Opinion

The growing intergenerational divide in Europe

An aging Europe cannot afford to squander the skills and talents of its youth. With this in mind, addressing the emerging intergenerational divide should be a top policy priority.

By: and Date: December 16, 2015 Topic: European Macroeconomics & Governance

This op-ed was also published in RzeczpospolitaEl MundoDer StandardPúblicoNeue Zürcher Zeitung and Le Monde.

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During the crisis, living and employment conditions of the young and the old diverged substantially in the European Union. Poverty indicators show that young people were hit especially hard by the recession compared to the old, not only in the countries worst affected by the crisis, but across the EU. Youth unemployment in the EU between 2007 and 2013 increased to almost 24%, amounting to 5.5 million people under 25.

The surges in youth unemployment and youth poverty are particularly worrying since they have long-lasting effects on productivity and potential growth. Research shows that a long period of unemployment after graduation, when workers should acquire the first skills in the workplace, can undermine whole careers and lead to lower productivity. Youth unemployment also has negative effects on fertility rates and demographics, possibly because of increased income uncertainty related to unemployment and subsequent decisions to delay starting a family.

Three types of policy actions significantly contributed to the growth of the intergenerational divide during the crisis. First, macroeconomic management; before the European Central Bank’s decision to start an Outright Monetary Transactions programme (OMT) in July 2012, financial conditions had diverged substantially in the euro area, pricing some countries and their businesses out of markets. Moreover, fiscal policy was overly restrictive in the euro area as a whole, aggravating the recession. Consequently, unemployment increased, but youth unemployment reacted much more strongly than total unemployment. This is in part because a disproportionate number of younger workers are on temporary contracts. Other factors also matter, such as the difficulty for young people to prove their skills in recessionary periods when they are looking for work.

Second, the composition of government spending changed during the crisis, to the detriment of the younger generation and future-oriented expenditures. Across the EU, the share of government spending on health, education and families and children decreased. By contrast, spending on unemployment went up, especially in the countries hit most by the crisis like Greece, Portugal, Spain and Italy. Only pensioners seem to have been spared from cuts and, in some cases, even benefited from increasing government spending. As the composition of public expenditure shifted from families and children and education towards pensioners, it contributed to a further deterioration of the intergenerational divide.

Third, governments in the most stressed countries implemented pension reforms during the crisis to address sustainability concerns. However, these reforms often fared badly in terms of intergenerational fairness. The pension benefit ratio, defined as the ratio of average pension incomes to average incomes in the working population, is set to decline considerably in the long term. This means that today’s young people will enjoy less generous pensions than today’s pensioners. Hence, the burden seems not to have been shared equally, as the implemented reforms have favoured typically current over future pensioners, contributing to an increase in the intergenerational divide.

Angela Merkel once stated that the European Union accounts for roughly 7 percent of the world’s population, 25% of its GDP, but over 50% of its welfare spending. This summarises the generosity of European welfare models well, while at the same time questioning its sustainability in the long run. However, when governments face demographic, fiscal or other pressures, they should aware of what to cut and how to reform.

An aging Europe cannot afford to squander the skills and talents of its youth. With this in mind, addressing the emerging intergenerational divide should be a top policy priority. Europe needs macroeconomic policy tools to better manage the euro-area wide fiscal stance. In the short term, we are sceptical about creating major European stabilisation functions such as a European unemployment insurance scheme. Such measures could prove effective, but they would require a substantial effort to create harmonised European labour market legislation.

Instead, it may be more practical to achieve a more symmetric and binding policy coordination framework for fiscal policy. To address youth unemployment, we suggest labour market reforms that allow for graded job security as workers acquire more permanent contracts once economic growth picks up. Furthermore, if new budget cuts become necessary, governments should learn from past mistakes and cut unproductive government spending, instead of investment in younger generations and the future. Governments should also reconsider the current composition of government spending. Lastly, intergenerational burden-sharing in pension schemes should be enhanced and pension reforms should not be carried out at the expense of the younger generations.


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