Ageing and Economic Growth in Europe Assessing the Impact of Systemic Pension Reforms

The expected declining population of working age and the increase in the dependency ratio in Europe is likely to have serious consequences for the growth of per capita income in the next decades. The macroeconomic consequence of demographic pressure is exacerbated by a PAYG pension system, which currently is the dominant source of intergenerational income transfer in the EU. Currently ten workers finance two and a half retirees, in 2050, ten workers will have to finance five retirees with their pension contributions. This has serious consequences for wage costs in coming decades if no reforms are undertaken. As shown previously, leaving the generosity of the PAYG system unaffected would require an increase in pension contribution rates from currently about 16% to about 27%1 in 2050, taken as given the demographic trends currently projected for the EU. Given the still high levels of unemployment in the EU and the fact that non wage labour costs are partly blamed for low employment rates in Europe, letting the current pension system in place does not seem to be an attractive policy option since it drags down the employment rate. There are two radically alternative fiscal strategies of financing additional pension expenditures if one wants to avoid ever increasing pension contributions. A first alternative could be seen in a switch to debt financing of additional ageing related pension expenditure requirements and freezing the replacement rate at current levels. An alternative strategy would be to partially move to a funded system, with a government guarantee of accrued pension rights for current pensioners and certain well defined age cohorts within the pool of current workers.