Looking into the future as far as 2070

Dr. S-W – 05/2021

Although it went largely unnoticed by the public, the EC routinely published its "2021 Ageing Report" in May. It contains projections for age-related public expenditure as far as 2070. This work, which is now almost 400 pages long – plus over 200 pages of methodology – is only available in English. Those who dedicate themselves to the work have to become involved with many "numbers". Four different expenditure blocks can be seen: pensions, health, long-term care and education/training. Several scenarios were used here as the basis: a basic scenario, in which it is assumed that the current regulations will remain unchanged and a large number of alternative scenarios and sensitivity tests.

The report anticipates that Europe's population will have shrunk by five per cent by 2021. But the population structure will also change. The proportion of the working age population (20 - 64) will drop from 265 million to 217 million. This means, despite the expected increase in the labour force participation rate, a 15.5% decrease in the labour supply. The increase in the participation rate can also be explained by the unemployment rate dropping from 6.8% to 5.8%.

At the same time, life expectancy will increase by 7.4 years for men and 6.1 years for women, which would amount to a given convergence. The so-called "age dependency ratio" is projected to increase by almost 25 percentage points over the projected period. This rate describes the ratio of the over-65-olds to the working-age population. In plain English, this means: whereas there are about three people of active age for every person over 65 today, there will be only two in 2070.  

It should be borne in mind that past pension reforms have raised the retirement age, significantly in some cases, and that this has led to an increase in older people participating in the labour force, namely by 10 percentage points in the 55 - 64 age group, mainly due to a higher number of women participating in the labour force. All in all, the participation rate of this age group will increase from 78.4% to 80.7%.

What does this mean when it comes to developing demography-related budget expenditure? According to the Ageing Report, it means that all four spending areas combined would increase age-related costs from 24% of GDP today to 25.9% in the basic scenario. However, there will be considerable variations between Member States in this respect. Germany is among the 15 countries where the increase is most significant.

An itemised breakdown of the increase is revealing. In the basic scenario, the "main driver" is health and long-term care expenditure (2 percentage points), whereas the contribution to pension costs is projected to fall back to its basic level after a temporary increase. Expenditure on education and training is expected to fall slightly. However, the long-term stability of the share of pension expenditure also comes at a high price, i.e. through a substantial decline in the wage replacement rate by about 10 percentage points in almost all Member States. It is not yet certain that all Member States will keep to their reforms.

The composition of the "cost drivers" is somewhat different in Germany's case. Pensions account for the largest share at 2.1 percentage points, whereas health and long-term care costs only account for an increase of 0.6 percentage points. 

So much about the standard/exit scenario. One of the risk scenarios clearly stands out. It considers possible cost-driving factors in the health and long-term care sector, namely those that have nothing to do with demographic changes. Such factors can push the increase to up to five percentage points instead of the approximately two percentage points in the basic scenario.