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Joaquín Almunia

European Commissioner for Economic and Monetary Policy

Older workers: a European success story?

EFRP Conference (European Federation for Retirement Provision)
Brussels, 20 June 2006

Let me begin by congratulating the EFRP on its 25th anniversary, during which time the organisation has established itself as a leading player in the debate on occupational pension systems, one of the most important policy areas at both European and national level. I would also like to thank the EFRP for inviting me to address such a distinguished audience on the economic, budgetary and social consequences of ageing populations.

Very often, the debate on ageing populations is presented in an unnecessarily alarmist manner with references to demographic time bombs. It is, however, important to remember that ageing is essentially a “good news” story for two reasons:

  • firstly, it is mainly the result of people living longer, with the gains in life expectancy being mostly spent in good health;
  • secondly, many Member States have already successfully modernised the social security systems to prepare for ageing populations. While much remains to be done, we can take heart from the knowledge that the challenges are surmountable provided policy makers act in a timely and effective manner.

1. Can Europe afford to grow old?

Let me begin by commenting on a new ageing report which contains budgetary projections for all Member States up to 2050. It was examined by the ECOFIN Council on 14 February 2006, and contains projections on pensions, health care, long-term care and unemployment benefits.

The projections were made jointly by the Commission’s Directorate General for Economic and Financial Affairs and the national authorities via the Ageing Working Group attached to the Economic Policy Committee. Their unique value-added and strength stem from the fact that this exercise brought together experts from both international organisations and national authorities. In this way, cross-country comparability has been assured, while at the same time due account has been taken of country specific circumstances and the enormous diversity of national pension and health care systems.

The exercise has led to three main findings.

Firstly, potential growth rates are projected to fall everywhere. For the EU15 -- i.e. before the enlargement of 2004 to 10 new Member States -- the annual average potential GDP growth rate is projected to decline from 2.3% in the period 2004-10 to 1.3% between 2031 and 2050. An even steeper decline is foreseen in the EU10, from 4.3% in the period 2004-10 to 0.9% between 2031 and 2050. The steeper fall is due to their less favourable demographic prospects, and to assumptions on productivity growth which are projected to fall sharply as the real convergence process unwinds.

Secondly, the projections show that ageing will lead to significant increases in public spending. For the EU as a whole, public spending is projected to increase by about 4 percentage points between 2005 and 2050. This increase is especially noticeable for pension spending.

Thirdly, and on a more positive note, recent pension reforms have had a positive impact on the sustainability of public finances. I would like to emphasise this point, because although there is no room for complacency, it is important to highlight European reform success stories. Sometimes, we overly concentrate on difficulties and areas of slow progress, and fail to give adequate emphasis to areas such as pensions and early retirement schemes where genuine progress has been made in recent years.

Since 2000, we have seen a dramatic increase in the employment rate of older workers aged between 55 and 64. This is a remarkable turnaround in decades-long trends towards earlier withdrawal from the labour market. It is all the more remarkable as this employment growth has taken place against a very subdued economic climate. The Commission has projected that this positive trend is set to continue for the next decade or so, in part thanks to the progressive phasing-in of pension reforms.

Recent pension reforms will also lead to significant budgetary savings. In countries such as Germany, France and Austria which have recently made significant reforms to their pension systems, the projected impact of ageing on public pension spending is visibly lower than what emerged from the 2001 projection exercise.

2. What are the policy implications of the findings?

Four of them deserve specific comments.

The first concerns the risks to the sustainability of public finances. During the course of 2006, my services in the European Commission will take an in-depth look at the budgetary projections, and provide, in a new Sustainability Report, a comprehensive assessment of the risks to the sustainability of public finances. I do not wish to pre-empt the outcome of this work. But, I would like to underline that an overall projected increase in age-related spending of some 4 percentage points of GDP is significant, especially since a number of countries are still running deficits above 3% of GDP. Based on earlier budgetary projections and analysis made in the context of the Stability and Convergence Programmes, there is a clear and unequivocal risk of unsustainable public finances in a large number of EU Member States, many of which are in the euro area. This is not simply a budgetary challenge. It raises serious doubts about the viability of social protection systems and the European social model.
A key question is whether Europe is on the right track to meeting the economic and budgetary challenge posed by ageing? In my view, the situation can best be described as mixed and in many countries one sees one step forward followed by one step backwards.

On the positive side, our analysis shows that recent pension reforms are yielding benefits in terms of higher employment rates of older workers. Moreover, they will generate large budgetary savings over time. On the downside, we have also seen an increase in the size of underlying budget deficits and rising public debt levels. The beneficial effects of pension reforms to making public finances more sustainable have regrettably not fully materialised due to unfavourable budgetary developments elsewhere.

Secondly, our analysis underpins the validity of the approach adopted in the Lisbon strategy, especially the need for economic policies strategies that try to raise both labour utilisation and productivity potential. The projections provide added weight to calls for EU countries to implement their Lisbon reform commitments. More specifically, they show that there is a fast closing "window of opportunity" to proceed with the Lisbon reforms. In fact, the employment and even demographic prospects for Europe are supportive until the middle of the next decade, and hence there is time to undertake reforms before the full economic and budgetary effects of ageing take hold.

In other words, ageing is not a tsunami that will overwhelm European economies in 2010 when the baby-boom generations start to enter retirement. It is an inevitable, but slow moving, development. Because it is predictable, it is also manageable provided policy makers take timely and well designed actions.

My third policy recommendation is the need for countries to pursue reforms that increase the employment rate of older workers and raise the effective retirement ages. Higher employment holds the key to successful policy adjustment, because it is the economic output of a country that determines the capacity to support high quality welfare systems. Despite recent progress, the employment rate of older workers is just above 41% for the EU as whole. While statutory retirement ages in most Member States are set at 65, the effective retirement age is actually close to 60. Put bluntly, Europe's welfare systems are not so much facing an “ageing problem” but a “retirement problem”.

Is it sensible that people retire at the age of fifty five or sixty only to be economically inactive for the last twenty or thirty years of their lives, most of which will be in reasonably good health? I do not believe this is what individual citizens actually want, and nor is it a viable option for our societies. Getting people to extend their working lives can lead to a double benefit:

  • it means that they contribute to economic growth and thus to the overall amount of resources available for sharing between retired and employed persons;
  • it can also serve to make social protection systems more financially viable. Workers would pay taxes and social security contributions for longer, while needing less, for instance, unemployment benefits. Regarding pensions, workers would accrue additional pension rights and benefit from higher pensions when they retire.

Changing retirement behaviour will be difficult and will require reform as regards the pathways to retirement. Tax/benefit and wage systems must be overhauled to give people incentives to remain economically active. It also means that there must be much better job opportunities for older people who have appropriate skills, and that entails policies to tackle age-discrimination and promote life-long learning.

The last key policy domain I would like to mention concerns migration. Inward migration can only partially offset the impact of ageing populations. As such, it should only be considered as part of an overall policy response but not as a panacea.

As regards the economic case for migration, important caveats need to be borne in mind. To begin with, the extent to which migrants can offset the economic and budgetary impact of ageing populations, depends on them being engaged in employment within the formal economy. In many, but not all EU Member States, the employment rate of migrant workers is actually lower than the employment rate of non-migrants. This may be due to cultural factors and lower educational attainment levels, but it is also due to the informal economy. To maximise the economic contribution of migrants to the EU economy, it is essential that active measures are taken to ensure their formal integration into the labour market, so that they contribute to the overall tax base.

A further caveat concerns the debate as to whether allowing in more migrants would improve the financial viability of public pension schemes financed on a Pay-As-You-Go basis. Ultimately, the answer depends on the design of the pension systems, and account must be taken of the fact that migrants engaged in legal employment also accrue pension entitlements. It is, therefore, essential to reform pension schemes so that there is a broad actuarial balance between contributions paid in during a working life and pension entitlements paid out in retirement. With proper pension reform along these lines, migration may “buy time”, at the cost of even larger unfunded pension liabilities over the very long run.

All this points to the need for better managed migration which allows us to maximise the economic benefits to migrants themselves and the EU economy.

3. What can the EU do?

In other words, how in practical terms can Europe move from engaging in dialogue on reform, to actual implementation? From a political economy perspective, the challenge is how to better integrate long-term considerations into political decision making. As Commissioner for Economic and Financial Affairs, but also based on my experience as a Minister in Spain during a difficult economic period, I am fully aware of just how difficult this is.

Short and medium-term challenges, such as raising growth and reducing unemployment, inevitably receive greater attention than long-term challenges which only emerge in the distant future, and often well beyond the electoral calendar. Moreover, politicians inevitably face pressures and temptation to take decisions which in the short run have limited costs, but which can have profound consequences for the public finances and for the entire economy in the long run. In addition, the main impact of an ageing population concerns pensions and health care programmes, which lie at the very heart of the social contract between governments and citizens. Negotiations on reform are inevitably complex and sensitive, but all the more so because there are very often large constituencies who seek to protect their vested interests.

Essential, but painful, policy choices have to be made. And they need to be made quickly as the difficulties mount with each passing year.

The EU can make a direct contribution to meeting the ageing challenge through the internal market programme, for example by ensuring the cross-border portability of pensions and the creation of integrated financial markets. However, the most difficult challenges lie in policy fields that fall under Member States' responsibility, such as pensions and health care system.

The main role, however, of the EU is a facilitating one and to help Member States pursue essential, but difficult, reforms. The EU can help share best-practices, and provide concrete illustrations of successful reform effort. This has been shown in the work at EU level on employment policies, and also on pension reform in the context of the open-method of co-ordination. The Stability and Growth Pact is another example of an instrument where clear requirements are established at EU level backed up with surveillance and peer pressure to help Member States conduct sound fiscal policies and ensure the reduction of government debt.
As shown in the recent report of the Commission and Council as part of the open method of co-ordination on pensions, the pace and ambition of pension reform has increased in recent years. Many countries have introduced substantial reforms to traditional Pay-as-You-Go financed defined benefit schemes. While the nature and design of the reforms has varied across countries, according to their starting position and political preferences, some common trends are evident:

  • within public schemes, stronger links are being introduced between contributions and entitlements which should increase the incentives to work and to remain longer in the the labour force;
  • changes in accumulation and indexation parameters will require persons to reflect more carefully on the adequacy of their public pensions, especially given trends in life expectancy. Citizens are now being asked to share some of the demographic risk of longer lives by rules which link pension annuities to future changes in life expectancy at retirement;
  • especially in the EU10 Member States, there have been reforms to shift pension from the public to the private sphere while relying on statutory arrangements;
  • finally, citizens will be expected to provide a larger share of their retirement income through voluntary savings.

I cannot enter into detailed discussions of individual reforms or country specific situations today. What I would like to emphasise is that although these reforms will reduce the fiscal risks for governments, other types of policy challenges will necessarily come to the fore. For example, as more and more citizens rely on private schemes for a larger share of their retirement income, regulation and prudential supervision will acquire added policy significance. Equally, citizens can only be expected to play a greater role in providing for their own retirement income if they have the means to make informed choice. Considerable efforts must be made to improve the transparency of information for ordinary workers on their pension entitlements and what they can reasonably expect to receive on retirement.

Overall, changes to European pension systems in recent systems mean that the nature of dialogue between governments and other stakeholders has to adapt. I know that we can rely on EFRP to continue to be a leading and constructive partner in the debate at EU level.

Let me conclude on an optimistic note. Ageing is a good news story, as most of us will enjoy the benefits of longer lives spent in good health. Ageing is not the source of the challenge facing policy makers. The challenge stems from the poor design of our public pension and health care systems which foster unrealistic expectations of citizens regarding retirement.

The scale of the challenge is surmountable. There are many cases of successful reforms which have been made by EU Member States. We can collectively “afford to grow old” provided we stop viewing ageing as a threat and instead start viewing it as an opportunity.

Thank you.

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