The future of social security systems and demographic change

Abstract

Based on the draft report of the author to the Committee on Employment and Social Affairs, on the future of social security systems and pensions: their financing and the trend towards individualisation. This article focuses on the demographic challenge and highlights its impact on social, financial and economic development. The labour market, pensions and healthcare development will also be emphasised.

Demographic development

Demographic development in Europe is moving towards a diminishing and significantly older population. In 2050, the population will be slightly smaller and considerably older than it is today. The reasons are well known: low birth rates that lag behind the replacement rate and ever-higher life expectancy. Thus the number of people over 65 will continue to increase and the number of young people will decrease, leading to a reversal of the age pyramid.

The current birth rate in the EU does not reflect either the desires of women or the wishes of Europeans for a family of their own; its roots are to be sought in the difficulties people have reconciling family and career. Lack of childcare solutions, inadequate socioeconomic support for families and weak work prospects for women are the key issues here. They are aggravated by social uncertainty about such things as a lack of job security, a difficult housing market and worries about the future.

It is doubtful that increased immigration will solve the problem. Were immigration to be increased so as to make up the 90-100 million workers that the economies of Europe will need due to the changes in the working population, cultural and religious differences would increase tremendously, with all the attendant problems. Also, it should not be forgotten that, by attracting highly trained workers, the best-educated human resources of the countries of origin are depleted, which has a significant negative impact on their economic and social development. The problem must be addressed in a different manner.

Social development

Against the background of the Lisbon strategy and the employment targets adopted at the EU level, it is necessary to increase the number of people sustainably employed in high-quality professions, strengthen the labour supply, modernise the social security systems, improve employers’ and businesses’ flexibility and security and reinforce investments in human capital by means of improved training and qualification. In transforming the welfare state, considerable progress may be achieved by taking into account not only social expenditures, but also social investment.

It is a scientific fact that, to a greater or lesser extent, lifestyles in all the EU countries are undergoing a process of diversification that takes the form of fewer marriages, higher divorce rates and an increase in the age at which women have their first child. Also, while traditional marriage remains dominant for the time being, alternative lifestyles are becoming more widespread. Increasing individualisation challenges citizens’ loyalty to and solidarity with the institutions of state and society, including the social security systems.

At the core of every European model of society is the principle of solidarity between those who are employed and those who are economically inactive, funded primarily from taxes on income such as social security contributions, or taxes on wages and salaries. As the population ages, workers will come under great pressure, jeopardising solidarity and hence the founding principle of the European social models. In view of the imperative need to avoid generational and social conflict, and in particular to avoid provoking a conflict between the younger and the older generations, new models must be found for an effective and just distribution of costs and benefits as the working population shrinks and the economically inactive population grows. Calling the principle of solidarity itself into question is not a promising avenue to a solution, so a new, fair way of achieving financial equilibrium must be found. Accordingly, discussions are needed on the role of solidarity and redistribution, including the option of more emphasis on subsidiarity. The problem is not new, and requires a sizeable effort by experts; but a solution may realistically be attained within the EU countries in Europe.

Financial development

Assuming current policies are continued, the ageing of the population in most of the EU members will require by 2050 an increase in public expenditures, primarily for pensions, health care and long-term care. Given the tendency towards smaller families and the increasing participation of women in the labour market, there will be a significant reduction of non-professional care. Health care funding will inevitably become a burden on government budgets, whether through the public health insurance schemes or public subsidies for care. Compensating for these additional expenditures by savings in education, for instance, will not be an option, as investments in vocational training and education, continuing education and lifelong learning will remain indispensable for European societies, whose chief strength lies essentially in their human capital.

Taxation will be influenced by structural changes and the increasingly formidable challenges such as growing global competition and the growing mobility of the factors of production. For this reason it will be essential to give thought to an alternative, robust tax base. I would caution against any reduction in tax revenues through the application of flat tax rates, as these are strictly dependent on the total number of workers. To make the economies of the EU countries more competitive and stimulate employment, it is important to reduce dependence on taxes on wages and salaries. The transition to a more capital-oriented taxation scheme will not be straightforward, given the low tax rates on capital and higher capital mobility. Consideration should, therefore, also be given to a broader use of ecological taxes and a greater emphasis on consumption as the basis for taxation, which would require greater use of progressive tax rates to reduce the pressure at lower income levels.

Economic development

The world is shaped by globalisation, that is, the acceleration of open trade and the rapid pace of technological advances, which increases competitive pressure and forces companies and employees alike to become more flexible and mobile, in view of the expanding marketplace. Forecasts show that the average annual growth rate of the gross domestic product (GDP) will fall in the coming decades. The driving forces behind economic growth will change. Thus, up to 2010, employment will make a positive contribution to growth, but after 2030, it will be a clearly negative one. By contrast, labour productivity will start to play a dominant role, and indeed in some cases it may be the only source of growth. Accordingly, greater investment in research and development is needed, if we are to be sure of achieving higher productivity.

The changed age structure in the working population may lead to changes in consumer behaviour and domestic demand, which would entail a redistribution between the sectors. More occupational mobility will be needed, lest additional distortions in the labour market lead to even lower employment.

Labour market developments

Structural changes will make themselves felt at several levels: in industry, in the regions, in employment patterns and in the level of employment. The main challenge is to achieve economic flexibility with a higher level of social protection, to ensure the environment is conducive to an optimum utilisation of the possibilities. In addition, a qualified and versatile labour force is needed; to that end, active policy measures for the labour market have to be combined with investment in lifelong learning to improve employment prospects. The results will include an improvement in vocational and further education, in particular for those with lower qualifications.

The key to a successful new policy is the labour market, as it is the economic performance of a country that ultimately determines its ability to sustain a high level of social services. Even assuming immigration remains at its present levels, the size of the working population will fall from 227 million in 2005 to 183 million in 2050. The portion of the population that is employed will grow to 70% by 2020, primarily as a result of an increase in the proportion of women working, a change that will come about as older women, from a generation traditionally with lower rates of employment, enter retirement age. The total number of workers will increase by 20 million by 2017, before falling again by 30 million by 2050.

With the associated fall in the unemployment rate, unemployment benefits should also have decreased by some 0.6% of GDP by 2050. However, this decrease is too insignificant to balance higher spending in other areas. With fewer active workers, the total number of hours worked will naturally be smaller as well. To compensate for this decrease, either the remaining active population will have to work longer hours, or part-time employees will have to shift to full-time. Higher employment rates depend to a great extent on success in involving all groups facing a disadvantage in the labour market. Hence the imperative need for balanced and effective options that will allow women to take part in economic life, and particularly for changes in the way in which important domestic services such as childcare are delivered, so that women can reconcile work and family obligations. Above all, the persistent and significant gap between men's and women's pay for the same work has to be eliminated. Few directives in EU law have such direct practical application as the principle of ‘equal pay for equal work’, part of the legal bedrock since the Treaties of Rome. Nonetheless, the EU, 50 years after its inception, remains light-years away from the practical realisation of this human right.

Another imperative will be to create and expand employment options for older workers with suitable qualifications and skills. It is a blight on European societies that companies in their hiring practice remain enthralled by the cult of youth, practising blatant age discrimination. Workers who have reached a certain age but retain their dynamism should be seen as an asset in any organisation, given their occupational and social experience. They possess the oft-invoked social competence that guarantees success, not only in management positions but in every position. Older workers must be supported by promoting lifelong learning and creating flexible retirement rules. As the population ages, public expenditures and tax revenues alike will come under increasing pressure, since globalisation means that the mobile segment of the tax base can take flight more easily. The total number of years spent in retirement and employment will continue to evolve, mainly as a result of the declining age of mortality. It will, therefore, be necessary to develop policy measures in the labour market and reform the taxation and social security systems so as to stimulate the supply side of the labour market, while other reforms of social security ensure that public finances remain viable despite the ageing of the population.

Development of pensions and public health expenditure

The evolution of demographics in all the EU countries will lead to growth in public spending on pensions. This increase may be cushioned to some extent by a partial change from the public pension system to private schemes, but greater reliance on private pensions comes with its own problems and risks, and will require appropriate regulatory mechanisms.

The pension systems in EU countries are, to a greater or lesser extent, the result of a historical evolution and based on a family-oriented model in which the family's provider is a man. It will be necessary to transform the traditional pension systems, which are based on systematic risk assessment and standard life histories, as the current trend is towards careers that include rapidly changing employers, with an increasing number of patchwork biographies. This has a significant impact on pension entitlements, aggravated by the negative effects that an irregular career progression has on advancement and earnings. The result is a new source of social risk: the increasing uncertainty facing many people, especially vulnerable groups like low-skilled workers and single parents. Culturally rooted perceptions, social expectations and lack of childcare options mean that the primary responsibility for childrearing continues to fall on women. This is reinforced in many countries by parental-leave arrangements that are restricted to women. For this reason it is imperative to compensate women for the career sacrifices they are called on to make, so that they can fulfil the role of mother without having to worry about being put at a financial disadvantage.

Looking beyond the public and private pension schemes, another way of providing for security in old age is for employees to share in company profits. Thus pension income may be augmented during the active work phase by a combination of incentive awards and employee equity plans (employee loans or stock options). Tax incentives for home ownership as part of old-age security is a further source of protection.

Public health care will also undergo drastic change. As the population ages, public expenditures on health care will inevitably grow, with increases of 1.5-2% of GDP by 2050 for most of the EU countries.

The ageing of the population will have a significant effect on long-term care, with sharply increased demand and spending increases of 0.5-1% of GDP.

The tendency towards smaller families and the increased participation of women in the labour market also means less non-professional care in households; accordingly, the need for professional care will grow, and long-term care could grow more than originally expected. Providing universal comprehensive health care for an ageing population will mean higher costs. Merely increasing contributions is not a satisfactory option, so the tendency will be, increasingly, to reduce publicly funded care to a minimum of basic services. Those who have the means may choose to leave the public system, changing from the public to a private health care scheme with more-comprehensive, higher-quality care. The result is more financial pressure on public health care, making it necessary to further decrease the scope and quality of services provided and undermining long-term confidence in the public health care system and social solidarity.

Conclusion

The demographic challenges created by an older, more heterogeneous population, and the associated financial constraints, will make it necessary for the EU Member States to reconsider such elements of the traditional social security systems as pensions schemes, labour market programmes, health and education policy and employee savings schemes.

One possibility for meeting these challenges is to increase the employment rate, especially in the 55-65 age group and among women, who currently have a much lower employment rate than men. Women must be given suitable opportunities to combine a career and family, in particular by providing childcare facilities and all-day schooling. Another essential measure will be to increase employment opportunities and conditions for people suffering from disabilities, and to combat social exclusion. These goals can be achieved by implementing the Lisbon Agenda, with an emphasis on reintegration into the labour market, fair wages and innovative employment incentives.

To ensure sustainability and fairness in health care and old-age income for the EU populations over the coming decades, measures will need to be taken at all levels of society, in politics, the economy and individual households. Reforms of this type naturally face strong opposition on social-policy and ideological grounds, as they require that short-term political considerations be subordinated to the need for longer-term ones.