Europe Faces A Retiree Crisis

Some 30% of adults will soon be old

Western policymakers concerned about sound public finances should be feeling pretty good these days. The U.S. faces a steady stream of surpluses in the wake of strong growth and fiscal restraint. And European nations, spurred by the European Monetary Union's membership rules, have gotten their fiscal houses in order.

Indeed, economists at J.P. Morgan & Co. expect the combined euro zone to post a rising surplus over the next four years. As a result, Europe may join the U.S. in paying down government debt.

Before policymakers relax, however, they would do well to ponder a study by Jagadeesh Gokhale of the Federal Reserve Bank of Cleveland and Bernd Raffelhuschen of the University of Freiburg. Their analysis suggests that within a decade or two, and sooner in some cases, Western governments will have to deal with the rising pension and medical bills of a surging elderly population.

"Based on the current benefit levels of their retirement and health-care systems," says Gokhale, "most nations that seem in relatively good fiscal shape today face heavy future liabilities."

European nations (and Japan) face the greatest demographic problems. Not only are their populations aging, but their numbers are expected to shrink--by 8% over the next 30 years, compared with a rise of 26% in the U.S.

Europe's elderly dependency ratio--those 60 and older as a share of total adult population 20 years and up--is already 28%. By 2020, it will reach 35%, which means that more than one out of three adults will be at least 60, which is the retirement age in Europe. By contrast, the U.S. ratio, which is 23% today, will still be a bit below 35% in 2035.

As the chart shows, some European countries, notably Sweden and Italy, will have elderly dependency ratios of 35% by 2015. And Japan's ratio, which is 29% this year, will hit 36% within a decade, and 40% in just two decades.

Unless they address the costs these projections imply, Western nations run the risk of imposing considerable pain on future workers and retirees. Based on current fiscal stances, the authors estimate that most countries would have to raise current taxes by 2% to 6% of gross domestic product to equalize the burden of population aging across generations.

Fortunately, the process has begun. Many European nations have started cutting benefits, encouraging later retirement, and in some cases funding future liabilities. The U.S., of course, has also moved in these directions. And improved economic performance in the U.S. and possibly in Europe, as a result of economic restructuring, promises to help as well.

The problem, says Gokhale, is that a lot more has to be done. "Because population aging is still a future problem, the danger is that policy changes will come too little and too late," he warns.

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