Hungary’s Aging Population – A Challenge as Well as an Opportunity

By Arup Banerji and Gordon Betcherman

In the first 25 years of this century, Hungary is slated to lose 8 percent of its population. The proportion of the population over 65 years of age will increase by 40 percent by 2025, so that more than one in every five Hungarians will be over 65.  If this dramatic aging is not managed effectively, it could knock Hungary off the path of converging with Western European economies and it could jeopardize plans to meet the requirements for joining the Euro zone.

Over the past 18 years, Hungary has progressed along a challenging political and economic transition course, with largely successful results. Of course, the accession to EU membership in 2004 was a key marker in this transformation – though much more still needs to be done. However, Hungary’s future progress toward the rest of Europe must now deal with the challenges of yet another transition that being driven by its shrinking and aging population. Quite a lot of attention has been given to prospect of aging populations of Western Europe but far less notice has been paid to similar demographic trends in Eastern Europe and the former Soviet Union – from Poland to Russia to Bulgaria. Indeed, the demographic transition in the former Eastern bloc has not hit the headlines as much as the political and economic upheaval since the late 1980s but still is a transition that may be just as far-reaching. 

This “third transition” is the rapidly aging of the 400 million people who live in these former socialist countries. All 27 of these countries will have a significantly higher share of people over the age of 65 in 2025 than they had at the turn of the century. During the next two decades, they are projected to see their total population shrink by almost 24 million people, with Russia alone standing to lose 17 million and Ukraine another 12 million.  These projections are dramatic but what really makes the situation unique is that Hungary and its neighbors to the east must deal with the impacts of aging in a much more challenging environment than its neighbors to the west. No other rapidly aging countries in the world are still in the process of developing mature economic and political institutions.  And it is unique precisely because – as in Hungary – the process of demographic transition is accelerating even though the process of economic transition is far from complete.

The overlapping of the demographic transition with the incomplete economic transition thus has the prospect of altering the socio-economic fabric of Hungary and its neighbors.  They run the risk of ballooning public expenditures, as historically large pension obligations mount with aging populations, and as institution-based elder care systems demand more and more public resources.  These societies also face a growth challenge, as the working age population shrinks and aging individuals potentially save less. 

A new World Bank report out last week warns that if this transition from “Red to Gray” is not handled in the right way, it poses a threat to the recent economic success of the ex-socialist countries, something that policymakers in both the former East and West should be concerned about. 
Where are the threats?  Consider pensions.  At over 10 percent of GDP, public pension spending in Hungary is higher than all other new EU members except Poland and well above what some Western European countries spend. How much higher can this go?  On the simplest assumption that pension spending will go up in proportion to the future rise in the percentage of the population older than 65, pension spending by 2025 will rise above 15 percent of GDP in Hungary, along with Poland, Croatia, Ukraine, and Serbia. But straightforward pension reforms – raising retirement ages and changing the method of pension indexation – can reduce this burden quite significantly over the next 20 years, if action is taken now.

Health care – but especially long-term care for the disabled aged population – poses another significant fiscal challenge.  Caring for these old – whose numbers by 2025 may be one-third higher than they are now in Hungary – can be extremely expensive if the care is going to be provided in hospitals or institutions.  Therefore, putting into place a strategy for long-term care that provides incentives and resources for informal, home-based care, along the lines of practices in Western European countries such as Austria, is going to be essential to avoid enormous fiscal responsibilities in the future.

Again, consider the challenge of the shrinking labor force, which can naturally accompany declining populations.  The number of people in the prime working age (15-64 years) in Hungary is due to shrink by almost 600,000 people between 2005 and 2020, which represents a fall in the potential labor force by 3 percent. But this does not automatically imply that, as some fear, overall economic growth will slow down.

There are two straightforward policy solutions – even discounting immigration, which may be an important factor, but socio-politically challenging.  The first is increasing the participation rate of those who are of working-age population today.  Hungary’s labor force participation rate in 2006 for those 15-64 years old is much lower at 62 percent than neighbors and comparators such as Germany (73 percent) or the Czech Republic (70 percent).  Among older workers, defined as being between 55 and 64 years of age, Hungary is even farther behind. Only 35 percent of this age group is in the labor force, fully 20 percentage points below the average for all OECD countries. Taking measures to increase labor force participation can make a huge difference in compensating for the loss in population.  But a second route is even more powerful – improving the productivity of those who are in the workforce.  To do this, Hungary will need to commit to a range of farsighted reforms – in improving education, including adult education and lifelong learning, and in ensuring that the investment climate will encourage the creation of new innovative firms and improvement in the productivity of existing enterprises.

The good news is that most countries in the region, including Hungary, still have the time during the next two decades to deal with the rising costs of an aging population by launching proactive reforms.   In pensions, cost pressures could be largely offset by well-understood changes in policy, for example by raising retirement ages, which are still relatively low in Hungary, compared to its Western European neighbors.  Recognizing that long-term care is much more expensive in hospitals, costs can be moderated by adopting policies supporting home-based caregivers.  If these sensible long-term policies are pursued today, many countries, including Hungary, can still put their budgets on a sustainable footing as the aging challenge mounts.  And any concerns about declining number of workers can be mitigated by moving aggressively on measures to improve productivity and improving participation.

Therefore, the challenges posed by the “third transition” for reformers in Hungary and its aging neighbors are clear and the reforms needed are well known.  Putting them in place is the issue – the time to act is now, and the only danger lies in complacency.

Mr. Banerji and Mr. Betcherman are lead authors of the World Bank report “From Red to Gray”.