October 7, 2010

WORLD: Governments forced to look at cost of longevity

LONDON, England / The Financial Times / Reports / October 7, 2010

Ageing: Governments are forced to look again at cost of longevity

By Norma Cohen, Economics Correspondent

The extension of human life was perhaps the most stunning achievement of the 20th century.

To start with, most of the improvement came from stopping people from dying young: improved nutrition, vaccination, access to clean water and sanitation and development of drugs that can kill infectious diseases. But by the second half of the century, it became apparent that life expectancy at older ages – generally defined as beyond 65, or beyond the age of economic productivity – was growing particularly rapidly.

That, coupled with falling fertility rates in both the industrialised world and emerging economies, is now posing huge challenges for governments already reeling under the effects of a severe recession.

According to the US National Institute on Aging, the number of children under the age of five has historically outnumbered those over the age of 65. But in a few years time that is expected to change. The number of those over 65 will grow from around 7 per cent of the world’s population today to around 14 per cent by 2040.

Moreover, the most rapid growth rates are to be seen among the “oldest old” – those 80 or 85 and over. Although the trend is evident everywhere, the demographic shift will happen in some regions more quickly than others: in western Europe, those 65 and older are already about 17.8 per cent of the population. By 2040, this will grow to 28.1 per cent, but the percentage of those 85 or older will almost double from 4.9 per cent today to 9.3 per cent.

According to the most recent data from Eurostat, the European Commission’s statistics agency, the old age dependency ratio, defined as the percentage of those 65 and over to those 15 to 64, will rise among the 27 European Union member nations from an average of 25 per cent today to 45 per cent by 2040 and to 53 per cent by 2060. In the US, where fertility rates and immigration are expected to boost the working age population, the picture is less severe, but in Japan, which has the longest life expectancy of any country, the lowest fertility rate and firm opposition to immigration, the outlook is far worse.

There is a further issue – a relatively low rate of workforce participation, which is a particular concern in Europe. When the numbers of economically inactive people – those outside the labour force – over the age of 64 are compared with the number of working people aged 15 to 64, the numbers look even worse. Among the EU 27, the old age dependency ratio is set to rise from 37 per cent today to 61 per cent by 2040.

Relying on governments to provide care for the elderly when the absolute number of elderly people is rising would require a taxpaying labour force growing at roughly the same rate. If anything, the opposite is the case.

At the current rate of spending, the situation is clearly unsustainable. As a result, governments are seeking significant reforms to state pension systems in many, if not most, industrialised countries.

Eurostat estimates that among the EU 27, pension and early retirement costs total 9.1 per cent of gross domestic product and, without reforms, this will rise to 11.1 per cent by 2040.

Governments in the industrialised world have been aware of the need to trim old age spending for several decades. Indeed, reforms to US Social Security that were enacted in 1983 are a key factor in explaining why many experts believe the US system could be sustainable with relatively modest alterations.

To deal with spiralling pension costs two approaches have been popular: encouraging private pension savings through tax incentives and schemes that require compulsory saving by individuals, and raising the age at which state benefits can be drawn.

The latter adds to the time that workers contribute to both overall GDP and the tax base and also means workers withdraw finance from the system for a shorter period.

Given that life expectancy at older ages has risen so far and so fast – a process that itself has contributed to soaring pension costs – such a move does not appear controversial.

Nevertheless, it has provoked violent protests across Europe – most recently in France – but also in Spain, Greece, Italy and to a lesser extent in Germany.

Counter-productively, European governments since the 1960s have been introducing measures that make it attractive to retire before the state retirement age but few incentives to keep working beyond it. While some reversals have been made, more countries are raising the state pension age than reducing incentives to retire early or indeed, introducing incentives for late retirement.

Les Mayhew, a professor at London’s Cass Business School and an expert on social security and healthcare, notes that rising life expectancy alone does not automatically translate into longer working lives. In a 2009 study, he concluded that “healthy” life expectancy is rising more slowly than life expectancy in general and that greater investment in healthcare – or one-off measures such as banning cigarettes – may do more to keep people in the workforce longer.

Nevertheless, his study, based on UK workers, concluded that, on average, people can go on working for 11 years past the state retirement age of 65 before acquiring chronic disabilities.

Meanwhile, as the percentage of older people grows, so, too, do healthcare costs. Dr Richard Suzman, director of behavioural and social research at the National Institute on Aging, says that in the US, healthcare spending on the elderly accounts for roughly 16 per cent of all health spending. But forecasting becomes difficult as the pace of innovation rises. “It is the rate of technological change that is hard to forecast,” he says.

Copyright The Financial Times Limited 2010