1. The fiscal costs of ageing in the euro area: will the young have to pay the bill? Ad van Riet Head of the Fiscal Policies Division European Central Bank Seminar on “Young People in an Ageing Europe”, Centre d’analyse stratégique, Paris, 5 March 2007 The views expressed in this presentation do not necessarily reflect the views of the European Central Bank.

2. 2 Outline Three questions: How will the ageing of society affect government budgets in the euro area? What budgetary and economic measures must be taken to ensure longer-term sustainability of public finances? How would these measures affect the young and the future generations?

3. 3 Net payments to / net receipts from government by age Source: Manzke (2002) for West Germany. Typically in euro area countries, on average, the young and the old are net recipients of government transfers, while persons of working age are net contributors. Major re-distribution tools are child benefits and education expenditure for the young; public pensions and health care benefits for the old; labour taxes and public pension contributions for the working age population.

4. 4 The ageing of society in the euro area Source: Maddaloni, Musso, Rother, Ward-Warmedinger and Westermann (2006) As the baby-boom generation born after WW II is about to retire and life expectancy is rising, the old-age dependency ratio (i.e. old-age relative to working-age population) is projected to double between now and 2050. As the fertility rate is expected to remain low in the euro area, the young-age dependency ratio (i.e. young-age relative to working-age population) will continue to decline somewhat until around 2025 and then broadly stabilise.

5. 5 Impact of ageing on public expenditure in the euro area (changes 2004-2050, as a % of GDP, assuming unchanged policies) Source: EPC/EC Report (2006) Note: Public pensions is calculated without Greece, long-term care without France, Greece and Portugal. As a result of this demographic shift, total ageing-related public expenditure is estimated to rise by almost 4% of GDP for the euro area average by 2050. Major contributors are public pensions, health care and long-term care; moderate savings may be possible for unemployment benefits and education. Raising taxes and contributions is no solution, as tax burden is already high.

6. 6 Impact of ageing on government debt in the euro area (% of GDP, assuming unchanged policies) Source: European Commission (2006) Without budgetary and economic reforms, the average euro area public debt ratio will start to rise rapidly from around 2020 and become unsustainable. Urgent need for action to restore sustainability: 1) reduce current public debt ratio and alleviate fiscal costs of ageing, 2) improve performance of the economy. Maybe also support population growth (higher birth rates and immigration).

7. 7 Comprehensive reforms can alleviate the burden 2) Measures to improve performance of the economy Raise employment rate and hours worked on a life-time basis: - raise employment rates for young, women, and older workers; - reduce unemployment, in particular for the young; - increase working hours per week/per year and postpone retirement. Increase productivity growth: - allow for more product market competition and labour market flexibility; - promote R&D, innovation and adoption of new technologies; - strengthen education systems, support life-long learning. 1) Measures to reduce public debt and alleviate fiscal costs of ageing Move to balanced budgets or a surplus, to reduce current public debt ratio. Reform public pension systems: - reduce generosity of public pension systems; - extend official retirement age, e.g. linking it to life expectancy; - introduce funded public pensions, link pension benefits to contributions. Reform public health and long-term care: - reduce generosity of public health care systems; - raise efficiency, increase cost control.

8. 8 Impact on the young and the future generations How will ageing and policy measures affect the young and future generations? As the working-age population declines, job-seekers will find a job more easily and both youth and total unemployment rates should fall (for those workers with the right education). More men and women of all ages should be willing to work and to work more hours on a life-time basis, so as to raise labour supply (which requires appropriate labour tax incentives, child-care facilities and less incentives to retire early). They will also need to be more flexible, by changing jobs if needed and accepting temporary contracts and variable wage rises in line with local productivity growth. Apart from a good basic education for the young, life-long learning will be key for all workers. They will need to accept responsibility for building up private pensions and health care insurance to complement the probably less generous public arrangements.

9. 9 Will the young have to pay the bill of ageing? Conclusions: The distribution of the fiscal costs of ageing between the young and the old and between current and future generations is a political decision. The young and the future generations will have to pay a larger share of the bill, if necessary budgetary and economic reforms are postponed until after the baby-boom generation has retired. Budget consolidation through expenditure restraint is urgent in order to avoid that the fiscal burden of ageing is largely passed on to the young and future generations. Economic reforms will help to increase income per head of the population and, thus, increase the financial resources available to cover for the fiscal costs of ageing. While they will have less “free time”, must accept more flexible work arrangements, and can rely less on pensions and health care provided by the government, the young and future generations are the main beneficiaries of budgetary and economic reforms