EU s evolving demographics & pensions need attention

Global Demographics & Pensions Research http://www.credit-suisse.com/researchandanalytics EU s evolving demographics & pensions need attention Global Demographics & Pensions Research Research Analysts Amlan Roy 44 7888 151 amlan.roy@credit-suisse.com Anais Boussie 44 7883 9639 anais.boussie@credit-suisse.com Mengyuan Yuan 44 7888 368 mengyuan.yuan@credit-suisse.com EU s demographic realities constrain growth, strain public finances & social stability Demographics is about people as consumers and workers and their multiple characteristics, not merely age. European workers contribute to making the GDP and European consumers expenditures account for the bulk of GDP expenditures. The EU s diverse, heterogeneous and changing demographics interact with and influence its economic, financial and social framework. We reiterate the need for all (policy makers, companies, institutions, households and individuals) to pay closer attention to trends affecting consumer and worker behaviour as it has profound implications for future growth, public finances, debt sustainability, currency value, capital flows and social stability. Ignoring and neglecting demographics has been responsible at least in part for the ineffectiveness of both monetary and fiscal policy. EU countries have vastly different demographics with population sizes ranging from.5 million (Luxembourg) to 82.6 million (Germany), old age dependency ratio ranging from 19.2 older people (aged 65+) per 1 population (of 15-64 years old) in Ireland to Italy s 33.8 in 15. Also, in terms of median age, the average German is almost 1 years older than the average Irish person. EU members also have differing economic structures and fiscal positions. Luxembourg has the smallest size of GDP (USD 63.9 billion) but highest GDP per capita (USD 1,752). The GDP per capita in Portugal is only USD 21,748, 8% lower than that in Luxembourg. The corporate tax rate is 12.5% in Ireland, but 34.4% in France. Greece needs to decrease its deficit by almost 1% of GDP in order to achieve a sustainable 6% debt-to-gdp ratio while Germany only needs to decrease its by 1%. While Germany and France had identical GDP growth rate averages over -13 of 1.21%, the highest was Ireland at 2.7% p.a. and the lowest was Portugal at.3% p.a. GDP growth differentials are mainly driven by differences in growth of labour productivity and working age population. Health and pension expenditures that are projected to grow close to % of GDP are unsustainable. Efforts towards health education and financial education on pensions need to be accelerated as is increased emphasis towards longer-term savings. The EU faces the tough economic and social challenges of coping with the highest post-war youth unemployment rates as well as unprecedented growth in shares of the old and the very old (). This requires brave policy actions through coordination and synchronization across monetary policy, fiscal policy and structural reforms in education, health, labour and taxes. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

EU s diverse changing demographics EU countries exhibit diverse and evolving demographics in terms of their consumers and workers. The changing demographics affect its macro environment (debt sustainability, low growth and low interest rate) as well as its social stability and progress. In the interest of parsimony, we restrict our discussions mainly to the set of EU15 countries rather than the EU28 without any loss of generality. The report is structured as follows. Section 1 presents trends, comparisons and contrasts in terms of core demographic indicators. Section 2 highlights from the worker perspective how those diverse and changing demographics influence GDP growth, labour productivity, wages etc. Section 3 focuses on how consumer differences across EU countries have implications for sectors, pensions etc. Section 4 highlights the public finances and pensions of EU 15 countries and Section 5 concludes. 1. EU15 core demographic indicators In this section we focus on the demographic profile of the EU15 countries as shown in Exhibit 1. These countries are very heterogeneous in terms of their population size, GDP and GDP per capita and their relative ranks are also displayed. Their population sizes are vastly different and when their GDP is normalized by the population size we note that the GDP based ranking does not always translate into similar ranking based on GDP per capita. The smallest country in population terms (Luxembourg) is the highest in GDP per capita and the largest in population size (Germany)is the 1 th highest in terms of GDP per capita. The EU15 population is slightly higher than that of the US (322.6 mn) but its total GDP is lower that of the US (USD17.42 trn). Exhibit 1: Population, GDP and GDP per capita (14) Population GDP GDP per capita Millions Rank USD (Billions) Rank USD Rank Austria 8.5 11 436.1 9 51183 5 Belgium 11.1 7 527.8 8 474 8 Denmark 5.6 12 347.2 1 61885 2 Finland 5.4 13 276.3 11 5451 7 France 64.6 2 292.3 2 45384 9 Germany 82.6 1 38.5 1 471 1 Greece 11.1 9 246.4 13 22318 14 Ireland 4.7 14 245.8 12 51159 6 Italy 61.1 4 2129.3 4 35512 12 Luxembourg.5 15 63.9 15 1752 1 Netherlands.8 6 88.4 6 52249 4 Portugal 1.6 8 228.2 14 21748 15 Spain 47.1 5 14.5 5 3113 13 Sweden 9.6 1 559.1 7 57557 3 UK 63.5 3 2847.6 3 44141 11 EU15 42.8-911.4-41984 - EU28 56.8-18398.7-3632 - Source: UN, IMF, Eurostat, Credit Suisse EU s evolving demographics & pensions need attention 2

Exhibit 2 displays the total fertility rate which represents the number of children per woman of child-bearing age (15-49 years old) and its change over 198-85 to 15- for the EU15 countries. We note that no country has a fertility rate above replacement rate in 15-. It is important to note that the fertility rate across the EU15 countries has neither uniformly decreased nor increased across all the countries over the 35 year period that we illustrate in Exhibit 2. It is very important to note that this is in contrast to the common perception that fertility rates are decreasing across advanced countries. Lower fertility rates translate into lower population growth rate on average across the EU15 as shown in Exhibit 3. Germany, Greece and Portugal exhibit negative population growth rates while Denmark, France, UK, Sweden, Ireland and Luxembourg have the highest population growth rates amongst the EU15 countries. Exhibit 2: Total Fertility Rate: 198-85 to 15- Children per woman 3 198-1985 15-2.5 2 1.5 1.5 A country s population change depends on natural population change and net migration. Exhibit 3 highlights the fact that population growth is higher in countries with higher fertility rates which contribute towards increasing the natural population change (which is defined as births less deaths). An additional factor that influences population growth but is hard to predict due to political and social reasons is net migration (immigration/inward migration less emigration/outward migration) Exhibit 3: EU15 Population growth: 198-85 to 15-. Rate per annum 1.4 1.2 1.8.6.4.2 -.2 -.4 198-1985 15- The countries with the highest population growth rates also typically have high net migration inflow contributions. Exhibit 4 develops this point further by presenting the decomposition of population change into two components. We emphasize that the trends are not uniform across the EU15 countries. The relative contribution of the two components varies across the countries this is related to social indicators, education, health and other government policies and over time too. EU s evolving demographics & pensions need attention 3

Exhibit 4: Population change decomposed Thousands Natural Population Change (Births Deaths) Net Migration Emigration) Overall Population Change Natural Population Change (Births Deaths) Net Migration Emigration) Overall Population Change Natural Population Change (Births Deaths) Net Migration (Immigration- (Immigration- (Immigration- Emigration) France Portugal Belgium 198-1985 1112 289 141 243-67 176 28-35 -7 Overall Population Change 15-987 6 1587-132 1-32 81 1 181 UK Greece Finland 198-1985 281-67 214 228 64 292 1 23 123 15-856 9 1756-97 5-47 31 5 81 Germany Ireland Denmark 198-1985 -495-18 -64 7-51 1 58-67 -9 15- -1181 5-681 187 5 237 38 75 113 Spain Netherlands Sweden 198-1985 124-43 981 285 8 365 13 27 4 15-9 5 59 139 5 189 14 34 Italy Austria Luxembourg 198-1985 285 266 551-8 18 11 1 2 3 15-56 75 244 8 15 158 11 23 33 EU15 s life expectancy at birth has dramatically increased over the past 35 years. Exhibit 5 shows that all the EU15 countries have a life expectancy at birth above 8 years old with Spain and Italy displaying the highest life expectancies at birth while Denmark and Portugal have the lowest life expectancy. Exhibit 5: Life expectancy at birth: 198-85 to 15-84 82 8 8 198-1985 15-8.8 81 81.2 81.2 81.3 81.3 81.4 81.5 81.7 81.8 82.4 82.5 82.8 83.1 78 76 74 72 7 Life expectancy at 65 years has also exhibited a significant increase since 199. As shown in Exhibit 6, people who would have retired aged 65 were expected to live years in retirement in 199. In contrast in 12 they are expected to live for another years. The government now not only has to support a larger group of retirees (baby boomers entering retirement period) but it also has to support them for a longer retirement period. This has very immediate as well as long-lasting consequences on health care, long term care and the pensions expenditures of governments. Appendix B presents the population pyramids (age distribution of populations) across all the EU15 countries showing that changing population structures are not identical across countries as in Exhibits 43-72. EU s evolving demographics & pensions need attention 4

Exhibit 6: Life expectancy at 65 years: 199 to 12 22 199 12 21 19.6 19.6 19.6 19.6 19.6 19.7 19.8 19.8 19.9 19.9 19 19 18 17 15 14.5.9 21.4 Source: Eurostat, Credit Suisse Low fertility rates combined with increasing life expectancies leads to an increasingly high old-age dependency ratio (ratio of population aged 65+ per 1 population aged 15-64 years) across the EU15 countries. Exhibit 7 shows how heterogeneous EU15 countries are. Indeed Ireland has an old-age dependency ratio of 19.2, while Italy has an old-age dependency ratio of 33.8. Exhibit 7: Old-age dependency ratio: 198 & 15 Ratio of population aged 65+ per 1 population 15-64, in percentage 36 34 32 3 28 26 24 22 18 19.2 21.2 27.6 27.8 27.9 28.1 198 15 29. 29.1 29.3 29.7 31.1 31.8 32.3 32.7 33.8 In addition to old-age dependency, one of the ways to assess and see the population changes is to pay attention to the entire age distribution or age structure of a country s population. Appendix A illustrates at a glance the ageing of the countries in terms of the flattening of the age pyramids over a 3-year period 1985-15. While, this shows details of the whole age structure, a summary statistics that reflects the change in age distribution is the median age which is shown in the Exhibit 8 below. We note that the median ages across EU15 range from a low of 35.9 years (Portugal) to 46.3 years (Germany). To make up a median age gap of 1 years requires nearly 5 years at the upper end. Note that all countries have experienced increases in their median ages due to health and living standard advances over the last 35 years. EU s evolving demographics & pensions need attention 5

Exhibit 8: Median age: 198 & 15 5 45 4 35 35.9 198 15 39.1 4.5 41. 41.2 41.5 41.9 42.2 42.4 42.6 43. 43.3 43.5 45. 46.3 3 25 2. Workers in nine selected EU countries This section presents several facets of workers within the EU countries. In this section we present GDP growth contributions, productivity, wages, gender gaps, education, skills etc. Growth contributions & productivity Exhibit 9 displays the decomposition of real GDP growth into the underlying demographics related growth components (i) Working age population growth (population aged 15-64 years) (ii) Labour-productivity growth (real GDP/hours worked) and (iii) Labour-utilization growth (hours worked/working- age population). Exhibit 9: Real GDP growth decomposition %p.a. 3.5 3. 2.5 2. 1.5 1..5. -.5-1. Real GDP 2.62 growth: 1.95 1.84 1.45 1.65 1.21 1.21.22 2.86 2.33.32 1.82 1.22 1.4.32 1.18 1.35.21.27.44.29.56.19.22 -.28 -.29 -.13 -.24 -.67 -.12 -.8 -.46 199-99 -13 199-99 -13 199-99 -13 199-99 -13 Source: UN, GGDC, Credit Suisse France Germany Italy UK Working age population Labour productivity Labour Utilization We have previously used the demographic factor based GDP growth decomposition to understand the relative contribution of the three factors towards GDP growth 1. As Exhibit 9 shows, the relative contributions are different over time and across four of the countries France, Germany, Italy and UK. Real GDP growth decomposition of Netherlands, Ireland, Spain, Portugal and Greece is shown in Appendix A (Exhibit 42). In Germany and France, where the overall growth rates were the same during -13, the sources of growth have been dramatically different. France has seen an increase in the working age population alongside a decrease in labour utilisation, while Germany saw 1 Credit Suisse Demographics Research (9), "A Demographic Perspective of Economic Growth" EU s evolving demographics & pensions need attention 6

an increase in labour utilisation along with a decrease in working age population. The positive growth experience of the UK relative to Italy over the last 14 years has been driven by the major contribution of labour productivity growth complemented by the highest working age population growth of the four largest economies in the EU15. Exhibit 1 shows that there exist productivity differences in terms of sectorial value added across countries. The gross value added per worker in agriculture varies between USD 1K (Portugal and Ireland) to USD 8K (Netherlands) whereas for industry it ranges from USD 34K (Portugal) to USD 142K (Ireland). In the case of services the highest gross value added is USD 99K (Ireland) to USD 44K (Portugal). The value added per worker across selected countries differs significantly across both the sectors and countries. Understanding these differences is important for both policy-makers and investors. Exhibit 1: Gross value added per worker (13) Constant 5 USD 15 Agriculture Industry Services 13 117 11 86 9 79 8 8 77 78 73 76 71 71 7 6 6 61 49 44 47 47 5 42 41 34 35 3 1 1 1 142 99-1 Source: World Bank, OECD, Credit Suisse Hours worked & wages Exhibit 11 and Exhibit 12 present the average annual hours of work and average annual wages for the nine selected European countries. We chose these countries as they have better data in terms of reliability and consistency. Exhibit 11 shows the differences across countries in terms of part-time and full-time workers. There are significant differences in part-time work when we contrast Germany with low part-time hours with Italy with much longer part-time weekly hours. Exhibit 11: Average weekly hours of work (13) Hours Total Full-time Part-time France 37.5 4.5 19 Germany 35.3 41 15.7 Greece 42.1 44.7 19.4 Ireland 35.4 4.7 18.7 Italy 36.9 4.9 19.3 Netherlands 3 39 15.7 Portugal 39.4 42.7 14.9 Spain 38 41.6 17.4 UK 36.5 42.7 17.5 Source: OECD, Credit Suisse Exhibit 12: Average annual wages 13 USD, constant price 5 1 13 France 41.4 44.1 46.4 46.9 Germany 44.6 44.9 45.4 47. Greece 24.7 29.9 29.4 24.9 Ireland 49.8 56.5 65.1 61.9 Italy 38.1 38.5 39.1 37.9 Netherlands 51. 52.5 56.1 55.2 Portugal 21.1 21.4 22.4 21.9 Spain 34.1 33.6 36.8 35.1 UK 45.6 49.9 5.6 49.2 Source: OECD, Credit Suisse EU s evolving demographics & pensions need attention 7

Exhibit 12 displays the wage differentials across countries which are an important influence in worker mobility not only across national borders but within European regional boundaries but also outside of those regional boundaries. There are significant average annual wage differences between Portugal and Ireland but it appears to reflect the gross value added differentials that we presented above. Skills Workers in different countries also possess different levels of skills. Exhibit 13 shows the percentage of population aged 25 years or over with tertiary education attainment. UK topped the chart with 38.9% in 14, while Italy, by contrast, has only 13.7%. Exhibit 14 shows the number of tertiary graduates in science and technology. Ireland has the highest number of science and technology graduates (22.5 for every thousand population aged -29 years old). It is followed closely by France and UK. In today s knowledge intensive economy while science and technology is the main driver for productivity growth, education (in particular, education in science and technology) is the key in securing the most important source of GDP growth. Exhibit 13: Tertiary education attainment (14) Population aged 25 yrs or over with tertiary education attainment (%) Exhibit 14: Tertiary graduates in science & technology (12) per 1 inhabitants aged -29 yrs old 45 4 35 3 25 15 13.7 17.1 22.9 25.1 28.2 28.7 3.1 35.9 38.9 25 15 1 1.7 13.2 13.9 15.6.2 19.4 19.8 22.1 22.5 1 5 5 Source: Eurostat, Credit Suisse Gender Source: Eurostat, Credit Suisse *Data is for 11 One way to increase the labour utilization rates is to close the gender labour participation gap. Some progress has been made in this area, but a lot more needs to be done. Exhibit 15: Labour force participation rate (14) Exhibit : Gender pay gap (13) By gender, percentages Difference between average gross hourly earnings of male employees and of female employees as a percentage of average gross hourly earnings of male employees, % 8 25 7 6 5 4 Gap: 18.6 9.3 1.7 11.9 11.5 15 11.6 12.2 15 13 14.4 15.2 19.3 19.7 3 1 7.3 1 5 Male Female Source: ILO, Credit Suisse Source: Eurostat, Credit Suisse * Data is for 12 EU s evolving demographics & pensions need attention 8

In view of the fact that women live longer and there are in many European countries more female university graduates than males, the gap in labour force participation rates needs to narrow through fairer labour policies and practices. According to the recent gender equality survey by the European Commission 2, there are still 62% of Europeans who think that inequalities between men and women are widespread in their countries. Women outlive men and in a previous research report in titled the Demographic Manifesto 3 we made a call to action for ageing countries to bridge the male-female labor force participation gap. Exhibit 15 shows that there are still sizable gaps in labour force participation rates between men and women, with Italy, Greece and Ireland having more than 15 percentage points difference. The government could narrow the gap further through measures such as providing better and more childcare benefits and encouraging more flexible work arrangement. Women also earn less than men. Exhibit shows the gender pay gap among the European countries in 13. UK and Spain have the highest income inequality by gender, with 19.7% and 19.3% differences in male and female gross average hourly earnings respectively. One welcoming trend is that the issue of gender inequality has become better recognized. According to the same survey, more than 75% of Europeans think that tackling inequality between men and women should be an EU priority Older workers The average effective retirement age has not increased in line with the longer life expectancy however. Exhibit 17 shows the average effective retirement age over five-year intervals. Only Portugal has an effective retirement age (68.4 and 66.4 for men and women respectively) higher than the conventional retirement age of 65. There have been increases in some countries from the s to 1s, but these changes are small and insignificant. As jobs today are less physically demanding in general, it makes it possible for older people to delay their retirement as long as they keep updating their skills, remain in reasonably good health and have a desire to work longer.. Exhibit 17: Average effective retirement age & normal pensionable age Male Female Effective Official Effective Official 1987-92 1997-2 7-12 12 1987-92 1997-2 7-12 12 France 59.8 58.5 59.7 65 6.1 58.5 6. 65 Germany.. 61. 62.1 65.. 6.2 61.6 65 Greece 63.5 62.5 61.9 65 6.7 61. 6.3 64 Ireland 63.3 65.1 64.6 66 63.3 66.2 62.6 66 Italy 61. 61.2 61.1 66 58.5 6.5 6.5 62 Netherlands 6.6 6.5 63.6 65 58.9 58.5 62.3 65 Portugal 64.6 65.9 68.4 65 63.8 63.6 66.4 65 Spain 61.7 61.6 62.3 65 64.4 61.4 63.2 65 UK 62.5 63.1 63.7 65 6.2 61.2 63.2 61 Source: OECD, Credit Suisse Official retirement age refers to the normal pensionable age 2 European Commission (15) Special Euro-barometer 428: Gender Equality Summary 3 Credit Suisse Demographics Research (), The Demographic Manifesto New Jobs, New People EU s evolving demographics & pensions need attention 9

Encouraging women to work and elders to work for longer can potentially help solve the problems created by an aging population. According to the World Bank, if the age profile of labour force participation can shift by 1 years for older age groups 4, dependency ratios in Central Europe and the Baltics would remain relatively stable despite significant population aging. This same trend could apply to other European economies. Youth unemployment Exhibit 18 shows the youth unemployment in our selected nine European countries relative to the general unemployment level. Historically, youth unemployment has always been higher than the general unemployment level. Exhibit 18: Youth unemployment vs. general unemployment Percentage 199 14 General unemployment Youth unemployment General unemployment Youth unemployment France 9.4 19.8 9.9 23.2 Germany 4.9 4.6 5. 7.7 Greece 7. 23.3 26.5 52.4 Ireland 14.1 19.7 11.3 23.9 Italy 9.8 28.9 12.7 42.7 Netherlands 7.7 11.1 6.8 1.5 Portugal 4.6 1.4 13.9 34.8 Spain.3 31.8 24.4 53.2 UK 7. 1.4 6.1.9 Source: ILO, Credit Suisse This is structural as younger people have less experience and they spend a longer time searching. However, the gap has since widened. In places such as Spain and Greece, youth unemployment has reached more than 5%. This has important implications for policy makers since it affects a countries political stability as well as its growth potential. Migration Mobility of labour is at the center of the concept of the EU. As shown previously in Exhibit 4, a country s population change is made up by natural population change as well as net migration. While fertility rates (shown in Exhibit 2) and death rates have been generally low across all the countries, they have a very different net migration profile. According to the European Commission 5, more than 1 million of the EU working age population are living in an EU country other than their own in 13. 77.7% of these mobile EU populations are economically active and 12.4% of them are unemployed. They tend to be younger and are more likely to have temporary jobs. Exhibit 19 and Exhibit show the number of foreigners living in the nine European countries and their level of education. As per Exhibit 19, Ireland has the highest percentage of foreign-born population (17%), followed by Spain, Germany, Netherlands and UK. Exhibit illustrates that the foreign-born working age population are highly educated in the UK and Ireland, with 46% and 43% of them with tertiary education respectively. In both countries, the foreign-born population has a significantly higher level of education on average than the native population. 4 e.g. if 55-year-olds by 6 participate in the labour force at the same rate as 45-year-olds in 3 5 European Commission (14) EU Employment and Social Situation EU s evolving demographics & pensions need attention 1

Exhibit 19: Foreign-born population (12) Exhibit : Highly educated share: foreign and native-born (13) As a % of the total population Percentages, with tertiary education Foreign born Greece 7 Portugal 8 Italy 1 France 12 UK 12 Netherlands 12 Germany 13 5 45 4 35 3 25 15 1 5 11 14 Foreign-born Native-born 21 22 22 24 28 43 46 Spain 14 Ireland 17 Source: OECD, Credit Suisse Source: OECD, Credit Suisse 3. Consumers in selected nine countries within EU In this section we present household structure and type changes and inequality. Household characteristics Exhibit 21 and Exhibit 22 show the share of households by size and type respectively. There is a significant increase in the 1 and 2 member families across all countries. In 14, 77% of Germany s households and 7% of Dutch households are 1 or 2 member households. The noteworthy point is that a significant proportion of the single and twomember households include people above the age of 6 reflecting the change in society. Exhibit 21: Share of households by size As a percentage of total. Legend displays number of members in each household 1% 8% 6% 4% % % 1 6 7 3 7 5 8 13 12 7 6 6 5 7 6 12 12 15 12 21 12 17 17 14 12 14 21 23 12 22 15 19 18 19 14 24 23 21 32 22 33 32 29 24 34 27 33 33 29 3 32 32 25 27 25 45 23 35 36 33 38 27 28 29 22 25 3 33 14 13 199 14 199 14 199 14 199 14 199 14 199 14 199 14 199 14 France Germany Greece Italy Netherlands Portugal Spain UK 1 2 3 4 5+ Source: Euromonitor, Credit Suisse Exhibit 22 displays the fact that not only is the household size changing but also the household types are changing. In previous research titled Longer Lives, Changing Life Cycles: Exploring Consumer and Worker Implications (July 11) we argued that when life cycle changes take place people are not only living longer but they are living differently getting married later, having children later, having fewer children, changing jobs and professions more frequently. EU s evolving demographics & pensions need attention 11

Exhibit 22: Share of households by type As a percentage of total, legend displays the type of household 1% 9% 8% 7% 6% 5% 4% 3% % 1% % 6 5 4 5 5 2 3 6 7 8 7 11 9 6 8 8 12 9 17 18 14 8 22 8 1 6 6 29 5 8 26 29 7 3 35 36 23 19 34 47 4 37 27 42 44 26 23 27 47 21 32 29 26 24 19 23 19 45 35 36 38 15 33 27 28 29 22 25 14 13 3 33 199 14 199 14 199 14 199 14 199 14 199 14 199 14 199 14 France Germany Greece Italy Netherlands Portugal Spain UK Source: Euromonitor, Credit Suisse Single person Couple without children Couple with children Single-parent family Other Inequality Exhibit 23 and Exhibit 24 show the wealth share of the top 1% over time and the changes in market income inequality between 7 and 11 respectively. Inequality by both these measures has increased since the crisis, with the most significant increase in Greece and Spain countries hit the hardest by the crisis. The increase in inequality could be attributed to the fact that lower income/wealth households have lost relatively more during the crisis and benefited less so far from the recovery. Exhibit 23: Top decile wealth share:, 7 &, 14 Percentages Exhibit 24: Market income inequality change (7-11) Percentage point changes in Gini coefficients 7 65 7 14 1% 8% 6% Disposable income inequality Market income inequality 6 4% 55 2% 5 % 45-2% 4-4% Source: Credit Suisse Global Wealth Report 14 Source: OECD, Credit Suisse Market income includes gross earnings and capital income According to the OECD, the drop in income of the bottom 1% was double of that of the top 1%. Also, note that the change in disposable income inequality is smaller than the change in market income inequality (which includes gross earnings and capital income). The difference is due to the redistribution occurring through taxes and social transfers. The income redistribution has been useful in moderating the widening income inequality driven by market forces. We should also note that the GDP per capita we use to measure relative economic performance across countries does not translate directly to measure of standard of living. Comparison of disposable incomes, which takes into account taxes and transfers, can tell a very different story. EU s evolving demographics & pensions need attention 12

4. Public finances and pensions in the EU selected nine countries Public finances The spending by EU governments on health care, long-term care and pensions has placed an increasing pressure on their public finances. Many EU governments had and continue to promise generous benefits to their citizens leading to fiscal imbalances. Exhibit 25 shows the general government structural balance 6 as a percentage of potential GDP. The government structural balance was at its worst in all EU countries in 1. Today most countries are still showing negative numbers but there are some small signs of recovery. Indeed due to fiscal consolidation programs, Germany, Greece and Netherlands have gradually shifted to positive numbers in 14. Exhibit 25: General government structural balance Percent of potential GDP 5 1 14 15 France -2.9-4.1-5.6-2.7-2.4 Germany -1.8-2.7-2.6.5.5 Greece -2.1-6.7-12.3 1.6 1.2 Ireland 2.8-3.6-7.9-3.3-2.2 Italy -3.4-5.5-3.8 -.8 -.3 Netherlands 1.2.4-3.9.1. Portugal -4.2-6.1-8.9-2.3-1.5 Spain -1.1 1.1-7.8-3.4-2.9 UK 2.7-5.3-8.4-4.1-3.6 Source: IMF, Credit Suisse Debt Since governments have not been able to cover their expenses with their revenues, they have had to borrow leading to higher general government gross debt in every country. Exhibit 26 shows that most countries have seen their debt more than double as a percent of GDP since the crisis,. Exhibit 26: General government gross debt Percent of GDP 18 France Germany Greece Ireland Italy Netherlands Portugal Spain UK Exhibit 27: Domestic credit to private sector Percent of GDP 25 France Germany Greece Ireland Italy Netherlands Portugal Spain UK 14 1 15 1 8 1 6 4 5 198 1983 1986 1989 1992 1995 1999 2 5 8 11 14 Source: IMF, Credit Suisse 198 1983 1986 1989 1992 1995 1999 2 5 8 11 Source: World Bank, Credit Suisse 6 The structural budget position is defined as the actual budget deficit (or surplus) less the effects of cyclical deviations of output from potential output. EU s evolving demographics & pensions need attention 13

On the other hand, domestic credit to private sector, which is a leading indicator of asset bubbles and financial crises increased a lot during the pre-crisis period but gradually decreased in 1 as the economies were deleveraging as shown in Exhibit 27. Tax Tax revenues that are used finance government expenditures vary across European countries. Exhibit 28 shows that France and Italy have the highest total tax revenue, which makes sense as they also have the highest government social expenditures (as shown later in Exhibit 3). Indirect taxes are higher than the direct taxes in France, Greece, Netherlands, Portugal and Spain. Exhibit 29 shows how tax rates differ from one country to another. With 52% Netherlands has the highest tax bracket. With 34.4% and 27.5%, France and Italy respectively have the highest corporate and capital income tax rates. High corporate tax might hurt their economies as other EU countries appeared much more tax-competitive, indeed Ireland with a 12.5% corporate tax rate may seem like a more appealing destination for companies. As illustrated in Exhibit 29, the consumption tax rate is high and quite homogenous across the EU countries, varying between 19% in Germany to 23% in Greece, Ireland and Portugal. Exhibit 28: Tax revenue (12) Exhibit 29: Tax Rate (14) Percentage of GDP Rate Direct Taxes Indirect Taxes Social Contributions Total Taxes France 12.4 15.7 17 45 Germany 12.1 11.4 15.6 39.1 Greece 1.2 12.7 1.8 33.7 Ireland 13.1 11.2 4.4 28.7 Italy 15.2 15.2 13.5 44 Netherlands 11.2 11.9 39 Portugal 9.4 13.9 9.1 32.4 Spain 1.6 1.7 12 32.5 UK 15.1 13.7 6.7 35.4 Source: European Commission, Credit Suisse Direct taxes: personal income tax, corporate income tax, and other income and capital taxes. Indirect taxes: VAT, excise duties and consumption taxes, other taxes on products, and other taxes on production. Social contribution: Actual compulsory social contributions' paid by employers and employees on the basis of a work contract, or by self and non-employed persons. Highest tax bracket (personal Income tax) Corporate and capital income tax rates Taxes on consumption (VAT/GST) France 45 34.4 Germany 45 15.8 19 Greece 42 26 23 Ireland 41 12.5 23 Italy 43 27.5 22 Netherlands 52 25 21 Portugal 48 3 23 Spain 3.5 3 21 UK 45 21 Source: OECD, Credit Suisse Fiscal consolidation Due to generous promises EU governments have led themselves into fiscally unsustainable positions. As a result, many EU countries have implemented or announced fiscal consolidation plans in 1. Fiscal consolidation refers to policies aimed at reducing government deficits and debt accumulation EU s evolving demographics & pensions need attention 14

Exhibit 3: Govt. Social Expenditures (14) Percentage of GDP Exhibit 31: Fiscal balance improvement needed to attain 6% debt-to-gdp ratio Percentage of GDP 35 3 25 15 1 5 12 1 8 6 4 2 Remaining consolidation need Consolidation plans in 12-15 Source: OECD, Credit Suisse Source: OECD, Credit Suisse The remaining consolidation need is the difference between the required average improvement in the underlying primary balance to achieve a gross general There is a significant variation in the composition of consolidation measures; some countries have structured their consolidation mostly around expenditure while others around revenue. Exhibit 32 shows that most EU countries have expenditure base consolidation programs. Exhibit 32: Expenditure-based versus revenue-based measures (9-15) % 1% 9% 8% 7% 6% 5% 4% 3% % 1% % Expenditure reductions Revenue enhancements Source: OECD, Credit Suisse These figures are the cumulative contribution to consolidation from expenditure and revenue measures. EU countries are enhancing revenues and reducing expenditures by cutting civil servant jobs, reducing benefits, reducing wages, cutting pensions, limiting investments. This has led to more poverty in Europe. EU s evolving demographics & pensions need attention 15

General government gross debt (% of GDP) 21 April 15 Material deprivation Exhibit 33 displays the severe material deprivation rate of EU selected nine countries. Severe material deprivation rate represents the proportion of people living in households that cannot afford four out of nine consumption items such as mortgage repayments, meal with meat etc. Exhibit 33: Material deprivation rates by age across EU 14 12 1 8 6 4 2 5 6 7 8 9 1 11 12 13 14 Source: Credit Suisse, Eurostat Less than 18 18-64 65+ We can see that the less than 18 and 18-64 age groups have the highest material derivation rates. This represents a threat as it could possibly lead to political instability and social upheaval. Fertility rates are declining and youth unemployment has led to a poorer young generation. In other words the new generation of workers is neither large enough nor rich enough to support the older generation. Exhibit 34 shows the relationship between old-age dependency ratios versus general government gross debt. Exhibit 34: Old-age dependency ratio vs. government debt (15) 18 Greece 14 1 1 8 6 4 Ireland Luxembourg Portugal Belgium Spain UK France Austria Netherlands Denmark Sweden 17 18 19 21 22 23 24 25 26 27 28 29 3 31 32 Old-age dependency ratio (ratio of population aged 65+ per 1 popilation 15-64) Source: UN, IMF, Credit Suisse Countries with a higher old-age dependency ratio tend to have higher public debt. In order to cope with increasing age-related expenditures governments incurred higher debts. EU s evolving demographics & pensions need attention

Social benefits Exhibit 35 shows that health care and old age account for more than 7% of total benefits. In an ageing world this does make sense, however as we have seen previously youth unemployment is higher than general unemployment in every European country. Exhibit 35: Social benefits by function (12) % of total benefits 1 5 9 8 11 5 9 5 7 4 8 6 7 6 8 8 11 5 7 4 7 7 7 9 7 8 4 21 24 7 6 25 33 29 36 5 34 26 49 4 3 51 53 47 4 45 33 36 36 1 21 France Germany Greece Ireland Italy Netherlands Portugal Spain UK Source: Eurostat, Credit Suisse Others Unemployment Family/Children Survivors Disability Health care Old age It appears that the EU government's public finances are directed more towards the older people (as they have the voting power and exercise it too) and they tend to direct less attention towards the younger generations. In all European countries the percentage of total benefits going to family and children is less than 11%. Yet as we know today's young generation are productive human capital assets for the future and will contribute towards future GDP. Hence European governments need to take a long-term multi-generational approach and invest in the younger generation too, in our view. Pensions Exhibit 36: Forecasted age-related expenditures 1 level and changes from 1 to 35 (% of GDP) 1 Affordability of pensions is one of Europe's biggest problems currently. The populations are ageing, fertility rates are decreasing and governments are facing extremely high debts. The question then remains Who will pay for the promised age-related expenditures for the older generation? Exhibit 36 shows the forecasted age-related expenditures which includes pensions, health care and long-term care. Pensions Health Care Long-term Care Change from 1 to 35 1 Change from 1 to 35 1 Change from 1 to 35 EU27 1.2 1.6 6.8.9 1.3.5 UK 6.7 1.1 7.6 1.1.8.3 Germany 1.2 1.7 7.6 1.2 1.6 Italy 14 1.2 5.9.8 1.7.4 France 13.5 1 8.2.9 1.5.4 Greece 11.6 7.8 5.1.8 1.5.8 Spain 8.9 3 5.6 1.7.3 Netherlands 6.5 3.5 4.9.8 3.5 2.7 Ireland 4.1 1.7 5.9.8.9.3 Portugal 11.9.4 7.3 1.1 Source: European Commission, Credit Suisse EU s evolving demographics & pensions need attention 17

In 1 the total aged-related expenditure in EU27 was 18.7% of GDP and is expected to increase to 21.3% in 35. The highest forecasted increase in pension spending is seen in Greece. It is worth noting that Greece is amongst the longest lived countries or in simple parlance one of the oldest countries in the world. 7 The structure of retirement-income is also very different within European countries. In Europe the public sector provides three main types of redistributive schemes: (i) resource tested (ii) basic and (iii) minimum. Exhibit 37 displays the different pension systems in the EU9. Defined benefit plans (DB) are the most common schemes in EU9. In these schemes retirement income depends on the number of years of contributions and on individual earnings. France and Germany have a points system, which means workers earn pension points based on their earnings each year and at retirement the sum of their pension points is multiplied by a pension-point value to convert them into a regular pension payment. Italy has national-accounts schemes (NDC), these record contributions and applies a rate of return to the balances. At retirement, the accumulated notional capital is converted into a stream of pension payment based on life expectancy. No EU9 country has a full defined contribution scheme (DC) but these are going to be more and more used in the future. In these schemes, contributions flow into an individual account and the accumulation of contributions and investment returns is converted into a pension-income stream at retirement. Currently Denmark, Poland, Norway, Sweden and Russia use DC schemes. Exhibit 37: Structure of retirement-income provision DB = Defined benefit, DC = Defined contribution, NDC= Notional accounts Targeted higher benefit to poorer pensioners & reduced benefits to better-off retirees Basic flat rate benefits (same for everyone) or benefit values depends on years of work (not earnings) Minimum value of entitlements takes takes account only of pension income Public Type Private Type France Yes DB + Points Germany Yes Points Greece Yes DB Ireland Yes Italy Yes NDC Netherlands Yes DB Portugal Yes DB Spain Yes DB UK Yes Yes Yes DB Source: OECD, Credit Suisse Public Exhibit 38 displays gross pension replacement rates for the average earner. The gross replacement rate shows the level of pensions in retirement relative to earnings. Pension benefits are shown as a share of lifetime average earnings revalued in line with economywide earnings growth. Across our selected nine countries, we note that there are significant differences across countries. UK, Germany and Ireland offer the lowest replacement rate, below 35%, whereas Italy, Spain and Netherlands offer a replacement rate above 7%. 7 In an earlier report we contrasted Greece to four other oldest countries in terms of macro sustainability as well as personal finances. See Credit Suisse Demographics Research 11 "Macro Fiscal Sustainability to Microeconomic conditions of the Old in the Oldest Five Countries". EU s evolving demographics & pensions need attention 18

Exhibit 38: Gross pension replacement rates for the median earner (13) Gross pension entitlement divided by gross pre-retirement incomes, % 1 91.4 9 8 71.2 73.9 7 64. 59.1 6 55. 5 42. 44.2 37.9 4 3 1 UK Germany Ireland Portugal France Greece Italy Spain Netherlands Source: OECD, Credit Suisse Replacement rates give a good measure on pension promise. However they only look at the benefit level at the point of retirement. In order to get a measure of the stock of future flows of pension benefit we need to look at pension wealth. Gross pension wealth displayed in Exhibit 39 is the total value of lifetime flow of pension incomes. Exhibit 39: Gross pension wealth for the median earner (13) Gross pension wealth is the total value of lifetime flow of pension incomes. It is measured as a multiple of gross annual individual earnings 25 15 1 5 5.3 4.5 6.9 5.7 Men Women 9.2 9.1 7.7 8.1 1.6 1.611.1 9.3 15.5 13.7 17.4 15.2 17.7.3 UK Ireland Germany Portugal France Italy Spain Greece Netherlands Source: OECD, Credit Suisse Governments need to implement pension reforms in order to improve the sustainability and affordability of their pension system. As we argued in the Demographic Manifesto (), we believe that retirement age should be extended in line with life expectancy increases and people should be encouraged to continue working after 65, even part time. Moreover governments should enhance people to save more as individuals hold more information on how much money they will need to maintain their living standard after they retire. Health According to a cross-sectional comparison of European countries, made by M. Lindholm Eriksen, S. Vestergaard and K. Andersen-Ranberg 8, Eastern European countries are more likely going to suffer from cardio-vascular diseases. They also found that Germany shows the same high levels of adverse health outcomes as East European countries. And finally they argue that differences in institutional factors have a major impact on health disparities and must be addressed to increase healthy and active ageing in Europe. 8 M. Lindholm Eriksen, S. Vestergaard and K. Andersen-Ranberg, (13), " Health among Europeans- a cross-sectional comparison of SHARE countries", Active ageing and solidarity between generations in Europe EU s evolving demographics & pensions need attention 19

As seen in Exhibit 36 forecasted health related expenditures are going to increase in every EU country, with Germany and UK seeing the greatest increase from 1 to 35 by 1.2 and 1.1 percent of GDP respectively. This will put additional fiscal pressure on EU governments that are already paying high health care costs. Exhibit 4 shows that all EU countries have health care expenditures greater than 8% of GDP and Netherlands, France and Germany have health care expenditures greater than 1% of GDP. Exhibit 4: Health care expenditures ( 13) Exhibit 41: Expenditure on health per capita ( 12) % GDP US dollars 14 12 1 Private Public 55 45 Private Public 8 35 6 25 4 15 2 5-5 Source: World Bank, Credit Suisse Source: OECD, Credit Suisse *11 In EU countries 8% of health care expenditures are paid by the public sector. We believe that as part of incentivizing individuals to take better preventive measures to avoid certain medical conditions, the share of government expenditures on health care should gradually decrease and individuals should contribute to a co-pay system of health care. Exhibit 41 illustrates differences in health expenditure per capita where we note that in Germany, France and Ireland individuals spend the most on health care on a per capita basis. With an ageing population and high unemployment rates the number of people requiring health care will increase, putting more pressure on countries with already high health care expenditures. We believe that these health care and pensions expenditures are unsustainable without holistic reform in the areas of labour, pensions, education and training. Indeed T. Bucher-Koenen and F. Mazzonna in their paper "The recent economic crisis and old-age health in Europe" (13) 9, have shown that a one percent increase in unemployment had a negative effect on health equivalent to more than an additional year of age. This effect is stronger for individuals who are still in the labour force and in Northern countries due to the high labour force participation of the older population. 9 T. Bucher-Koenen and F. Mazzonna, (13), "The recent economic crisis and old-age health in Europe", Active ageing and solidarity between generations in Europe EU s evolving demographics & pensions need attention

Conclusions EU countries have diverse and evolving demographics. As shown in this report, they have huge implications on workers, consumers as well as the economy. To counter the drag imposed by an aging population on the economy, policy makers as well as the private sector should provide more incentives for women to work as well as encourage elder workers to stay in the work force longer. Labour productivity will be the key for driving the next phrase of economic growth in the European economy. This could be achieved through investment in education, continuous training and investments in technology as well as research and development. With an aging population in the EU economies, pension expenditure as well as other oldage related spending such as health and long-term care are projected to increase significantly. This poses huge fiscal pressures on government budgets. We believe policy makers should not adopt a one-size-fit-all policy across the EU as these countries are vastly different. Fiscal consolidations, while necessary for long-term sustainable growth and development, have to take into account relative poverty, youth unemployment, income inequality and long-term investment, in our view. EU s evolving demographics & pensions need attention 21

References 1. T. Bucher-Koenen and F. Mazzonna, (13), "The recent economic crisis and oldage health in Europe", Active ageing and solidarity between generations in Europe 2. Credit Suisse Demographics Research (14), Why has recent macro-policy not been that effective? A demographic view 3. Credit Suisse Demographics Research (11), Longer lives, Changing life cycles: Exploring consumer and worker implications 4. Credit Suisse Demographics Research (11), Spotlighting the European Union s Demographics 5. Credit Suisse Demographics Research (9), A Demographic Perspective of Economic Growth 6. Credit Suisse Demographics Research (), The Demographic Manifesto New Jobs, New People 7. European Commission (15) Special Euro-barometer 428: Gender Equality Summary 8. European Commission (14) EU Employment and Social Situation 9. M. Lindholm Eriksen, S. Vestergaard and K. Andersen-Ranberg, (13), " Health among Europeans- a cross-sectional comparison of SHARE countries", Active ageing and solidarity between generations in Europe 1. OECD (14), Rising inequality: youth and poor fall further behind. 11. OECD (13), "Government at a Glance 13", Fiscal sustainability 12. OECD (13), Pensions at a glance OECD and G indicators 13. OECD (12), "Fiscal consolidation targets, plans and measures in OECD countries", Restoring public finances 14. The Age of Responsibility, Economics and Demographics (15) 15. World Bank Group (15), What s next in aging Europe: Aging with growth in Central Europe and the Baltics Appendix A: Real GDP growth decomposition Exhibit 42: Real GDP growth decomposition %p.a. 8 7 6 6.9.8 5 Real GDP 2.7 4 growth: 3.1 3. 4.6 2.7.1 3 1.6 1.9 1.4 1.2 2.3 2 1..3.4 1.1 2.2.2 1.2 1 1.3 1.1.8 1.4 1.4.5.6 1. 1.1 1.2.7 1..2.1.2 -.6-1.1 -.9 -.4-1 -.9 199-99 1-13 199-99 1-13 199-99 1-13 199-99 1-13 199-99 1-13 -2 Netherlands Ireland Spain Portugal Greece Source: UN, GGDC, Credit Suisse Working age population Labour productivity Labour Utilization EU s evolving demographics & pensions need attention 22

Appendix B: Age structure of EU15 populations. Exhibit 43: Germany, 1985 Exhibit 44: Germany, 15 4, 3, 2, 1, 1, 2, 3, 4, 4, 3, 2, 1, 1, 2, 3, 4, Exhibit 45: France, 1985 Exhibit 46: France, 15 3, 2, 1, 1, 2, 3, 3, 2, 1, 1, 2, 3, Exhibit 47: UK, 1985 Exhibit 48: UK, 15 3, 2, 1, 1, 2, 3, 3, 2, 1, 1, 2, 3, Exhibit 49: Italy, 1985 Exhibit 5: Italy, 15 3, 2, 1, 1, 2, 3, 3, 2, 1, 1, 2, 3, EU s evolving demographics & pensions need attention 23

Exhibit 51: Spain, 1985 Exhibit 52: Spain, 15 2, 1,5 1, 5 5 1, 1,5 2, 3, 2, 1, 1, 2, 3, Exhibit 53: Netherlands, 1985 Exhibit 54: Netherlands, 15 8 6 4 4 6 8 8 6 4 4 6 8 Exhibit 55: Belgium 1985 Exhibit 56: Belgium 15 6 4 4 6 6 4 4 6 Exhibit 57: Portugal 1985 Exhibit 58: Portugal 15 6 4 4 6 6 4 4 6 EU s evolving demographics & pensions need attention 24

Exhibit 59: Greece 1985 Exhibit 6: Greece 15 6 4 4 6 6 4 4 6 Exhibit 61: Sweden 1985 Exhibit 62: Sweden 15 4 4 4 4 Exhibit 63: Austria 1985 Exhibit 64: Austria 15 4 4 4 4 Exhibit 65: Denmark 1985 Exhibit 66: Denmark 15 3 1 1 3 3 1 1 3 EU s evolving demographics & pensions need attention 25

Exhibit 67: Finland 1985 Exhibit 68: Finland 15 3 1 1 3 3 1 1 3 Source: Credit Suisse Exhibit 69: Ireland 1985 Exhibit 7: Ireland 15 1 1 3 1 1 3 Exhibit 71: Luxembourg 1985 Exhibit 72: Luxembourg 15 1 1 3 1 1 3 EU s evolving demographics & pensions need attention 26