The impact of population ageing on public budgets and the welfare state

High unemployment and early retirement combined with increasing life-expectancy and low birth rates are a threat for social security systems as they increase income and reduce tax revenues. This weakens the financial foundation of the welfare state. To guarantee the functioning of social security systems in the future and to support economic growth, it is important to use existing resources more effectively. For example, increasing the employment by reducing the unemployment and mobilizing hidden resources (those in the working age who are unavailable for the labour market), as well as the fostering of participation and employment rates of older people.

The total expenditure relating to the elderly in Finland added up to about 11 billion Euro in 2001. The share of pensions and other income transfers made up 90 percent while the remaining 10 percent was spent on social services. With regard to the financial development in the future, researchers seem to have little doubt about a negative effect of the population ageing. According to results by the Commission for the Evaluation of the Development of Social Expenditure, for example, the social expenditure share of the GDP in Finland is going to increase from 25 percent in 2001 to 30 percent in 2030.The reason being, first and most importantly the increasing financial burden in the pension field from 2010 and on. Also, the commission expects higher expenditure on social and health care in the 2020s and 2030s due to the increasing number of elder people in the country.

A similar prediction is made by Jukka Lassila and Tarmo Valkonen in 2002. They took the people’s education level and expectations concerning the standard of social services into account. Finland has a high education level and it is considered a competitive advantage, which has positive effects on growth and welfare in the country. With regard to the ageing population, however, this can become a problem, as pensions are largely earnings-related. Well educated people usually earn more than low educated ones; so, if their share among the retirees is increasing, the amount of money spent on pensions will also go up.

In the report Seniori-Suomi, the Finnish National Fund for Research and Development (Sitra 2003) made three different predictions concerning the development of pension expenditures. Situation one assumes that the productivity per employee is increasing by 2 percent per year while the employment rates of the different age groups remain at the same level as of 1990. Against this background the share of the pension expenditure on the GDP would increase from 11 percent in 2001 to 15 percent by 2030 and decrease to 14 percent by 2050. In the second scenario, (based on higher economic growth than the first scenario) the pension expenditure would increase only by one percent and then come down to the current level in 2050. The third situation is based on the assumption of lower economic growth. Here, the pension expenditure would reach its peak in the late 2030s with 18.5 percent and remain above the 18 percent level until 2050.

Higher spending due to population ageing is also expected in the field of social and health care. However, the effects seem to be frequently overrated, especially with regard to the health care sector. According to a statistic comparison by the Organisation for Economic Co-operation and Development (OECD 2003: web document), there is no underlying connection between the share of the elder and the spending in health care. But, a decently quantitative comparison may not understand qualitative differences. Other research projects have indicated the development of health care costs; a number of additional factors need to be taken into account. There is a need for home help services. Not only is it influenced by the age structure of a society, but also by the health status and the liveliness of people. Another important factor is the accessibility and quality of services and institutions, as well as the care arrangements, like, who is looking after the elderly in case they need help: the state, the family or others.

Some local experiences from Finland emphasize that population ageing does not automatically lead to higher spending in the social and health care field. For example, the total amount of elder people in 2002 was already as high as it will be in the whole country by 2030. Yet, there has not been a rise in social expenditure. Instead, a restructuring of the local budgets could be observed: the spending in the field of elderly care increased between 5 and 8 percent, while the social expenditure on children and juveniles decreased by 5 percent because of lower birth rates and the declining need for day care and education. Yet, generalisations are difficult because the quality of services need to be considered too. A lot depends on the local economic development, fertility rates, elderly care arrangements and people’s health status too. In spite of everything, the examples underline the fact that the old-age dependency ratio alone is not enough to make predictions concerning the financing and the arrangement of social and health care services at the regional level.

Suppose the elderly are using as many services in the future as three years ago and the productivity in the social and health care sector remains unchanged, population ageing will unavoidably lead to a major increase in total spending. But if economic growth is high and the development of prices in the social and health care sector is moderate, the increase in spending will be more moderate. A good health status of the elderly can have a positive influence on public budgets in this context; therefore, an increase of preventative measures may pay off in the long-run. The costs for medical technology and medicine, in addition to the spending on wages and salaries, on the other hand, increase the financial burden. Another factor which should not be underestimated is the growing wealth and the higher education level of future retirees which may lead to increasing demands for high quality services. As the local level is responsible for social and health care services in Finland, these trends and developments are a challenge for regional towns.

Lassila and Valkonen (2002) conclude that the public division did not sufficiently prepare for the financial consequences of population ageing in Finland. In order to keep the social expenditure under control, they suggest a decrease of public debts, in addition to the establishment of pension and health care funds. However, there will not be much time left before the spending will start to increase and the possibilities to acquire additional assets through savings are limited. The pension reform is an important measure. It was intended to get the spending on pensions under control and maintain the scope of the Finnish social policy. Still, there are a number of uncertainties related to the calculation of social expenditure in the future. While the amount of pensioners can be estimated somewhat accurately for the next twenty years, future birth rates, economic trends or fiscal developments are hard to predict. If the productivity and the efficiency of the social security system cannot be improved (through cost cutting, the reduction of benefits, the reorganisation of work), an increase of taxes may be unavoidable although the popular thing has been to lower taxes in recent years (see Ketola and Kunz 2005).The alternative however would be further cuts in welfare.

http://scientificjournals.org/journals2007/articles/1077.htm