Rafael Pampillón. Professor. IE Business School
7 June 2010
Low birth rates coupled with a growing life expectancy paint a picture of the future that requires immediate measures to guarantee Spain’s social security system.
At the end of January, the Spanish government announced its intention to extend the retirement age to 67 years old. The proposal follows the report issued by the Rato Commission, which says that the pension system will enter into deficit by 2022 if certain measures are not taken, such as increasing the age of retirement.
Yesterday, the INE (Spain´s National Institute of Statistics) said that, according to its forecasts, the population of over-64s in Spain will double in 40 years and account for more than 30% of the total as a result of the ageing of the population pyramid. What´s more, the European Commission has been warning the Spanish government for years now about the risk of long-term budgetary imbalances caused by higher future public spending in the area of pensions.
In its periodical report on the Spanish economy, the OECD also usually insists on the need to change the system for calculating pensions and suggests that the government should include all the income throughout a person´s working life.
Why is there so much concern about pensions? The usual answer to that question is that Spain will have one of the oldest populations in the world in 2050: 30% of the population will be 65 years old or older. This rapid ageing of the population is the result of the birth rate (one of the lowest in the world) and the increase in life expectancy (at the present time, women born in Spain live longer than anyone else in Europe, reaching 84 in comparison with the European average of 79; whereas men reach the age of 78 when the European average stands at 71). Both factors (low birth rate and longer life expectancy) lead to an increase in the average age of the population.
Logically, this increase in ageing involves a growth in the dependency rate i.e. an increase in the percentage of people who do not work in relation to those who do. In other words, the proportion of working people is falling. So, According to the INE, in 2049, almost 9 out of every 10 people will be potentially inactive in Spain, i.e. those below 16 years or over 64 years. In other words, the dependency rate will rise from the current level of 48% to 90%.
Therefore, in the future, either pensions will be lower or the tax burden will have to be increased (or both), since a smaller number of workers will have to support a greater number of pensioners. This means that, in proportion, fewer workers will have to pay more taxes because the government needs to pay for more social services: pensions and medical expenses for the elderly.
Each year, the Social Security system will consume a large part of our national income. The percentage of the GDP allocated to pensions will rise from the present level of 9.5% to 18% in 2050, which throws serious doubts on Spain´s capacity for guaranteeing the public pension system. Increasing taxes and lowering benefits is one solution, but it is inevitably unpopular. Another option is to increase retirement payments, which, in economic terms, is the same as increasing the tax on work. Another solution would be to increase the birth-rate. And yet another would be to increase the retirement age.
A rapid rise in the number of older citizens will be unavoidable over the next few decades and it will only be reduced if the birth rate increases. The figures show that the birth rate in Spain is on the increase (thanks to the contributions from foreign mothers), reaching the level of 1.44 children per woman, the highest since 1993, but still a good way from the 2.1 of the generational replacement rate.
However, although immigration may relieve the burden of an ageing population, it will not be able to invert the trend of longer life expectancy, nor will it be able to increase the birth rate to a level that is sufficient for generational replacement.
Consequently, measures need to be taken to enable the financial viability of the current social security system. Furthermore, we cannot leave our children a heavy public debt and a pension system that becomes more burdensome the higher the number of pensioners. Hence, the decision to increase the retirement age is a step in the right direction.