Ageing cost projections – new evidence from the 2024 Ageing Report

Prepared by Edmund Moshammer and Joachim Schroth

Published as part of the ECB Economic Bulletin, Issue 5/2024.

This box analyses the projections produced over the last 15 years for costs in euro area countries related to the ageing population, using new evidence from the recently released 2024 Ageing Report. This report^[1], which was published on 19 April 2024, is the latest in the series of reports prepared every three years by the Ageing Working Group of the Economic Policy Committee, which supports the work of the Council of the European Union. It provides projections of public spending related to the ageing population for EU Member States over the period 2022-70.^[2] Its findings are a key input into long-term fiscal sustainability analyses produced by the European Commission and the ECB. The projections are also an important element in the implementation of the reformed EU fiscal framework. This framework came into effect at the end of April 2024 and puts greater emphasis on the need for governments to address risks to fiscal sustainability.

The 2024 Ageing Report projects ageing-related fiscal costs in the euro area, expressed as a share of GDP, to increase from 25.1% in 2022 to 26.5% in 2070. Developments in ageing costs differ across countries owing to their different starting positions, for example in terms of population structure and regulatory environments (Chart A).^[3] Nine countries are estimated to see increases of over 4 percentage points, while six countries are projected to experience a decline in costs. The increase in total ageing costs for the euro area is seen to be mainly the result of increasing pension costs, and, to a lesser extent, healthcare costs and long-term care costs. Education costs are projected to decrease slightly in all countries. When comparing the intervals 2022-2045 and 2022-2070, the timing of increases in ageing costs is foreseen to be very different across countries. Generally, such long-term projections entail a large degree of uncertainty. By way of an illustration, in a risk scenario which assumes for health care and long-term care a higher demand elasticity and a cross-country convergence of costs and coverage, the report estimates that in the euro area ageing-related costs could increase by 4.0 percentage points by 2070, compared with a 1.4 percentage point increase estimated in the baseline projections.

Chart A

Changes in total ageing costs and their components

(percentage points; 2022-2070)

Compared with the previous projections published three years ago, euro area ageing-related costs are estimated to be 0.3 percentage points higher by 2070. This reflects upward revisions to ageing-related fiscal costs in ten euro area countries and downward revisions in ten other countries. The largest upward revisions are for Spain where expenditure is estimated to be 7 percentage points higher by 2070, in part owing to a partial reversal of the 2011 and 2013 Spanish pension reforms, and for Cyprus where expenditure is seen to be 6 percentage points higher. Conversely, for Slovakia, expenditure in 2070 has been revised down by 4 percentage points and the projected cost increase from 2022 to 2070 has been revised down to 6 percentage points, following a pension reform in 2022.

Taking a longer-term perspective by looking at the Ageing Reports published since 2009, some notable patterns emerge (Chart B). A positive development evidenced in the latest report is that only two countries are assessed to see ageing-related public spending increase by more than 6 percentage points over the forecast horizon.^[4] In the earlier reports, twelve countries crossed that threshold. However, most countries are still projected to see a significant increase in costs. Only seven countries show stable or declining trajectories with an increase in spending of less than 1 percentage point of GDP, while in the 2015 Ageing Report nine countries were in this group.

Chart B

Total ageing costs in 2023 and long-term costs across projections

(percentages of GDP)

The latest Ageing Report shows that increased public spending on pensions owing to population ageing is expected to be mitigated through lower benefit ratios, later retirement and other structural labour market effects. Analysing pension spending in more depth, the dynamics can be broken down into four main components: the dependency ratio, the coverage ratio, the benefit ratio and labour market effects. The dependency ratio, i.e. the numbers of young people and elderly people in proportion to the working-age population, is estimated to drive up public spending on pensions in all countries, with expenditure rising by 6.2 percentage points on average by 2070 (Chart C). This effect is seen to be countered by contributions from the benefit ratio (-2.9 percentage points), the coverage ratio (-1.3 percentage points), and labour market effects (-1.1 percentage points). The benefit ratio measures the generosity of the pension system by looking at pension payments relative to wages and is driven by how quickly and to what extent benefits are adjusted in response to inflation and productivity gains. The largest cost savings from this component are projected for Greece and Portugal. The coverage ratio looks at the number of pensioners relative to the total number of people older than 65 and is driven by past reforms targeting the retirement age, such as access to early retirement or changes to the statutory retirement age. The largest cost reductions from this component are foreseen for Slovakia. Labour market effects are driven by changes affecting employment, working time and the labour force participation rate of older people. These effects are projected to decline owing to reforms encouraging longer working careers and an assumed increase in the employment rate. Their impact is greatest for Italy, where a higher employment rate and longer careers are seen to reduce public spending on pensions by 2.8 percentage points by 2070.

Chart C

Drivers of pension cost projections

(percentage points; 2022-70)

Population ageing is also projected to have a detrimental impact on public finances in the period to 2070 by lowering potential output growth. The 2024 Ageing Report projects euro area potential output growth to decrease from the average level of 1.4% estimated for this year and the last two years, to stand at 0.8% in the early 2030s, as labour input growth turns negative (Chart D). Compared with the 2021 Ageing Report, the 2022-24 level of potential output growth has been revised up based on upward surprises in net inward migration, labour force participation rates and employment rates, while potential output growth in the first half of the 2030s is unchanged, resulting in a sharper deceleration than was previously projected.^[5] Over the long run, potential output growth is projected to be lower than the estimated current level and to gradually decrease to stand at 1.0% in 2070. This is lower than the previous projection of 1.4% and is due to revisions to all components. In particular, total factor productivity (TFP) growth in 2070 has been revised down by 0.2 percentage points to stand at 0.8%.^[6] However, the level of uncertainty surrounding the projections is high, given the evolution of migratory flows and the fact that the implications of the digital and green transformations are hard to predict. Furthermore, the estimates do not capture all the effects that population ageing could have on potential output, such as through reduced aggregate productivity as a result of decreasing physical abilities, declining health, or reduced innovation. Neither do the projections consider the impact that changes to the composition of public spending may have on potential output – for example if higher ageing-related expenditure leaves less resources for infrastructure investment.^[7]

Chart D

Projections for potential output growth and contributions of components

(average annual percentage growth over five-year periods)

Rising ageing costs are a key consideration in assessing long-term fiscal sustainability. Demographic shifts, leading to a greater proportion of elderly citizens and increased demand for pensions, health care, and long-term care services, will strain public finances. The evolution of ageing cost projections reveals that while progress has been made in some countries, the challenges ahead remain substantial. To address the economic and fiscal consequences of population ageing, there is a need for fiscal buffers, a more growth-friendly composition of public finances and structural reforms.^[8] Furthermore, to limit the adverse impact on potential growth, productivity-enhancing policies are needed – for example policies promoting innovation, life-long learning and a faster integration of migrants into the labour market.