The European Union is Old and Expensive

By TJ Kim

October 18, 2012

Composed of 27 member states, the European Union (EU) boasts one of the most heterogeneous demographics, economic, and political structures in the global stage. The EU was formed in 1951 with six original members. Today, it has 27 member states with the total GDP of 12.2 trillion ECU/Euro. While the EU is adding more heterogeneity in continuous efforts to create a united Europe across the continent, it is important to understand the overall demographic trend in the EU nations to understand the underlying economic trend created by the demographics.

Looking at the demographic profile of the EU 15 countries, Germany, France and the United Kingdom are ranked as the most populous nations while Luxembourg and Ireland among the least populous. Delving into population of the EU, Amlan Roy, Sonali Punhani and Liyan Shi from Credit Suisse wrote in Spotlighting The European Union’s Demographics,

“Most EU15 countries have managed to boost their population growth since 1980-1985, except Germany, Portugal, Greece, the Netherlands and Finland. The sources of population change for the EU15 countries are shown in Exhibit 5, where we decompose overall population change into natural population change (number of births less the number of deaths) and net migration. France, the Netherlands, the UK, and Ireland have high levels of natural population growth, while Greece, Italy, and Spain have high levels of immigration dominating their overall population growth.”

Due to low fertility rate and improved medical conditions, life expectancy has increased and changed life cycle changes across the EU.

“… such as longer years in education, delayed marriage and parenthood, school-breaks, college-breaks and career breaks, multiple jobs, phased retirement, caring for children and older parents and extended retirement periods. For example, in the EU27 expected years of education has increased from 16.6 years in 1999 to 17.2 years in 2009. During 1995- 2005, mean age of women at birth of first child has increased from 27.5 years to 29.1 in Germany, from 28.4 to 29.3 in Spain and from 29.3 to 30 in the UK.”

Moreover, the EU’s growing ageing population increased old age dependency ratio, which measures the ratio of population aged 65+ per 100 population 15-64. Coupled with up-sloping old age dependency ratio, average retirement ages across Europe have decreased over the past decades. As a result, the EU is increasingly populated with the ageing population while the labor participation is dropping due to early retirement ages of the ageing population.

“Over 2010-2015, the old-age dependency ratio of Italy is projected to be the highest at 31.0 with Germany at 30.8 while Ireland has the lowest projected old-age dependency ratio of 17.4 for the same period. In fact, four of the five oldest countries in the world, measured in terms of old age dependency ratio, are in Europe, namely Germany, Sweden, Greece and Italy. Old age dependency ratios influence the burden of the ageing population on government finances… there is a dramatic decline in economic activity rates post 55 years. For countries such as France, Italy, and the Netherlands, the decline is greater as we move from 55-59 year olds to 60-64 year olds…For the rest, the decline is greater as we move from 60-64 year olds to 65+. In most European countries (France, Germany, Greece, Italy, the Netherlands, and Spain), workers retire even before the official retirement age… The mismatch between increasing life expectancy and falling effective retirement age is prolonging the retirement period and making pensions and health care obligations of the governments unsustainable.”

On a larger scale, demographics impact Gross Domestic Product in three broad categories: workers, consumers and government.

Workers

As mentioned before, the EU is facing slow population growth, and naturally this trend is followed by slow labor force growth. In countries such as Italy, Portugal, and Greece, labor force is projected to shrink in 2010-2015. In France, Germany, Italy and the UK, labor production growth accounts less and less for the GDP growth, meaning the productivity has plummeted across the four nations. Meanwhile, labour-utilization growth expanded its share in GDP growth, which point to longer hours worked per working-age population.

In regards to value added per worker, a sectoral decomposition of GDP shows which industry has the highest value added per worker in each nation.

“All the nine countries are primarily services dominated economies France has the highest share of value added in services (79.2% of GDP) while the UK has the highest share of employment in services (78.6%). Ireland has the highest share of value added in industry (32%) while Italy has the highest share of employment in industry (29.3%). Greece, Portugal, and Spain have relatively higher shares of value added and employment in agriculture. Greece and Portugal, in particular, have over 11% of their labor force employed in agriculture.”

Comparing wages across the EU selected nine countries, Ireland and the Netherlands have the highest annual wage while Greece and Portugal among the lowest annual wage. Annual average wage and productivity appear to be related to tertiary education attainment as seen below. Ireland, the highest average wage earner is on the top of the highest tertiary education attainment while Portugal with the lowest average wage sits on the bottom of the lowest tertiary education attainment.

Consumers

Over the past decades, families have grown smaller in size in the EU selected nine countries.

“The share of 1-person and 2-person households has increased, while that of 3-person, 4-person and 5+-person households has declined. We also note that the southern European countries, such as Portugal, Greece, Spain, and Italy, tend to have larger families. This reflects the stronger families ties, later home-leaving, and greater family-based sense of solidarity in these countries.”

In terms of consumption baskets across different age groups in the EU nations,  younger generations tend to spend more on clothing, footwear, transport, communication and education while population aged over 80 spend more on healthcare, recreation, housing, and culture. Below is Household Consumption Expenditure by age of household head in Germany

Household finance of the EU selected nine countries also reveal an important aspect of how consumers in those nations manage their wealth.

“• Currency and deposits: The share of currency and deposits declined in most countries. Greece is a striking exception where the share increased from 56.5% (1995) to 72.6% (2009).

• Securities other than shares: The share is low in most countries, but very high in Italy (20.6% in 2009).

• Shares and other equity, except mutual fund shares: The share is lowest in Germany and Netherlands and highest in Italy and Portugal.

• Mutual fund shares: The share is low in Ireland, Greece and UK and high in Germany, Spain and France.

• Net equity of households in life insurance and pension: The share increased in all countries from 1995 to 2009. It is the highest in Netherlands (58.4%), followed by the UK (52.1%) and is the lowest in Greece (2.9%).”

Governments

The EU governments have been generous providers of benefits to their citizens, especially pertaining to the elderly. However, due to aforementioned increasing ageing population, these entitlement spending are growing disproportionately to an extent that it may no longer be sustainable within governments’ budget, as demonstrated from the recent crisis.

“The growth in entitlement spending has placed an increasing strain on public finances. Many European countries have experienced long periods of fiscal imbalances. As shown in Exhibit 27, the general government structural balance, measured as a percentage of potential GDP, in the EU selected nine countries was negative pre-crisis, and has deteriorated further during the crisis… Countries with higher old-age dependency ratio tend to have higher public debt. A possible reason is that European governments devote a large share of their benefit expenditure to help people cope with the costs of old age, health care and disability. In 2010, general government expenditure amounted to 50.3% of EU-27 GDP. More than half was devoted to social protection and health.”

“The union also got more complacent in the imposition of fiscal discipline after periods of high asset returns and growth in the 1980s and 1990s. Increasing life expectancies which result in higher shares of the elderly in the population and the high levels of old age benefits promised across Europe are leading to unsustainably high fiscal burdens for now and for the future. On top of that, projections of decreasing population and labour force growth rates tend to lead to weaker future GDP growth.”