Economic commentary for

WEEKLY ECONOMIC COMMENTARY IN THIS ISSUE: Global Economic Research • Europe's Retirement Challenge 50 South La Salle Street • A Review of 1929 Chicago, Illinois 60603 northerntrust.com • Neutral Rates Nosing Up Carl R. Tannenbaum Europe's identity has always been shaped by age. It is home to ancient institutions, Chief Economist historic cities and traditions that stretch back centuries. Europe’s economic identity is being shaped by age in the present day. Demographically, Ryan James Boyle it is now the oldest continent, and this development is reshaping everything from labor Chief U.S. Economist markets to public finances. But the impact of Europe’s aging is most visible in the debate over pensions. Vaibhav Tandon Across the continent, governments are confronting a difficult reality: systems designed Chief International Economist when workers vastly outnumbered retirees are becoming harder to sustain. By 2070, there will be barely two working-age adults for every person over 65, down from around three today, according to the European Commission. Birth rates have fallen well below replacement levels across most of the continent, while life expectancy continues to rise. The median citizen of the European Union (EU) is already 45 years old, at least six years older than other continents’ populations.

The economic costs of ageing are already substantial. Public spending on retirement benefits, healthcare and long-term care accounts for roughly one-fifth of the EU's gross domestic product (GDP). Across the EU, nearly half of all social protection spending is devoted to old-age and survivor benefits.

Most member states rely heavily on public pension systems financed on a pay-as-you-go basis. Workers contribute through payroll taxes, and those funds are used to pay today's retirees. Retirement security therefore depends largely on government promises and the willingness of future workers to finance them. Public systems cover more than 90% of

employees, while occupational and private pensions play a much smaller role in most of Europe. Contributions flow primarily toward current benefit payments rather than investment portfolios.

Europe's pay-as-you-go model worked well when populations were younger and workforces were expanding. As populations age and labor force growth slows, pension finances come under increasing strain.

The United States follows a more diversified approach. Social Security, also primarily a pay-as- Europe's aging you-go system, provides a safety net. Employer-sponsored defined contribution (DC) plans, such population is testing as 401(k)s, play a much larger role. Some argue that Americans bear greater investment risk the sustainability of under this system, but they have also accumulated a far larger pool of retirement assets. its pension model. Europe's pension challenge is not just about fiscal sustainability; it also represents a missed economic opportunity. Much of Europe's retirement wealth remains invested conservatively, often concentrated in government bonds and other low-risk assets. As a result, less capital finds its way into productive investment, which Europe could use a lot more of.

Across the EU, funded retirement assets amount to just over $5 trillion, less than 30% of GDP. America's 401(k) plans and pension funds manage roughly $45 trillion in assets, equivalent to over 150% of GDP. Only a handful of European countries, including the Netherlands, Denmark and Sweden, have built investment pools that are comparable to the size of their economies. Significant portions of these portfolios are invested in equities and other growth-oriented assets, helping create some of Europe's deepest and most dynamic capital markets.

The implications extend beyond market structures. European governments today face growing demands for defense spending, infrastructure investment and debt servicing. Every euro devoted to pension support is unavailable for other priorities.

Europe is beginning to confront these challenges. The Savings and Investment Union is an effort to channel more household savings into long-term investment capital. A key part of the strategy is to improve retirement outcomes and create larger pools…