Pensions and productivity: The economic impact of an ageing population

Europe’s population is ageing at an unprecedented rate, faster than any other continent, and is economically unsustainable. Nearly 25% of the EU population will be over 65 by 2030, an increase from 17% in 2005. The number of people aged 65 and over compared to working-age people (aged 15-64) is expected to double by 2050, from one person in four to one in two.

With this prediction in mind, the LEPAS research project has tackled the urgent need to better understand how an ageing population is likely to influence the economy and whether or not those changes will be sustainable. To do this, the project integrated a detailed biological representation of individual ageing into modern dynamic models of economic growth. Without this extra level of complexity, previous studies using simpler economic models may have been misleading, say the researchers.

The main policy message from the project is that the current rate of ageing in the EU is economically unsustainable. Life expectancy is increasing but the retirement age is not, meaning that people are spending longer time in retirement, putting greater pressure on pension systems. An ageing population, where ageing is understood as the gradual deterioration of physical and mental health and abilities, is also likely to put greater pressure on national health services.

Some of the main results from the LEPAS analysis are presented below.

What factors affect ageing?

  • Both child and adult mortality are lower in richer countries.
  • In 2000, differences in prosperity between EU countries could account for differences in longevity of up to a decade, but this gap is expected to close in years to come as the differences converge.
  • Higher income affects a person’s decision to invest income in their health and diet, thus slowing down ageing and prolonging health. An increase in personal income of 100% increases life expectancy by 8%.
  • Improving healthcare efficiency has a greater impact than increasing per capita income. In theory, increasing healthcare efficiency by 100% could increase life expectancy by around 50%, although other factors are likely to preclude humans living this long.
  • Better-educated people generally live longer as, according to the study, they have more human capital to protect, which drives healthy behaviour. Every extra year of education increases life expectancy by approximately six months.

Why does ageing affect economic growth?

  • Life expectancy is continually increasing while retirement age is staying the same. Thus, the number of years spent in retirement is increasing.
  • Higher income affects longevity but not the age of retirement, therefore higher income is associated with a greater number of years spent in retirement. In Latvia, the average retirement period in 2003 was just ten years, compared to nearly 20 in Italy.
  • A growth in real wages in the EU of 1-2% by 2050 would result in an average retirement period of 19-25 years.
  • This means that the average EU citizen will spend an increasing number of years in retirement, and receiving a state pension, for every year spent as an active part of the labour force.
  • As human frailty and disability increases with age, the demand for healthcare services will increase per person over their lifetime.
  • Differences in the age and skill distribution of the workforce between countries will trigger migration, but the impact on productivity in the short and long term is still not well understood.

Policy recommendations and further work

Since variations in healthcare were found to have the most significant impact on longevity, the researchers suggest that efforts to increase longevity in developing countries should focus on improving the efficiency of healthcare technology, which will be more effective than re-distributing income. From a European perspective, their analysis suggests that improving education opportunities at young ages is the most promising policy approach to promoting health equality among adults within the EU.

Having presented a thorough investigation into the factors that influence ageing, the LEPAS project discusses how conventional theories differ as to the impact of ageing on productivity, as measured by Gross Domestic Product (GDP). One school of thought suggests that increasing longevity and decreasing birth rates will slow down economic growth by weakening the productivity of the labour force.

Add to this the fact that an ageing population will put greater pressure on healthcare and state pensions, (i.e. pensions may start to pay out more than they take in) and it is clear to see how GDP will suffer as a result. Alternatively, the incentive to save for old age may increase savings and investment, stimulating economic growth. This emphasises the importance of not oversimplifying the ageing process, as is the case in current economic models.

To extend the outcomes of the LEPAS project, further research should now focus on combining the updated life-cycle model with macroeconomic models to give quantitative predictions of the effects of ageing and related factors, such as health and migration, on national productivity and economic growth in the EU.

Methods - How do you estimate the economic impact of ageing?

The starting point for the LEPAS researchers, from Alicante (Spain), Copenhagen (Denmark), Hannover (Germany) and Vienna (Austria), was a current economic life-cycle model, which relates individual ageing to size and distribution of the workforce and productivity. The motivation for the project was the fact that ageing is over-simplified in such models and represented only as the probability of death at a given age.

Instead, the LEPAS researchers integrated a detailed representation of the physiological process of ageing and the fact that ageing can be influenced by external factors, such as income and healthcare efficiency, and by the choices we make, such as level of education, higher consumption at a younger age or investing in health through exercise and a well-balanced diet, and deciding between working longer or retiring.

LEPAS – Long-run economic perspectives on an ageing society (duration: 1/4/2009 – 31/3/2012). FP7 Socio-economic Sciences and Humanities, Activity 3, “Major trends in society and their implications”, Research area 3.1 “Demographic changes”. Collaborative project (small and medium scale focused research project).

See: http://www.lepas-fp7.de/

Contact: Holger Strulik, holger.strulik@wiwi.uni-goettingen.de