Can Europe avoid economic decline?

The public sector strikers outside English schools, hospitals and government offices today are protesting not against government pension policies but against something much bigger.  There are profound economic problems that need to be dealt with, and would need to be dealt with even if there were no crisis in the eurozone.

This blog has already observed that the eurozone crisis is a crisis of politics and not one of economics: taken together, the public finances of the eurozone are not unmanageable.  The crisis arises because those finances are not being taken together, so the solution must be in part an institutional one.

The economic problems facing Europe have not come from nowhere: they have deep roots.  They have been widely discussed in the past (including on this website five years ago – read the article here) but almost nothing has been done to address them.  The heart of the problems is demography.

The population of the European Union is not getting larger but is getting older.  A fall in the birth rate and an increase in life expectancy see the average age of a European citizen increase, as will the proportion who are retired and no longer working.  The proportion of the population that is working will therefore decline, so it is on fewer shoulders that the burden of maintaining the European standard of living will fall.  The figures for the UK and Italy are set out below (as percentages), as they are the extreme examples of the trend – the other EU member states fall somewhere between these two.

This chart reveals the effect of two factors, one that cannot be changed and one that might be.  The effect of the ageing population, before which we are essentially helpless, is shown in the bottom row of the chart: this is the proportion of the population aged below 18 and above 65, and it will increase.  The middle row is the proportion of the population between these ages that is nevertheless not in work: labour market policies might be able to reduce this percentage a little and increase the numbers in the top row, the proportion of people who are actually working.  (An increase in the retirement age would also help somewhat.)

In the UK, it can be seen that the working age population (the top two rows together) is forecast to decline by 9 per cent and the actual working population by 15 per cent (if policies do not change).  In Italy, the forecast decline is even steeper: 17 per cent (working age) and 27 per cent (working).

If, despite the smaller proportion of the population actually working, we want to sustain the same standard of welfare provision for the people who are not working, the burden on those people in work will have to go up.  The size of the fall in the working population corresponds to an increase of between 10 and 18 per cent in the UK and by between 20 and 37 per cent in Italy.  The more people are working, the smaller this increase, so you can see the relevance of labour market reforms to increase the number of people who are productive.  (And this assumes that older people do not make more expensive claims on health and social services than younger people, which we know in fact is not true: if anything, those predictions are underestimates.)

This is the background to any discussion of the public sector strikes over pensions.  The proportion of income that anyone in work has to put aside for the benefit of people who are not working, whether by saving for their own retirement or by providing for other people at the present time, is going to have to rise.  We cannot go on as we have been.

But how to decide what to do?  There are decisions to take about how to allocate the increased burden: how much on the rich, and how much on the poor?  (Some of these questions are discussed on the blog here.)  As with the eurozone crisis, these economic problems have been allowed to get so severe in part because we lack the political institutions necessary to deal with them.  It is an economic issue, but also a political one, if we want to avoid economic decline.

(Data in the chart is derived from Economist, “World in figures”, and McMorrow and Roeger “Economic consequences of ageing populations”, quoted in Niall Ferguson, “The Cash Nexus”, Penguin, 2001)