1. 1 Financial aspects of the European ageing society An assessment f inancial consultancy S o v e r e i g n Drs A.P.Ranner © Transnational foresight, The Hague 3 Dec. 2004

2. 2 Financial aspects of the European ageing society Impact on financial markets and economy Policies to meet the challenges Some consequences f inancial consultancy S o v e r e i g n Three parts:

3. 3 Financial aspects of the European ageing society: Impact on financial markets and economy EU forecasts: Old age dependency ratio increases from 24% (2000) to 49% (2050) EPC report (October 2003): With unchanged policies: 1) Ageing populations leads to a public spending increase of between 3 and 7 % of GDP in most Member states (without new members) in 2050: in particular health care, long-term care and state-funded pension schemes. This would imply risk of unsustainable public finances i.e. budget deficits and state debt (reference value 60% GDP) As raising taxes is no option corrective spending actions are necessary

4. 4 Financial aspects of the European ageing society: Impact on financial markets and economy f inancial consultancy S o v e r e i g n

5. 5 Financial aspects of the European ageing society: Impact on financial markets and economy 2)Fall in labour supply and of economic production / growth and prosperity (reduction of annual average growth rate by around 0.4%)  Increased pension- and health care contributions by workers (or their employers) imply less disposable incomes (or less profits) and a loss of resources to finance capital investments.  The sale of financial assets to finance retirement consumption lowers the value of assets and rises the costs of capital impacting growth and investment  Drawing on corporate pension liabilities could (a) reduce profitability of corporations liable to fund the pensions and (b) a disposal of securities implying a rise in the costs of capital (interest rates) and so economic growth 3)Unsustainable pension entitlements (effectively paid by a relatively smaller workforce with a bleak view as to their old age finances inter- generational problem )

6. 6 Macro-economic relationships A Results from econometric literature (1)  Per capita growth related positively with relative size of population negatively with changes in share elderly  However: per capita growth also positively related to life expectancy positive effects from open and competitive markets investments in education fiscal discipline depth of financial sector  Crucial relation: life-cycle hypothesis of saving Savings rise over a worker’s active career and then decline in retirement. So savings increase with an increase of the share of the working–age population, and decrease with a decline with share of elderly Financial aspects of the European ageing society: Impact on financial markets and economy Productivity / allocation gains Gains from trade Risk reduction

7. 7 Macro-economic relationships A Results from econometric literature (2)  Current account balances increase with the relative size of the working-age population and deteriorate with a rise in the elderly dependency ratio  Governmental budgets deteriorate due to higher spending on pensions,health care and long term residential care and lower tax revenues Financial aspects of the European ageing society: Impact on financial markets and economy  A rise in the share of elderly puts a downward pressure on real equity prices

8. 8 Macro-economic relationships Disadvantages of econometric analysis  historical correlations might not reflect causality  each variable is considered separately and not part of an integrated system  international interdependencies frequently neglected Financial aspects of the European ageing society: Impact on financial markets and economy f inancial consultancy S o v e r e i g n

9. 9 B Results from multicountry model IMF (INGENUE), September 2004  Global demographic changes lower output growth in all regions, the output growth of developing countries is below the decline of Europe (and Japan)  In Europe saving rates decline sharply with a fall in the share of working age population and a growth of the share of the elderly: social security contributions have to be raised to finance additional pension expenditures: the propensity to save of elderly is lower than that of younger people  The lower saving rates in Europe causes a deterioration of the current account, the capital account also changes as capital is increasingly repatriated This to the detriment of developing countries. Financial aspects of the European ageing society: Impact on financial markets and economy

10. 10 1.Long term maco-economic forecasts (50 years) are not accurate due to (a) data limitations (b) incomplete coverage of all relevant economic relations Financial aspects of the European ageing society: Impact on financial markets and economy f inancial consultancy S o v e r e i g n

11. 11 2.The development of the savings ratio is of importance Reduction of savings by the elderly could be less than assumed:  uncertainty of longevity is a reason to continue to smoothen consumption and try to maintain wealth.  the value of heritages (“windfall” profits to working generation) are consequently also uncertain These effects can not be measured (empirical data is lacking), but in any case implies less severe macro economic outcomes Financial aspects of the European ageing society: Impact on financial markets and economy

12. 12 3. With a relatively smaller labour force EU investments could be lower. However the magnitude of the difference between future rates of savings and of investments is critical for the future development of the balance of payments (current account deficits and cross-border capital) as well as of exchange rates ! Financial aspects of the European ageing society: Impact on financial markets and economy f inancial consultancy S o v e r e i g n

13. 13 4. Empirical evidence for the influence of the population age structure on the level of stock prices is weak the magnitude of investments abroad and the wealth and income effects of owning securities are uncertain 5.In most projection exercises the impact of non-demographic factors are not explicitly modelled Factors like globalisation, EU integration, technological developments, increasing flexibility and increased risk management mitigate the effects of ageing on economic growth and macro-economic balances or could even be of more importance Financial aspects of the European ageing society: Impact on financial markets and economy f inancial consultancy S o v e r e i g n

14. 14 Reduced growth rates of living standards + potential output. Increase in public expenditures. Shifts in relative importance of different world areas. Current account imbalances of EU members are to occur reflecting savings-investments imbalances. Lower economic growth in the EU leads to institutional savings flowing to specific developing countries at detriment of domestic investments. Financial aspects of the European ageing society: Impact on financial markets and economy Though magnitudes of changes are uncertain, the directions of longer term macro-economic developments in EU ceteris paribus are plausible:

15. 15 Financial aspects of the European ageing society: Part 2 policies to meet the challenge As a few policy changes will not solve the problem a comprehensive policy package is generally advocated f inancial consultancy S o v e r e i g n

16. 16 Financial aspects of the European ageing society: policies to meet the challenge  Increase in labour force participation rates  Reductions in structural unemployment  Increase in effective retirement age to 65 years  Structural reforms aimed at 1) enhancing allocative efficiency 2) increasing flexibility of goods, services and capital markets Ensure more open and competitive global trading conditions Consensus

17. 17 Financial aspects of the European ageing society: policies to meet the challenge Policy documents (EU, OECD and IMF) propose the following responses: 1.Boost labour supply women older workers immigration ( but problems of integration) raising fertility rates is not effective (takes to long) through pension reform: raising retirement age work incentives requires skills needed for work education more flexible labour markets reduction of employment discrimination

18. 18 2.Increase savings to realise more labour-efficient capital stock a. governmental fiscal surpluses/ reduction of debt but competition with increased expenditures for health care decrease public sector contributions to (1) pensions (raise retirement age, reduce generosity elements) to (2) health care In any case stick to fiscal discipline / fast pace of debt reduction Financial aspects of the European ageing society: policies to meet the challenge

19. 19 2.Increase savings b.reform private pensions: eliminate or reduce indexation to wages / prices, raise retirement age, eliminate provisions that subsidies early withdrawal from active life PMstimulate private savings by fiscal instruments Financial aspects of the European ageing society: policies to meet the challenge f inancial consultancy S o v e r e i g n

20. 20 3.Public sector measures to increase productivity a. reduction impediments to competition b. improve flexibility of labour market and prices c.spur innovation Financial aspects of the European ageing society: policies to meet the challenge f inancial consultancy S o v e r e i g n

21. 21 (1) The priority given to fiscal restraint (in contrast to an expansionary economic growth policy) and safety implies a relative reduction of non or little age related public expenditures (housing, infrastructure and education of younger people) that also influence economic growth negatively. (2) Many of the traditional growth stimulating factors (e.g. investment in human and business capital, technological innovation) are left to the market. Uncertain whether the private sector will deliver (3) The results of economic analysis can lead to different views as to the intensity of the package of measures the proper policy mix Financial aspects of the European ageing society: part 3 some consequences of measures

22. 22 In any case differing positions between member states: (a) fertility rates, (b) generosity levels of pension and adequacy of its funding (pay as you go/advanced funding), (c) levels of public sector debt or deficits (d) institutional and political set up (e) level of national income imply there is no solution that fits all. Financial aspects of the European ageing society: some consequences of measures f inancial consultancy S o v e r e i g n