The Impact of Ageing Populations on the Economy, a European Perspective: From Baby Boom to Baby Bust?

Europe is ageing and this will have an impact on retirement systems (pay-as-you-go as well as funded), government expenditure and general economic growth.Theoretically, ageing populations could lower per capita GDP growth in Europe by around 0.4 per cent annually. However, this should be seen as a worst-case scenario; it is quite likely that some of the underlying assumptions will not fully materialize. Around two-thirds of the potential negative impact for Europe originates from a sharply declining work force relative to the non-working (dependent) population.Our overall conclusion is that if Europe continues its reforms, particularly to pension and labour markets, ageing populations should not have any impact on the economy. The biggest political challenge is to convince people that we cannot continue to live longer and work shorter without paying a price, in the form of lower living standards for workers and/or pensioners. The right combination of labour market and budgetary reform could deliver even stronger economic growth rates than we have experienced in Europe in the past.Our first message is that the real problem is not the impact on the pay-as-you-go retirement systems, but on the overall economy itself. If you take away the negative impact of ageing populations on the overall economy, it is quite likely that you solve most of the other problems too.The second message is that we believe that, in flexible labour markets, ageing populations should lead to lower unemployment and higher labour force participation, without too much government intervention. A combination of lower unemployment and higher labour force participation can almost fully compensate for the negative effect of ageing on the economy.At the European Council meeting held in Lisbon in March 2000, European leaders agreed a new strategic goal for the E.U. in order to strengthen employment, economic reform and social cohesion as part of a knowledge-based economy. As part of the employment strategy, the European Council agreed to aim for a rise in the participation rate from 61 per cent today to as close as possible to 70 per cent by 2010. Although this shows that Europe has accepted the challenge, it is still up to the individual Member States to set national targets and implement strategies to achieve these targets.The other one-third of the potential negative impact of ageing populations on the economy is generated through budgetary effects. Europe has already implemented strict budgetary controls, and total debt relative to GDP for the 15 E.U. Member States has dropped from around 72 per cent of GDP in 1995 to around 63 per cent of GDP in 2001. If Europe is to continue to adhere to the Stability and Growth Pact, it is important that pension reform continue, with a small reduction in the generosity of the public retirement systems included in the reforms. The most important reform, however, would be an increase in the average retirement age in Europe by a couple of years. Without this increase, it will be difficult to keep pension budgets and overall budgets under control and it will not be possible to raise labour force participation rates sufficiently.The economic models show that by combining labour market reforms and budgetary reforms it should be possible to increase living standards even beyond levels we have experienced over the past decade.Our more positive tone as regards the impact of ageing populations on the economy does not take away from the fact that some countries in Europe will have more to do than others. Labour market reform is the key. We believe that those countries that are able to implement widespread labour market reforms, resulting in lower structural unemployment and higher labour force participation rates, should not see any impact from an ageing population.It is often argued that it is the baby-boom generation now moving through its prime earning years that is causing the economic as well as the stock market boom. By the same argument, one should expect lower economic growth and a more difficult stock market environment if and when the baby-boom generation retires. We have looked extensively at some of the arguments behind this theory and have come to two conclusions. First, there is not too much evidence that it is the impact of the baby-boomer alone that is causing this economic and stock market boom. There is even less evidence of this in Europe than in the U.S. Second, there is a lot of evidence in countries such as the U.S. and the Netherlands, which have reformed their labour markets, that the labour market has reacted naturally to demographic changes. Looking forward, we therefore expect labour markets in those countries that have implemented labour market reform to also react naturally to the ageing of the population. This means lower unemployment and higher labour force participation rates.Theoretically, baby-boomers are now in their prime saving years. They have reached the top of their career and earnings paths, the children are independent (at least Financially), the mortgage has been reduced and they should be saving. This savings boom is stimulating today's economy and asset markets. When the baby-boomer retires he will consume his savings (negative savings), economic growth will slow down and asset markets will collapse. This is the theory. The good news is that, in reality, savings rates have come down over the past ten years and we are not sure how savings rates will develop in the future. The Geneva Papers on Risk and Insurance (2001) 26, 529–546. doi:10.1111/1468-0440.00138