European Social Models: the challenge of an ageing population

While the European Social Model is a topical subject, in fact there does not appear to be any single model. Instead there are a wide variety of models in the Member States, reflecting different histories, circumstances and political choices that have shaped social welfare provision over the course of time. However, they are faced with new challenges and must adapt to new circumstances. One such challenge today is an ageing population, and DG ECFIN analysts are studying how Europe can respond to this demographic change.

The demographic challenge that Europe’s ageing population presents to these common features has its origins in a falling birth rate over the past decades and an increasing life expectancy that is predicted to grow by five to seven years by 2050. This ageing population is shown in Graph 1 that compares age distributions in 2004 and 2050.

Eurostat projections which form the basis for figure 1 show that while the total population of the EU-25 will only fall slightly by 2050, the age structure will change dramatically. By 2050, the EU will have lost 48 million people of working age (15- to 64-year-olds) and will have gained 58 million pensioners (65 and over). This means that fewer workers will pay for more pensions. From four working-age people supporting each pensioner in 2004, this ratio will drop to two to one by 2050. While living to an older age in good health is to be welcomed, unfortunately, when combined with historically low birth rates it poses a severe financing problem for existing social welfare systems.

Figure 1: Age pyramids for EU-25 population, 2004 and 2050

Source: EPC and European Commission (2005)

Growing pressures on public finances

Studies by DG ECFIN show that, if nothing else changes, the economic consequences of an ageing population include rising pressures on public finances in the Member States.

Figure 2 shows that

• a progressively smaller workforce will drag down economic growth, from an envisaged average of 2.25% in 2004-2010 to an average 1.25% in 2031-2050 in the EU-15. The situation will be worse in the new Member States as they have even less favourable demographics and their currently high growth rates will converge to the lower values of the EU-15;
• over time, productivity will become the main source of growth. This confirms the validity of the Lisbon Strategy which emphasises the need for improved training and education to support an economy geared to producing high knowledge-content products and services;
• the next decade presents a window of opportunity for the necessary reforms before the full effects of ageing kick in. This window exists because employment is projected to rise, particularly among women and older workers, over the next decade or so, offering a breathing space for economies to be strengthened and reforms implemented. A number of reforms are already under way in the Member States and the available results indicate that so far they do work, and that it is possible to achieve successful adaptations to social models that preserve their European core values.

Figure 2: Projected (annual average) potential growth rates in the EU-15 and their determinants (employment/productivity)

Source: EPC and European Commission (2005)

The policy challenges ahead

Slower growth will come at the same time as the extra costs of the ageing population start to peak. Ageing could increase public expenditure on health and pensions significantly between 2000 and 2050. This indicates that further reform of social welfare systems is needed. Social models must be improved to address the demographic challenge in a way that produces opportunities for Europeans and not threats to their way of life.

A comprehensive set of new policy actions across a broad front will be needed to meet the challenge of lower growth and ensure social welfare provision and its core European features can be afforded. As well as improving public finances, and in particular reducing debt, some pension systems may require changes to ensure their sustainability under the future demands outlined here.

The main response to projected falling growth must, however, involve reforming the labour markets as these determine overall wealth and the capacity to sustain high-quality welfare systems. As well as raising employment to make sure the jobs are there, reforms must improve incentives to work across the age spectrum, ensuring that older workers do not meet discrimination and that the young do not face greater barriers to finding a job because their parents work longer. Perhaps the critical, but also difficult, challenge is to extend working lives – we must all work longer.

Ageing is not the source of the problem; after all, better health care and anti-wrinkle creams are making it quite pleasant for many. In fact, it is our retirement behaviour that poses the main challenge for pension systems. Raising actual retirement ages so that people work longer has a double benefit: in the first place, demands on pension systems are reduced, and in the second place, people become productive for longer, thus contributing longer through their taxes to public finances.