Europe's Pension Crisis

The data from the European Commission suggest a bleak demographic picture in this century. In 2030, old-age dependency ratio of EU25 is estimated at 40.3 percent. Countries with the highest dependency ratio in 2050 are likely to be Spain (67.5 percent), Italy (66 percent), Greece (58.5 percent) and Slovenia (55.6 percent). On the contrary, the lowest dependency ratio in 2050 is estimated for Sweden (40.9 percent), Estonia (43.1 percent) and Ireland (45.3 percent)

While Mediterranian countries will likely face the worst demographic scenario, the estimates for Cyprus and Malta are the most favorable in the entire European Union.

The rapidly aging European population will sooner or later require a radical change in the financial structure of the pension system. Right now, most social security systems are based on Bismarck's PAYG (pay-as-you-go) schemes in which pension liabilites are funded by the current working population. The sustainability of the system is impossible since higher income tax rates would discourage economic activity. These schemes have created massive unfunded government pension liabilites which inflated the major source of long-term fiscal imbalance in European countries. The second problem is that in many countries, lower effective retirement age has been achieved under political pressure rather than on cost-benefit analysis.

According to OECD, net financial liabilities in European countries are very high. The most fiscally unstable countries are Greece, Italy, Slovenia and Belgium. In Greece and Italy, net financial liabilities have already exceeded 100 percent of the GDP. Until 2050, government spending on pensions in Slovenia will likely increase by 7 percentage points of the GDP; the highest increase in the developed world.

Rapidly chaging demographic picture will neccesarily require a radical change in the structure of the pension system. In 1981, Chile became the first country in the world with a fully-funded private pension system, thanks to Jose Pinera. Government-funded pension systems in European countries are likely to bankrupt unless policymakers enforce privatization of pension systems. Sweden and Slovakia have already relied on the supplementary role of the private pension system. In Great Britain, private retirement savings compose 43.8 percent of total retirement income - the second highest share in the European Union, just after Netherlands (46.5 percent).

The task of social security reform is the most difficult challenge European countries will face in this century. But without the intelligent privatization, Europe's ailing social security systems will exacerbate a difficult and unsustainable fiscal situation.