Can Europe Afford to Grow Old?

• Author: Giuseppe Carone and Declan Costello
• Position: The authors are Economists working in the European Commission's Directorate General for Economic and Financial Affairs. Servaas Deroose, Nuria Diez Guardia, Gilles Mourre, Bartosz Przywara, and Aino Salomäki contributed to this article

The EU must face up to recent projections showing that aging will have a major economic and budgetary impact

The population of the 25-member European Union (EU) in coming decades is set to become slightly smaller-but much older-posing significant risks to potential economic growth and putting substantial upward pressure on public spending. The region's old-age dependency ratio (the number of people 65 and over relative to those between 15 and 64) is projected to double to 54 percent by 2050, meaning that the EU will move from having four persons of working age for every elderly citizen to only two. In addition, upward pressure on spending has fueled concerns that unsustainable public finances could jeopardize the smooth functioning of the single currency, the euro.

Population aging in Europe is occurring because of the interaction of four demographic developments. First, fertility rates in all EU countries are, and are projected to remain, below the natural population replacement rate. Second, the recent decline in fertility rates followed the postwar baby boom, and the impending retirement of these cohorts will lead to a transitory increase (albeit lasting several decades) in the old-age dependency ratio. Third, life expectancy at birth, having increased by eight years since 1960, is projected to rise by a further six years for males and five years for females by 2050, with most gains resulting from longer life spans. Fourth, large net migration inflows are projected up to 2050: although cumulating to close to 40 million people, they will not offset low fertility and growing life expectancy.

Indeed, according to official projections, between 2004 and 2050, the number of young persons in the EU (aged 0-14) will drop by 18 percent (see table). The working-age population (15-64) will fall by 48 million, or 16 percent, whereas the elderly population aged 65+ will rise sharply, by 58 million (or 77 percent), and the fastest-growing segment of the population will be the very old (aged 80+).

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Governments have not been idle in the face of the aging challenge. At the European level, the European Commission has worked with national authorities in the Economic Policy Committee (EPC) to develop more comparable long-term projections to assess how population aging will affect EU labor markets, economic growth potential, and public finances. Published in early 2006, the projections-which assume no change in current policies and follow up on an assessment published in 2001-point to the need for substantial policy reform and adjustment.

Dramatic repercussions for growth and labor

Although most of the debate on aging concerns the budgetary cost, the most immediate impact will be felt in the labor market. EU projections, however, point to a mixed picture, with improvements in employment delaying somewhat the onset of the economic repercussions of aging.

For the EU as a whole, the employment rate is projected to rise from 63 percent of the potential labor force in 2004 to 67 percent by 2010 and to 70 percent by 2020 (see Chart 1). This improved performance results mainly from higher female employment rates, which are projected to rise from just over 55 percent in 2004 to almost 65 percent by 2025 and is explained by the gradual replacement of older women by younger women who have higher educational attainment and a stronger attachment to the labor market. In addition, the employment rate of older workers (ages 55 to 64) is projected to increase...