Over the next three to four decades, Germany will be faced with a period of “overt” demographic change, in which the baby boomers born in the late 1950s and early 1960s will enter retirement, and the number of individuals of working age will substantially decline. As a consequence, policy makers should address in good time the resulting risks for the long-term sustainability of public finances as these may already be important for budgetary decisions taken with an intermediate time horizon. Following up on two earlier projects with similar tasks, the Federal Ministry of Finance has therefore commissioned the Ifo Institute with running projections that span the time until 2050 and mainly focus on the financial development of the German system of social insurance. The projections form an important ingredient of the “Second Sustainability Report” of the Ministry which has been published in July 2008.
The projections cover public expenditure on old-age provision (Statutory Pension Scheme; Civil Servants’ Pensions), health care (Statutory Health Insurance; Public Long-Term Care Insurance), unemployment (Unemployment Insurance; benefits for the long-term unemployed) and on the young generation (child-related benefits; education). When assessing the fiscal consequences of demographic change in any of these areas, the projections are meant to take into account a certain corridor of plausible, future scenarios for the development of demography, labour markets and aggregate growth.
The projections are run with the CESifo Pension Model which is based on a simple accounting framework, taking into account projected shifts in the age composition of the population. In any of the budget branches covered, aggregate expenditure are basically converted into per-capita amounts, differentiated by age and gender of beneficiaries, which are then used to estimate annual expenditure keeping track of changes in population size and composition. A simple macroeconomic background scenario is used to include real growth of wages and GDP. The results of two diverging baseline scenarios are amended by a series of sensitivity analyses and policy simulations. To assess the impact on the long-term sustainability of public finances as a whole, a set of sustainability indicators is being used which has been developed in recent years by the OECD and the Economic Policy Committee of the EU.
All variants of the projections are based on the latest official population projections of the German Federal Office of Statistics. In addition, actual data from the System of National Accounts and other official data sources provided by ministries and social insurance administrations are taken into account which are then projected into the future, in line with the results of the Federal government’s medium-term fiscal planning (for the period until 2011) and reasonable assumptions about long-term developments.
Aggregate expenditure covered by the projections amounted to 27.6 % of GDP in 2006. In the optimistic baseline scenario this ratio will, following a temporary decline until 2011, increase by about 1.3 percentage points until 2050; in the pessimistic scenario, the total increase will be 4.9 percentage points. The resulting “sustainability gap” of German public finances, measured as an improvement in the annual primary budget balance which starts immediately and is maintained over time, is between 0.0 percent and 2.4 percent of GDP. In both cases, this requires that the medium term fiscal target of improving this balance by 2.1 percentage points until 2011 are fully met. Otherwise, the sustainability gap will rise accordingly, on a one-for-one basis. A total of 29 alternative scenarios included in the study expand the range of the corresponding sustainability gaps to between -1.2 percent and 4.7 percent of GDP. There are thus higher upward risks than downward risks.
The results of the up-dated projections are nevertheless considerably more favourable than those prepared for the first official Sustainability Report. This is mainly due to continued reforms of the public pension scheme and substantial efforts to consolidate current budgets since 2004. The new results are also influenced by improvements in the labour market situation which are assumed to persist. Policy implications which can be derived from the study are therefore that the path of the pension reforms devised in 2004 and 2007 should be followed without any major deviations; that budget consolidation should remain a priority task of fiscal policy; and that the framework for the labour market should be further adjusted to allow for fundamentally favourable trends, despite the cyclical deterioration that may come. Since, in many of the scenarios considered, social insurance contributions will have to increase under the current law, the structure of revenues may also have to be reconsidered, for instance, by financing expenditure with a weak tax-benefit link from general taxation.
M. Werding and H. Hofmann (2008), Projektionen zur langfristigen Tragfähigkeit der öffentlichen Finanzen, ifo Beiträge zur Wirtschaftsforschung, Vol. 30, Ifo Institute: Munich (Abstract).
Federal Ministry of Finance (2008), Zweiter Bericht zur Tragfähigkeit der öffentlichen Finanzen, BMF: Berlin.
Earlier projects with parallel tasks:
M. Werding and H. Blau (2001), Auswirkungen des demographischen Wandels auf die staatlichen Alterssicherungssysteme, ifo Beiträge zur Wirtschaftsforschung, Vol. 8, Ifo Institute: Munich (Abstract).
M. Werding and A. Kaltschütz (2005), Modellrechnungen zur langfristigen Tragfähigkeit der öffentlichen Finanzen, ifo Beiträge zur Wirtschaftsforschung, Vol. 17, Ifo Institute: Munich (Abstract).
RSS