Introduction. Key results of the EU s 2018 Ageing Report. Europe. 2 July 2018

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1 Europe 2 July 2018 The EU s 2018 Ageing Report and the outlook for Germany The analysis of the European Union s latest Ageing Report provided in the Finance Ministry s June 2018 monthly report shows that the long-term sustainability of public finances in the EU member states continues to face major challenges as a result of demographic. Germany is disproportionately affected by increases in age-related spending. The long-term sustainability of public finances in the EU member states continues to face major challenges as a result of demographic. Germany is slightly below the EU average when it comes to age-related expenditure as a percentage of gross domestic product (GDP) but is disproportionately affected by increases in age-related spending. Many member states have initiated reforms of their social security systems in order to tackle demographic. The projections in the report are based on the assumption that these measures will be implemented. According to the report, growth-friendly and future-oriented fiscal policies, in combination with targeted structural reforms, could increase the sustainability of public finances in the EU member states. Introduction Demographic poses major challenges to the long-term sustainability of public finances in the EU member states. It is essential to have a picture of the long-term financial outlook in the EU member states that is as precise as possible, so that suitable responses that ensure intergenerational equity can be developed. Bearing this in mind, the EU member states, in close collaboration with the European Commission, developed a reporting system early on that functions as an early-warning system for assessing fiscal sustainability in EU countries. The latest report continues this well-established practice. The 2018 Ageing Report describes the long-term risks to social security systems and public finances in connection with demographic in quantitative terms, using a coherent methodology and comparable EU-wide data. It therefore makes an important contribution to improving economic and fiscal policy coordination and reporting within the EU. Key results of the EU s 2018 Ageing Report The ECOFIN Council has endorsed the 2018 Ageing Report, which is subtitled Economic & Budgetary Projections for the 28 EU Member States ( ). The report was prepared by the EU s Economic Policy Committee s Ageing Working Group (AWG) and the Commission services (Directorate General for Economic and Financial Affairs) on the basis of jointly agreed assumptions and methodologies. As with previous reports, the 2018 Ageing Report contains projections on age-related public expenditure (pensions, health care, long-term care, education and unemployment benefits). The projections, which were calculated under the assumption of no-policy-, reveal that, from today s perspective, there is an imminent need to take fiscal policy action, in relation to existing legislation, in order to deal with demographic. The calculated increase in age-related expenditure informs the medium term budgetary objectives (MTOs) that are set for member states as part of the EU s budgetary monitoring; it also forms the basis for the European Commission s analysis of the long-term debt sustainability of the member states. In the baseline scenario, it is assumed that average annual potential growth will be 1.4% during the whole period. A significant increase in total factor productivity (TFP) and labour production is also assumed, which will partly offset the decline in the labour supply. In the less optimistic scenario, which assumes a smaller increase in TFP, the estimated annual GDP growth rate in the EU would only be around 1%. The baseline scenario foresees average annual potential growth in the EU as a whole remaining at its current level over the long term; however, there are significant

2 differences in potential growth among the individual member states. In particular, the decline in the working-age population, which affects different countries to different extents, will hamper economic growth in the long term, something that also applies to Germany. The baseline scenario assumes a below-average increase in potential output of 1.2% per year over the whole period for Germany. In the risk scenario, the equivalent figure is only 0.8 to 0.9%. In an EU-wide comparison, there was a relatively wide range of age-related expenditure levels in different countries in 2016, ranging from 15.1% of GDP in Romania to 31.0% of GDP in France (EU average in 2016: 25% of GDP). According to the projections, age-related public expenditure in the EU as a whole will rise by 1.7 percentage points of GDP between 2016 and 2070, reaching 26.6% of GDP in 2070, although trends in individual countries diverge significantly. If a less favourable macroeconomic scenario is assumed, then the expenditure would increase by 2.2 percentage points between 2016 and 2070, reaching a level of 27.1% of GDP in Germany s total age-related expenditure, measured as a percentage of GDP, is currently slightly lower than the EU average. However, age-related expenditure as a percentage of GDP is expected to rise in Germany from 23.5% in 2016 to 27.7% of GDP in 2070 (an increase of 4.2 percentage points), which is significantly above the EU average. Hence Germany belongs to the group of countries which will see a large increase in age-related spending (along with Belgium, the Czech Republic, Ireland, Luxembourg, Malta, Slovenia and the UK, among others). The report also shows that most of this increase in age-related expenditure will take place in the coming two decades, as the baby boomer generation reaches retirement age. Trends in age-related spending, as % of GDP/in percentage points of GDP

3 2018 Ageing Report 2015 Ageing Report 2016 level AWG baseline scenario AWG risk scenario level AWG baseline scenario Belgium Czech Republic Germany Greece Spain France Italy Netherlands Austria Poland European Union EU28 definition Source: 2018 Ageing Report The projected increase in the age-related expenditure ratio in the EU is mainly due to spending trends in pensions, longterm care and health care. For example, the report shows that public pension expenditure is expected to increase by 0.8 percentage points of GDP in the period until 2040, assuming no s to legislation are made. After that, it will fall slightly, sinking to a level just below the starting value by 2070 (11% of GDP). Assuming unfavourable demographic and macroeconomic conditions, projected pension spending would reach a significantly higher level in 2070 (11.4% of GDP) compared with the starting year. Here, too, significant differences between member states can be seen, depending on their specific age structures, the rate of population ageing, the outlook for potential growth, the specific characteristics of their national pension systems and progress with structural reforms. For Germany, the report predicts that pension expenditure will rise from 10.1% to 12.5% of GDP by 2070, an increase of 2.4 percentage points. Without the structural pension reforms of recent years, age-related costs in the area of pensions would be much higher, as would pension contribution rates. Structural reforms in some member states, as well as the favourable economic situation, have contributed to the trend in age-related costs being more moderate compared with the results of the 2015 Ageing Report. In particular, the starting level for ageing costs is now more favourable. However, the rate of the predicted increases remains as high as before. In

4 this respect, there has not been any fundamental improvement compared with the previous report. In the case of Germany, methodological s aimed at better representing the expected spending increase have partly offset the more favourable underlying trend compared with the 2015 Ageing Report. With regard to public expenditure on health care and long-term care in the EU, the baseline scenario predicts that demographic will cause an increase of 2 percentage points of GDP (from 8.4% to 10.4% in 2070). If possible cost factors for health care and long-term care spending that are unrelated to demography are also taken into account, then expenditure on health care and long-term care could even increase by 4 percentage points of GDP between 2016 and In Germany, health care spending as a percentage of GDP will rise by 0.7 percentage points to reach 8.1% of GDP in 2070, according to projections. In the area of long-term care, a significant upward spending trend is also expected, with an increase of 0.6 percentage points to 2.1% of GDP over the projection period. From the macroeconomic perspective, it must be taken into account that this spending simultaneously represents income which is generated in the health care sector, for example. Taking uncertainties and risks into account The long-term projections should not be regarded as forecasts. Given the long time period involved, the projections are characterised by substantial uncertainties; even small s to the assumptions result in significant trend deviations over the long term. The report also contains sensitivity analyses on the key political variables which ensure that these uncertainties are adequately taken into account. Regarding the labour market, employment rates that could be 2 percentage points higher or lower are also assumed, for example, as well as employment rates for older people that are 10 percentage points higher. With a view to the technological developments that are expected to take place in the long term, scenarios with TFP growth that is 0.4 percentage points higher or lower were modelled, as was a risk scenario with a TFP convergence value of 0.8%. Against this background, the current Ageing Report places a greater emphasis than previous reports on risks arising from technological progress that could potentially increase expenditure, in addition to demographic and macroeconomic risks. In addition, the report also highlights possible consequences of a convergence of living standards within the EU.

5 For example, the increase in spending on health care could also be twice as large (up to 1.5 percentage points of GDP) and three times as large for long-term care (up to 2.1 percentage points of GDP), given the high human resources requirements in these sectors and the uncertainty about the impact of technological. Overall, the risk scenario predicts an increase in age-related spending that could amount to as much as 6.4 percentage points by In the baseline scenario, however, the sustainability risks in Germany are not yet classified as high by the European Commission. This is mainly due to the current situation, which is very favourable, and the fact that the expected increases in expenditure are still sustainable over the medium term. Conclusions for economic and fiscal policies The projections for age-related costs in the EU can be used as a basis for assessing the fiscal sustainability of public budgets in the EU member states. The projections are an integral part of the budgetary surveillance of the member states by the European Commission and the ECOFIN Council and are also included in the European Commission s analysis of the fiscal sustainability of EU member states within the framework of the Fiscal Sustainability Report. The results of the projections show what a large impact demography could have on long-term economic conditions in Germany and Europe. Changes in the population structure will have a long-term negative effect on the potential workforce and output. At the same time, the effects of demography on age-related costs will start to materialise during the next decade in many member states, including Germany. Here it must be noted that additional costs will also have an impact on future growth trends within a national economy. Many member states, including Germany, have already responded to these challenges with substantial reforms. Demography-related trends can be countered by changing the long-term orientation of the pension, health care and long-term care systems in such a way as to improve their resilience. Even if it is assumed that the reforms will have the desired effect, supplementary fiscal policy measures could still be necessary in order to increase the sustainability of public finances. Hence the long-term outlook must also be taken into consideration today when designing fiscal policies. From the fiscal policy perspective, growth-friendly and future-oriented policies remain key. The combination of sound budgetary policies and the forward-looking use of resources aimed at increasing potential growth means that Germany and the EU are in a position to tackle the challenges of demographic at an early stage. Long-term fiscal sustainability continues to be one of the factors used when determining the medium-term budgetary objectives under the Stability and Growth Pact. Looking at the overall perspective, what is mainly needed are economic policy measures to increase the employment rate and productivity, according to the report. In this context, it would certainly be expedient to use the labour pool in a targeted way. This would include measures that create incentives to stay in the labour market, promote active ageing and prevent an early exit from the labour market. It is also essential to continue to sustainably increase women s participation in the labour market, to structurally reduce the base level of long-term unemployment, and to promote the migration of qualified workers. This also impacts on areas such as life-long learning, work-life balance and exploiting the digital economy in a positive way. This type of broad-based approach does not only mean that the government must take suitable measures; it also inevitably requires all stakeholders to the way they think. Against this background, the ECOFIN Council adopted conclusions on the current Ageing Report on 25 May In order to adequately address the challenges of an ageing population, growth-friendly budgetary policies in line with the requirements of the Stability and Growth Pact are regarded as necessary, as are structural reforms that boost potential growth and improve the sustainability of public finances. The ECOFIN Council welcomed the recent reforms in many EU member states, especially concerning pensions, which will hinder excessive increases in government spending. At the same time, the scope of reforms is not sufficient to halt the increase in age-related public expenditure. In order to raise awareness of the results of the report, the Federal Ministry of Finance held a specialist conference on 22 June 2018 which examined the European and domestic implications of demographic trends, as well as highlighting policy recommendations aimed at enhancing economic growth potential and the sustainability of public finances. For its part, the European Commission will publish the next Fiscal Sustainability Report at the end of 2018, in which it will present an up-to-date assessment of the risks to fiscal sustainability in the member states.

6 More on this topic The 2018 Ageing Report Federal Ministry of Finance