Curse of old age stunts growth

THE problems that longer lifespans are causing for pension funds are well known. However, there are also much wider implications for the economy.

It is generally accepted that the prospect of an ageing population presents a bigger problem for many of our European partners than it does for the UK. But we are by no means insulated.

The latest figures from the Government Actuary's Department demonstrate the scale of the problem in the clearest possible terms.

The percentage of the population of pension age and above is set to rise from around 18.5 to 22.5 between now and 2030 and it will continue to increase beyond this point.

This shift will have important ramifications. Take the trend rate of growth, for example. In last year's Budget, Gordon Brown trumpeted the improved performance of the UK by raising his estimate to 2.75%.

Whether he was justified in doing so is not a matter we will address here. But it was a convenient time to reach such a conclusion as it enabled the Treasury to show that it could continue to meet its key fiscal rules in the face of the big increases in public spending.

Even on the standard-assumptions accepted by the government, the trend rate of growth is set to slow sharply over the next 25 years. It is expected to expand by a more moderate 2.25% between 2011 and 2020 and then by just 1.75% between 2021 and 2030.

The risk is that even this meagre performance could prove too optimistic.

The European Commission in a recent study came to the conclusion that the contribution of productivity could slip to just 1.5% by 2030. In these circumstances, the trend rate of growth would drop to barely 1.25% - less than half the Chancellor's current estimate.

Does this matter? Unfortunately, the answer is an unequivocal yes, as the trend rate of growth effectively measures the scope for our living standards to rise.

As we indicated earlier, it is also a crucial assumption in the fiscal arithmetic. Even on the government's own estimate, the primary Budget balance, which excludes interest payments, is projected to be in deficit to the tune of 3% of gross domestic product in 2030.

The risk is that the shortfall will be rather greater than this, as the ageing population means the Treasury has to grapple with a diminished revenue base and an expanding level of commitments.

Tax increases may not be inevitable, but it is easy to see how the debate could veer in that direction. Put crudely, to bring the Budget back into balance, on the government's own numbers, would require a 10p increase in income tax.

Interestingly, while much of the focus has been on the rising costs of pensions, the real black hole is likely to be found in the area of health care. The sting in the tail could be the prospect of even lower interest and annuity rates.

This is an issue which is already causing a great deal of real pain for people retiring, but it could get worse as the demand for capital to finance investment falls away more sharply than the level of savings.

Is there a way out of this? Quite possibly. A new wave of technical innovation that boosts productivity would help. So would a big increase in immigration or a raising of the retirement age.

Either way, however, some difficult choices will need to be taken over the next few years.

Simon Rubinsohn is an economist at fund manager Gerrard