The ageing of the population (part II): The Spanish situation compared to the other countries in the European Union

The ageing of the population (part II): The Spanish situation compared to the other countries in the European Union

Theme: The following analysis compares Spain’s strengths and weaknesses in taking on the ageing challenge with other European countries.

Summary: In this analysis we scrutinize the ageing of Europe’s population and the way Spain’s ageing process differs from other European countries. The purpose is to determine when it is prudent to start the inevitable reform work necessary to accommodate the rising public expenditures that the ageing process contains. The analysis questions whether Spain’s ageing process is delayed compared to Europe as a whole. A delayed ageing process would justify a slow start in the reform work. The findings reveal that Spain indeed is different than Europe as a whole in this regard. However, the differences do not support the notion that Spain’s ageing process is delayed. Since the late 1990’s Spain’s ageing process is just as advanced, or even more advanced, than that of its neighbours. Moreover, Spain’s ageing process is found to be much more far-reaching than other European countries. This implies higher costs to accommodate the ageing population’s needs, and that Spain is likely to face a rougher reform work than other European countries. The conclusion is that Spain can no longer ignore the ageing problem if it wants to continue prospering economically, and close in on its European neighbours in terms of economic development. Waiting further to initiate the reforms deemed necessary to accommodate its growing share of elderly people would just distance the country from the parts of Europe that already are confronting the problem.

Analysis: In the “The ageing of the population (part I): Scope and future outlook in Spain” I outlined the ageing of Spain’s population from a national perspective. In this analysis, the focus is on comparative aspects instead. One of the main purposes is to analyse the need for political actions in relation to the ageing challenge, based on an assessment of differences in the ageing processes in Spain and other European Union member states. The analysis focuses primarily on the demographic aspects of ageing. These aspects contain the key to understand the ageing process. The speed and scope of the demographic transition causing global ageing dictates how and when it is prudent to engage in activities related to problems arising from the process. The purpose is to establish in which way Spain differ from other European countries, and whether theses differences, if they exist, warrants a different course of action or a more rapid or slow response on behalf of the Spanish Government when addressing the consequences of ageing. For the sake of simplicity and space, in talking about the problems and economic effects caused by advanced ageing, I will only refer to the cost of the pension system and the problem to sustain the European pension model. This does not mean that other, equally important social welfare benefits are not subject to the effects of ageing. All sectors of society are likely to be affected by the ageing phenomenon to some extent. Pensions, however, are judged to be the most problematic ones in terms of rising cost magnitude (see Part I for an overview of sectors subject to structural change with serious economic consequences).

The fundamental change brought about by the ageing of the European populations is a serious shift in the demographic balance between the number of people in working age and the number of people in retirement age. This shift is threatening the European pension model, which generally covers the cost of pensions through a system of inter generational transfers based on an assumption of continuous population growth. That is, those who work today pay the pensions for those who are retired today. Today’s workers can then expect the same treatment when it is time for them to retire. The ageing of the population cause the number of retired people to rise relative to the working age population, and balancing state expenditures on pensions becomes increasingly difficult. The equation is surprisingly simple; current projections have it that the share of the elderly people compared to the active population will at least double in the next decades. Thus, if a state is balancing, for example, pension expenditures relying on say 2 contributors for every retired person, the advancement of population ageing will force it to balance pension expenditures relying on 1 contributor for every retired person. With few exceptions, most European countries will experience such a shift between now and 2030. The need to confront the shift is likely to occur much earlier, and is estimated to between now and 2015.

The concern of the economic effects of ageing has already made some countries reform their pension system with a view to avoid financial hardship in the not too distant future. Most institutions and scholars believe that even though some countries will not face serious financial problems in sustaining pensions before the second decade of this century, the time to implement the necessary reforms to avoid financial hardship is now. The reason for this concern is based on the simple assumption that reforming a complex benefit system such as pensions requires ample time to phase in the changes. In many cases, the new “reformed” system and the old system will be operational in parallel due to difficulties in accommodating people in their fifties and sixties in the transition.

The increased costs resulting from ageing are huge – in some cases they are in the range of 10 percentage points of GDP if no reforms are introduced. The prospects for successfully accommodating the rising cost of pensions and other benefits are not only a national concern. The close inter-communitarian economic cooperation makes it vital that all EU states manage the ageing challenge as smoothly as possible. If any one country fails in this task, it may upset the EU economy in general, and threaten and destabilize the economic union. As a result, many institutions are currently preoccupied with monitoring the effects and remedies of ageing related problems in European countries. Many are conducting comparative analyses aimed at disclosing countries that are at risk of running into financial problems as a result of their ageing populations. The objective is to compare to what extent reform work, or lack of reform work, influences the state finances on a long-term basis.

Perhaps one of the most interesting and extensive assessments of the capacity to meet the ageing challenge is made by the Centre for Strategic and International Studies (CSIS). CSIS analyses a number of developed countries in four dimensions: 1) The cost magnitude of the projected old-age dependency burden on state finances; 2) The countries projected fiscal room to finance the increasing costs of ageing; 3) The projected degree of old people’s dependence on public benefits (how vital public benefits are for the elderly survival); and 4) The relative living standard of old people compared to young people (room to cut benefits). Its scope and methodology makes it one of the more rigorous comparative exercises on the market today, as well as a reference source for inter communitarian debate on ageing.

The conclusion of CSIS’s assessment is that global ageing indeed is challenging the developed world and that many, if not most, developed countries are running a high risk of finding themselves in a fiscal and economic crisis if serious reforms are not introduced in the next few years. And what is more, the general assessment is that the potential fiscal and economic problems are worse than what is usually assumed by governments. From a European point of view the findings are discouraging – European countries are, in general, facing more difficulties in addressing the ageing challenge than the US, Australia, and Canada. (See “The 2003 Aging Vulnerability Index” for a full account of the country assessment.) While the general assessment is negative to the future, some countries are standing out as being much less prepared than others in the comparison. The study has received much attention by the European Commission, and is used as reference material in addressing the ageing problem in Europe today.

Interesting from a Spanish viewpoint is that the CSIS study ranked Spain as the country with the largest future problem in accommodating the costs resulting from an increasing share of elderly people, followed by Italy and France. All other European countries, including Germany that has a reputation of being a country with a gigantic reform work ahead to save state finances, are better positioned than Spain.

The CSIS is not the only institution that place Spain in an unfavorable position with regards to its future financial situation as a result of ageing. OECD, in its yearly follow-ups of the developed countries, arrives at similar conclusions. And many Spanish experts find that the costs of maintaining Spanish pensions at current levels and under the current rules would come at a price exceeding that of any other European country (see particularly the work by FEDEA). Most experts assessing Spain’s future outlook seem to be in agreement that Spain would have the highest increase in pension expenditures of all EU countries, and the largest financial difficulties in solving the needs of its increasing elderly population.

In comparing European Union countries, why is Spain considered to be in such a bad position in taking on the ageing challenge? And a second question: how serious is it for Spain to be downgraded as the least prepared country in taking on the ageing challenge?

The first question can be answered in a great number of ways, but there is a key element worth highlighting. It concerns the timing of the reform work that goes on inside Europe today. Many of the European countries have already started to implement serious reforms to their social welfare systems in response to the ageing challenge (Italy, Germany, Sweden and the UK, for example). Since these reforms are already enforced, and done out of concern to counteract the problems captured by indicators such as those used by the CSIS, countries who have started reforming their pension systems have a tendency to score better than Spain when evaluating future capacities to deal with the ageing challenge. Spain, on the other hand, has not even started any serious reform work. The lack of reform in Spain could be explained by the popular belief that Spain entered into the demographic transition causing population ageing later than its European neighbors. And indeed, when politicians address the ageing problem and its potential to damage the government’s capacity to cover pension expenditures etc., they frequently cite Spain’s late entry into the demographic transition as a reason for not hurrying reforms in this area.

From a comparative perspective, a late entry into the ageing process implies that Spain is not fully comparable to other countries, unless the time factor is accounted for when comparing countries. Many of the indicators used in comparisons such as the CSIS study are to some extent insensitive to a late entry into the ageing process since the comparative indicators primary task is not to answer to the question of when reforms should be done, but rather to show the extent of the financial damage on a long-term basis if, for example, the pension systems are left unreformed. Thus, the lack of reform makes Spain’s welfare state and current pension system very vulnerable to cross European comparison based on projections, even though its current capacity to balance pension expenditures is excellent. Once the reform work is in motion, we can expect Spain to improve on a number of issues dealing with ageing in the coming years, and its future rankings may very well be more happy reading.

If there were a significant time lag in Spain’s favor, its poor performance in comparisons with other countries would be less serious since this would imply that there is still time to make up for the differences. However, if Spain’s ageing is as advanced as in other European countries, it is fair to ask why Spain has not tried to improve its future outlook with the same intensity as its neighbors. To answer how serious Spain’s ranking vis-à-vis other European states is, we need to assess the timing of the events causing the need for reform. In other words, we need to find out how late Spain entered the demographic transition causing ageing compared to other EU countries, and how different Spain’s ageing process is compared to these countries.

The occurrence and advancement of ageing is governed by two demographic trends – increased life expectancy and decreasing fertility. In terms of increased life expectancy, the trend in Europe is more or less universal and existing differences are merely of academic interest. If anything, Spain is, and has been, a leading country with respect to increased life expectancy in Europe, indicating that it entered this part of its ageing process earlier rather than later compared to its European neighbors.

The second and most important demographic trend causing ageing is fertility. In figure one I compare Spain’s fertility development with the European average fertility development. In calculating the EU average fertility I exclude Spain for comparative reasons. (See Figure 1.) The data is from EUROSTAT

Figure 1 Fertility.

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While it is clear that Spain’s fertility has been substantially above the European average between the late 1960’s until around 1980, the general trend is indicating that Spain’s fertility pattern started descending at approximately the same time as the European average fertility started its decent. Both have been descending since the mid 1960’s. The main difference is that in the first ten years of decreasing fertility, Spain resisted longer above the replacement level (2,1) and saw slower annual decreases than its neighbors. However, around 1975, Spain’s fertility basically collapsed, it dropped from the high end in Europe to way below the European average. Thus, judging by the development in increased life expectancy and fertility, it appears as if the ageing process has been occurring in parallel in Spain and Europe. However, the initially slowly descending fertility in Spain, suggests that the ageing phenomenon may be materializing significantly slower in this country.

To conclude whether the ageing process is delayed, and to assess how advanced the ageing process is in Spain compared to Europe, it is necessary to analyse the structural changes implied by the ageing of the populations. There are two main structural changes resulting from the ageing of Europe’s population. The first is an increase in the number of old people in the society and the second is a decrease in the number of young people. In assessing the changes, it is common to contrast the two groups with the active population. The reason for this is fundamentally an economic one; the active population, theoretically speaking, supports the young and the old people in society, (the latter in the form of pension transfers).

In constructing the three groups – young, active and old – I use the age interval 0-19 for young, 10-59 for active, and 60 and over for the old population. I choose these cuts because they best correspond to the actual behaviour of Europeans today. The results can be presented in two graphics. One measures the dependency ratio between the young and the active population and the other between the old and the active population. Data and projections (from 2003 and onwards, 1999 revision) are from EUROSTAT.

Figure 2a and 2b – Young age dependency ratio and old age dependency ratio.

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In the two figures, population ageing can occur in two ways: 1) if the share of young people decreases relative to the active population; 2) if the share of old people increase relative to the active population. When the line development is parallel to the X-axis there is equilibrium, and the transition is concluded.

The main conclusion from looking at both figures is that Europe is in the middle of the ageing process, and that, from an economic point of view, the worst is still to come. It is in the middle of the ageing process because the transition from a high to a low share of young people compared to the active population is basically being completed in this very moment (the share of young people compared to the active population does not decrease beyond 2003, nor does it increase) and because the really significant increment of older people is yet to come. More importantly for this analysis, however: there is currently no evidence that Spain’s ageing process is less advanced or delayed compared to other EU states.

As the figure depicting the young dependency ratio shows, while Spain initially saw some tendency supporting the notion that the ageing of its population was materializing slower than in the rest of Europe, Spain caught up with its neighbours, and passed them already in the late 1990’s. One consequence of this is that Spain shows significant signs of a more advanced ageing process than Europe as a whole – its share of young people compared to the active population is among Europe’s lowest.

As for the old-age dependency ratio, the process towards an increase has been present across Europe, including Spain, throughout the observation window covered by the data used here. However, the changes have been much less dramatic than the changes in the share of young age dependency ratio. It is worth noticing that Spain’s old-age dependency ratio has been above the European average since the 1990’s. Hence, its ageing process as regards to an increased share of elderly is as advanced as Europe as a whole judging by this indicator.

The future outlook is spectacular for Europe. The old age dependency ratio will rise with a speed never seen before in the coming decades as the large birth cohorts from the forties, fifties and sixties reach retirement age. For Spain the future outlook is even more spectacular. As shown in the figure, while Europe reaches equilibrium in the ageing process around 2030, Spain’s population would continue ageing through 2050. This is largely due to Spain’s consistent below EU average fertility in the last decades.

Conclusions: It would be a mistake to conclude that the demographic transition causing population ageing started later in Spain than in other European countries. On the contrary, data show that it started at approximately the same time. It is more correct to conclude that Spain is subject to an ageing process that is slightly different from other European countries. The differences are twofold. Firstly, the ageing process in Spain has materialized slower compared to the EU average in the late 1960’s and early 1970’s. In the 1980’s, Spain was making up for its early slow development, and since the late mid 1990’s, its ageing process is more advanced than the EU average. Secondly, from the mid 70’s and onwards, Spain’s decreasing fertility has been brutal and persistent. The long-term effect is a shrinking active population, (see part I). This development set Spain up for a more problematic ageing challenge than other European countries. While most European countries can look forward to complete its transformation into an older society by 2030, Spain will continue ageing for two more decades. Its population will eventually become one of the oldest in Europe by 2030. The second difference is influencing Spain’s capacity to meet the financial challenge of ageing. Spain will have a much higher old age dependency ratio than its European neighbors, and hence, the cost of sustaining Spanish pensions is likely to become much higher than in other countries. No doubt, this is contributing to Spain’s poor performance in long term inter European comparison exercises of the type mentioned earlier. This does not justify Spain’s poor performance in such comparative exercises. Rather the opposite. The more severe ageing process combined with the evidence we have just seen, that Spain’s ageing process is just as advanced as in its neighbor countries, is a very strong indication that the Spain’s poor performance in comparative exercises could be a real and serious problem. Despite the common belief, immigration is not a solution to the future problems. A large intake of immigrants is cushioning some of the effects of ageing, but immigrants also grow old eventually. To have a significant impact, immigration levels would probably have to triple over the coming decades. It is highly unlikely that a yearly immigration level of around 300 thousand is sustainable in the long run.

One of the arguments used to justify delays in reforming the pension system and other social welfare institutions affected by ageing, is that the current financial situation in maintaining these is good. Spain is not facing any severe budget deficit in relation to pension expenditures until 2015. However, this strategy is nothing but a temporary solution. The demographic variable shown in this analysis is not going to change in a foreseeable future, and the prediction regarding the steep increment in elderly people over the next decades is unavoidable. The reason for this is the persistent low fertility in Spain. This trend has now been present for 25 years. If fertility were to change favorably in the next years it would take another 25-30 years before the effects of such improvements would have any impact on the old age dependency ratio – 25-30 years is the time it takes before new birth cohorts enters into the active population and starts contributing towards, for example, pensions. If such a change is produced at all it is still highly unlikely that the Spanish state finances would be strong enough to subsidize the pension system until the demographic changes become effective. Thus, the problem exists whether we like it or not.

The situation itself is confusing. The longer the government waits in reforming pensions the more ambiguous is the situation for the working age population. A large share of the Spanish labor force is currently contributing to a system that demographers and economists alike have declared unsustainable in a not too distant future. To justify the inter-generational transfers financing current pensions, it is necessary to clarify how the ageing process will affect future transfers. There are many reasons for this. The most important, however, is that if future pensions are going to be significantly lower as a result of ageing, the labor force will need ample time to make personal adjustment to these changes. Private pension plans compensating for decrementing public pensions, require continuous savings for decades to become a significant supplement to public pensions. The generousness of Spanish pensions under the current regime makes many Spaniards prioritizing away private savings for retirement. Given the ageing development shown in this analysis, it cannot be excluded that the government has to cut pension benefits to make ends meet. Many people in the labor force today may reconsider private pension plans if they had information about how the future pension system might look like. Currently, they are restricted to guessing whether it is necessary to make private provisions or not.

The scope of Spain’s ageing problem compared to the rest of Europe is of international concern. Spain has come a long way in closing in on its European neighbors in terms of economic development. It is not difficult to imagine that if Spain’s future public expenditures on pensions raise more, and for a longer time than in other European countries its future economic development will be at risk. Financing the growing pension expenditures would take away resources that Spain is currently investing in other areas – infrastructure, research and development etc. The enlargement of the EU complicates things further. The structural funds that Spain has enjoyed since its entry into the Union will soon be a memory. Thus, not only does Spain have to rely on its own capacity to finance a range of development activities that have been subsidized by EU funds in the past, and which have contributed significantly to its stunning economic performance in the 1980’s and 1990’s, but it also has to find the financial room to do this at the same time as its public expenditures on, for example, pensions are in for its largest rise in the history of the Spanish welfare state. To avoid a situation of competing interests of this kind, it is paramount that Spain finds a way to reform its public benefits in a manner that makes them compatible with a structurally different society, dominated by elderly people. To succeed in this task, it is not unlikely that the government has to consider unorthodox solutions whereby the current pension system has to give way to a fundamentally different one, which reconsiders such issues as retirement age, length of contribution and solutions combining private and public pension plans. The sooner Spain achieves a sustainable solution to these problems the better is the outlook for continued economic growth and development.

Rickard Sandell

Rickard Sandell

Written by Rickard Sandell