sustainability issues’.
In turn, the Lisbon European Council of March 2000 called for more emphasis to be placed on the quality and sus- tainability of public finances, a report on which was sent to the Stockholm European Council of March 2001 (1).
The Stockholm European Council agreed that ‘the Coun- cil should regularly review the long-term sustainability of public finances, including the expected strains caused by the demographic changes ahead. This should be done both under the [broad economic policy] guidelines and in the context of stability and convergence programmes’. The long-term sustainability of public finances in light of ageing populations is becoming an integral part of the budgetary surveillance process at EU level, and must be factored into the assessment of Member States’ public finance positions under the SGP. The joint report of the Commission and Council to the Stockholm European Council outlined a three-pronged strategy to tackle the budgetary implications of ageing populations, which includes:
• the running down public debt at a fast pace;
• measures to raise employment rates, especially
amongst women and older workers;
• reform of pension and health systems to place them on
a sound financial footing including greater recourse to the funding of public pensions.
These three elements are examined in turn below. This strategy and, as will be shown, involves taking measures to address the budgetary pressures at source (both from age- and non-age-related expenditures items) as well as measures to raise real output. It should be noted that the sustainability of public finances also depends on progress being made to implement structural reforms in product, services and capital markets, in order to warrant sustained economic growth, high productivity, and raise employ- ment rates.
2.4.3. Sustaining sound public finances
and ensuring a fast reduction of public debt
The contribution which respect of the SGP target can make towards meeting the additional budgetary costs of ageing populations is illustrated in Table 29. This presents illustrative calculations showing what would happen to public debt and interest payments in 2010, 2020 and 2030 if Member States stick to the medium-term targets for 2003/4 set down in their recent stability or convergence programme (see Part I, Chapter 3 for more details) (2).
Sticking to the level of budget balances projected for 2004 would allow countries to substantially reduce their stock of debt and achieve a fall in the interest burden. This effect is particularly strong for countries that currently have large surpluses, and also for high-debt countries: these countries could achieve a fall in their interest burden of around 3 percentage points of GDP by 2020 and about 5 points by 2030. These potentially large reductions in the interest burden could go some way to offsetting the addi- tional spending on public pensions shown on Table 27: however, in most cases, it would not suffice to offset all of the additional expenditures especially if account is taken of the additional costs on health care.
It must, however, be recognised that sustaining budget balances at the 2003/4 target levels over the very long run will be extremely difficult. Moreover, the above exercise is a partial equilibrium analysis: as discussed above, with- out structural reforms to avoid a further rise in the tax burden, the demographic impact could have a substantial negative effect on output (which in the above calculations is set exogenously) thereby undermining the sustainability of public finances via the GDP denominator. Finally, the 2003/4 SGP targets will be achieved by running very high
(1) European Commission (2000a), Council of the European Union
(2001).
(2) It should be noted that some Member States (e.g. Sweden and
Finland) are already running large surpluses, and intend to continue doing so over the medium-term, precisely to prepare for the bud- getary impact of ageing populations.
primary surpluses and by having tax burdens at close to historical highs in many countries, and it may not be economically desirable to sustain these at such levels over the long run.
In accordance with the conclusions of the Stockholm European Council, the long-term sustainability of public finances must be factored into the assessment of public finance positions of Member States under the SGP. This in no way alters existing commitments or the principal purpose of stability and convergence programmes, namely to define a medium-term budgetary strategy. However, addressing the long-term sustainability of public finances in programmes underlines the fact that Member States must respect the SGP over the long-term and emphasises the need for policy actions well in advance of the major demographic changes.
Most importantly, it recognises that, although the bud- getary impact of ageing populations only become evi- dent in the long-run, it is determined by short- to medium- term policy decisions taken within the time frame of programmes. Current policy choices such as the medium- term target, the pace of debt reduction and the scale and type of tax reforms, will therefore be assessed against the commitment to place public finances on a sustain- able footing. The joint Commission–Council report to
the Stockholm European Council (Council of the EU, 2001) recognised that tax cuts are not fully self-financing, and to be sustainable need to be accompanied with a firm control on public expenditure. Consequently, an appro- priate balance has to be drawn between cutting taxes and running down public debt, and implies that priority should be given to the latter in high-debt countries.
The Community institutions are currently considering how to implement this agreement in practice. A first attempt was already made to include issues related to ageing population in the 2000 updates to stability and convergence programmes. This served to underline the need for further work in developing comparable data and indicators. The projections for expenditures on public pensions of the EPC are an important step in this regard, and will benefit from plans to extend this work to health care and other age-related expenditures and revenues. Given the sensitivity of results to underlying assumptions and starting budgetary positions, as well as the fact the pension reforms are underway in several Member States, consideration should be given to producing common pro- jections on a regular basis, say every two or three years, and by countries after they introduce major reforms to their pension system. Further consideration should also be given to the merits and feasibility of developing a wider set of indicators of budgetary sustainability at EU level.
P a r t I V
T h e q u a l i t y a n d s u s t a i n a b i l i t y o f p u b l i c f i n a n c e s
Table 29
Projected debt levels assuming respect of SGP targets
Assumptions Projected debt levels Change in interest burden (*) Deficit 2004 (*) Debt 2000 2010 2020 2030 2010 2020 2030 B – 0.6 111 69 40 22 – 2.1 – 3.5 – 4.5 DK – 2.7 48 14 – 13 – 30 – 1.7 – 3.0 – 3.9 D 0.0 60 42 28 18 – 0.9 – 1.6 – 2.1 EL – 2.0 104 52 17 – 6 – 2.6 – 4.4 – 5.5 E – 0.3 61 36 20 10 – 1.3 – 2.0 – 2.5 F – 0.2 58 39 24 14 – 1.0 – 1.7 – 2.2 IRL – 4.6 39 – 10 – 43 – 64 – 2.5 – 4.1 – 5.2 I – 0.3 112 72 44 26 – 2.0 – 3.4 – 4.3 NL – 1.9 57 23 – 1 – 16 – 1.7 – 2.9 – 3.6 A 0.0 63 43 28 18 – 1.0 – 1.8 – 2.2 P 0.0 56 36 23 14 – 1.0 – 1.7 – 2.1 FIN – 4.9 42 – 1 – 40 – 66 – 2.2 – 4.1 – 5.4 S – 2.0 59 23 – 1 – 17 – 1.8 – 3.0 – 3.8 UK 1.0 40 33 29 27 – 0.4 – 0.5 – 0.6
(*) In column deficit 2004, (–) signifies surplus and (+) a deficit. Debt projections assume Member States stick to the deficit/surplus for 2004 (2003 for IRL, L and S) and assume a growth rate-interest rate differential of between 2 and 2.25 %. The change in the interest rate measures the fall in the interest rate burden compared with its level in 2000.
2.4.4. Reforms to achieve higher employment rates
The second element in the strategy to address the bud- getary consequences of ageing population is to raise employment which could partially offset the negative impact of demographic developments on the ratio between active to inactive persons. This would directly mitigate the budgetary impact of ageing due to higher tax revenues and contributions to pension schemes as well as lower numbers of persons drawing pensions and other transfers: moreover, it would also work through
the GDP denominator, since ceteris paribus per capita
income would be higher with higher employment rates. Progress in raising employment rates across all groups and age cohorts will help countries meet the budgetary consequences of ageing populations, and underlines the importance of meeting the target set by the Lisbon Euro- pean Council to ‘raise the employment rate from an aver- age of 61 % today to as close as possible to 70 % by 2010 and to increase the number of women in employment from
an average of 51 % today to more than 60 % by 2010’ (1).
In the context of ageing populations, however, particular attention should be paid to raising employment rates amongst older workers if the overall target of full employment by 2010 is to be attained. Participation rates of men aged over 50 have fallen considerably in the EU in recent decades, and are low (for both men and women) compared with other industrialised countries, and conse- quently the Stockholm European Council ‘agreed to set an EU target for increasing the average EU employment rate among older women and men (55–64) to 50 % by 2010’. There is now a very substantial gap (between six to seven years) in most EU countries between the statutory retire- ment age and the effective retirement age, i.e. the age at which people actually retire. Since 1960, life expectancy at retirement age has risen by some four years, from 79 to 83 years. With the age of retirement decreasing by about three years over the same period, the average duration of receipt of a pension has increased by seven years (i.e. from 13 to 20 years) and consequently has substantially increased the costs of pensions (Visco, 2001).
There is strong evidence that the shedding of elderly workers has taken place in response to technological change, industrial restructuring, and reforms to employ- ment protection legislation. The surge in the numbers of aged long-term unemployed (which were viewed as dif- ficult to re-introduce into the labour market) has led many countries to utilise early retirement schemes to alleviate high unemployment. In this sense, early retirement was often not a voluntary choice on the part of the persons concerned, and was sometimes (e.g. to cope with large- scale labour downsizing by firms undergoing restructuring) the result from collusion between both sides of the market.
The design of tax and benefit systems (2) may also have
introduced a bias in favour of early withdrawal from the labour market. For instance, once the eligibility condi- tions to retire have been met, there may be very little, if any, incentives to continue at work because the pension rights may not accrue although contributions would con- tinue to be paid (Orszag and Stiglitz, 1999).
To reverse the fall in the effective retirement age, many Member States have established comprehensive strate-
gies, which inter alia comprise reforms to unemployment
benefits, employment protection legislation, working time rules and access to lifelong learning-professional reha- bilitation. Eligibility to early retirement schemes must be restricted, and tax and benefit reforms must ensure ‘neu- trality’ in the decision as to when to retire. Active mea- sures will also be required to improve access to ensure the job opportunities are available to older workers which requires measures to promote lifelong learning and active ageing.
There is some evidence that recent policies have reversed the decline of older labour's employment rate since the 1980s. Many early retirement schemes have been scrapped and schemes to defer workers’ shift to inactivity (e.g. part-time retirement) are being introduced in many coun- tries. However, activity rates among those aged 55–64 still diverge greatly from some 69 % in Sweden to 27 % in Belgium. With the numbers of older workers aged between 55 and 64 set to increase (by around 1.3 % up to 2010) higher participation among older workers is a necessary
(1) The assumptions provide for both male and female participation
rates gradually converge to 83 % by 2045, and for male and female unemployment rates to 4 % by 2045, the projections for working age population being taken from the high scenario provided by Eurostat, and productivity levels and productivity growth converg- ing across European countries and to the level and growth registered in the United States by 2050.
(2) Pension schemes provide alternative pathways to retirement
through schemes other than the old-age scheme, such as early retirement, pre-retirement and disability pension schemes. These schemes or their relaxed eligibility rules were often created in order to facilitate the exit of older workers in firms affected by industrial restructuring. See, Gruber and Wise (1997 and 1999), Blöndal and Scarpetta (1998 and 1999).
step to contribute to a return to full employment and to preserve stable public finances.
However, higher employment rates alone will not resolve the budgetary challenge of ageing populations. Sensitiv- ity tests of the EPC have shown that even meeting the ambitious employment targets agreed in Lisbon does not completely offset the pressure on public finances (this is not surprising, as people earn additional pension entitle- ments the longer they participate in the labour force). Hence, reforms to raise employment rates need to be accompanied with reforms that tackle the pressures for increased age-related spending at source.
2.4.5. Reform of pension systems
The third element in the strategy to address the budgetary consequences of ageing population is further reforms of pension systems. As stressed above, such reforms should seek to limit pressures for increased public spending, pro- mote employment and economic growth and ensure that the financial consequences of ageing are shared equitably between the generations.
Given the diversity of pension systems which are at dif- ferent stages in the reform process, it is difficult to draw