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The Economist (UK), September 30, 2004

Old Europe; Demographic Change; The trouble with ageing

AMERICANS have long seen Europe as the old world. Now they have another reason to count the difference. Europe is ageing much faster than the new world. The old world faces a daunting demographic challenge. This year's expansion of the European Union from 15 to 25 countries increases its population from 380m to 455m—way ahead of America's 295m. Yet by 2050, the United States will have almost caught up: if forecasts prove correct, there will be 420m Americans, compared with 430m Europeans.

The main reason is that European women have fewer children. In both America and Europe, the post-war baby boom gave way to a bust in the 1970s, and fertility fell below the replacement rate of just over two per woman. But American birth rates have since recovered to replacement level, while the birth rate is just 1.5 in the EU; in Germany, Spain and Italy it is only 1.3 (see chart 1).

Populations age when people live longer and have fewer children. Life expectancy is rising at roughly the same pace in most rich countries—although not in Russia (see box on next page). So it is low fertility that explains why Europe's population is ageing faster than America's. In Germany, the median age will rise from 40 in 2000 to 47 by 2050; in Italy, it will reach 50 as early as 2025. In America, by contrast, it will rise only from 35 in 2000 to 40 in 2050.

Europe's rapid ageing will inflict economic pain. For a start, there will be a big decline in the number of workers. In Italy, for example, the working-age population will shrink by 20% between 2005 and 2035, and a further 15% by 2050. Unless there are offsetting changes in employment rates and productivity, falling numbers of workers will drag down economic growth. Adverse demographics mean that Europe's growth will be half a percentage point lower in 2050 than now, according to estimates in this week's IMFWorld Economic Outlook.

Even as numbers of workers fall, the numbers dependent on them will rise. In Italy, the population aged 65 and over will jump by 44% between 2005 and 2050. Combine that with a decline of over 30% in the working-age population, and the result will be a spectacular jump in the dependency ratio, from 32% in 2005 to 67% by 2050. In France, even though fertility has been higher, the dependency ratio will still jump, from 28% to 51% over the same period (see chart 2 on next page).

This soaring elderly dependency ratio will test European budgets to the limit. Looming ahead is a big rise in spending not only on pensions but also on health and long-term care. According to the European Commission, adverse demographic change may push up public spending by between five and eight percentage points of GDP (in the EU 15) by 2040. It will be hard to get taxpayers to foot that bill. Most European countries already suffer from too heavy a tax burden, and governments are running into resistance to higher taxes.

As if all this were not enough, the demographic challenge facing Europe may be even greater than most of the projections suggest. Population forecasters have been caught on the hop by unexpectedly big improvements in longevity. Medical breakthroughs may continue to raise life expectancy beyond the levels built into population forecasts.

What can be done? One response is to try to alter the demographics by encouraging immigration of younger workers. But immigration on the scale needed to stop dependency ratios from rising would be politically unimaginable. Germany, for example, would need to take in an average of 3.6m immigrants a year between 2000 and 2050, according to UN estimates.

An alternative strategy is to try to raise birth rates. In the past few years fertility has risen a little in Italy and Spain. Recent attempts to encourage more births by increasing financial support for parents seem to have been quite successful in France and Estonia. Whether this approach would work in the longer term is less certain. The effect is often to change the timing of child-bearing, rather than the number of births: women bring forward the decision to have children but keep to the number they originally planned.

Birth rates are now especially low in Mediterranean countries where relatively few women work; and a lot higher in Scandinavia, where most women work. Scandinavian countries appear to have found ways, such as enhanced child-care facilities, to make it easier for women to reconcile work with raising children. But such measures assume that women are otherwise being foiled in their desire, on average, to have a family of two. Awkwardly, recent evidence from Germany suggests that women may actually want fewer children than the two-child norm.

All this suggests that population ageing, although a demographic problem, requires an economic rather than a demographic solution. Faster productivity growth would help, but it would be foolish to bank on it. Indeed growth in output per worker may well fall in ageing economies, given the link between innovation and youth. Entrepreneurship tends to be stronger in more youthful populations, says Sylvester Schieber, research director at Watson Wyatt, an actuarial firm.

That leaves two possible economic remedies. The first is to push more of the working-age population into jobs. At the Lisbon summit in 2000, EU leaders set themselves targets for 2010 of reaching an overall employment rate of 70%, and of 50% for 55-64-year-olds. Last year, these rates had risen to 65% and 42% respectively, still short of the Lisbon objectives, let alone of America's rates of 71% and 60%. Raising employment rates is desirable on competitiveness grounds, as well as in response to ageing.

The second remedy would be to increase the size of the working-age population by raising the retirement age. Since Europeans tend to retire before the official state-pension age—in Germany, for example, at 60 rather than 65—there is plenty of scope for this. But proposals to raise the retirement age are deeply unpopular. German politicians were swift to distance themselves from a recommendation by a commission last year that the retirement age should be raised to 67.

These economic remedies are hard, but also vital. Europe still has much work to do to make the labour-market and pension reforms that are needed to counter the adverse effects of its ageing population.

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