How to defuse the timebomb

Nicola Sturgeon snarled in return that if Labour wanted to make universal benefits the dividing line in Scottish politics, "bring it on!"

"In the country it sounds like a lot of nonsense," shot back Lamont, wondering how it could be fair that someone like Sturgeon, with an annual household income in excess of £200,000, should get free prescriptions.

Then the Deputy First Minister wheeled out the ghosts of British politics past, yelling that Lamont was a "poster girl for the Tories" and the "new Blair".

Lamont's change of tack coincided with another revelation in last week's news headlines: this year is seeing a 29% rise in the number of people turning 65 in England and Wales. Scotland's figures, which will follow shortly, are expected to be similar.

Subtract 65 years from 2012 and you get 1947, the year after the majority of surviving soldiers returned home after world war two. Which means this year marks the start of the (male) baby-boomers reaching pensionable age – a moment that professional worriers have been dreading for some time.

Like a python swallowing a rabbit, this bulge has been moving through the population for all the years in between. Now that the boomers are starting to draw state pensions, and in some cases public-sector employee pensions too, we are reaching the point where they start becoming more costly to the state. Not only are we now facing much larger numbers of 65th birthdays for the foreseeable future, it will get worse by the mid-2020s as the cost to the NHS of keeping this first crop healthy starts soaring in the last few years of their lives.

This problem is being aggravated by life expectancy. Doctors may wring their hands over Scotland's obesity and alcoholism epidemics, yet still we are living longer than in the past. Since 1950 life expectancy has gone up from 64 years to 76 for men and from 69 years to 80 for women. This may be some way below much of the Continent, but it's still a huge change in half a century.

And the trend looks to be continuing. For the UK as a whole, whose life expectancy is also slightly higher than Scotland's, the forecasts for 2035 are that men will live to 83 on average and women to 87.

In short, both the proportion and total number of old people in society are on the rise. Where today around 17% of the UK is aged 65 or over, it will be more than 23% by 2035. In Scotland the change is happening even more quickly, mainly because young people are leaving the country in larger numbers. By 2035, our over-65s proportion will be just short of 25%, made worse by our disproportionate number of occupational public-sector pensions.

Little wonder that the ageing population was almost the first phrase out of Johann Lamont's lips when she started making her case last week for ending what her supporters are calling "freebie Scotland". Equally, the Parliament's finance committee has just kicked off a study into the sustainability of Scotland's public spending.

While it is easy to diagnose this problem, it is hard to gauge the effects because there are so many unknown variables. In the short term, George Osborne's Office for Budgetary Responsibility (OBR) reckons they look more moderate than off the scale.

This might at first seem surprising in view of the sudden jump in people retiring, but it makes more sense when you think about older people as a whole. The number of people reaching 65 is still less than one in 10 of the total number of pensioners, so it will take a few years to have a big effect on the figures.

According to the OBR's latest forecasts, the national social-security bill – of which state pensions are almost half – will have risen by 18% between fiscal 2010 and 2016 from £169 billion to £199bn. This is somewhat ahead of the 13% rise for Government spending as a whole, and will include a chunky rise in pension costs.

Rowena Crawford of the Institute For Fiscal Studies (IFS) points out that these costs are being made worse by the fact the Coalition has actually reversed the 1980s decision to break the link between state pensions and earnings with its so-called "triple lock" guarantee. "That will make the future size of the state pension greater," says Crawford.

Crawford was the author of a report last year that looked at what the ageing population will mean further down the line. It found health and pension spending would have to become much bigger proportions of Government spending to cope with all the extra old people.

Between fiscal 2010 and fiscal 2060, it reckoned these two costs would rise from 34.2% to 51.4% of public spending.

The Government would be faced with a choice between shaving 8% or over £50bn off other departmental budgets or spending 5% more as a proportion of GDP than at present. That might not sound like a crazy figure, but the calculations assume annual GDP growth will average 2.4% in this 50-year period. Suffice to stay we are not looking like achieving these kinds of figures for the next few years, and some economists argue it will be the 2030s before growth returns to normal.

The IFS – borrowing from the OBR – is also assuming there will be net migration into the country of several hundreds of thousands of people each year. Migrants tend to be of working age, meaning they pay taxes that contribute to the national coffers. It is often said that this was one of the reasons why Labour risked the ire of the right-wing press by quietly allowing so many into the country during its 13 years in power.

Professor Robert Wright, a Strathclyde University economist who has studied Scottish demographics, is not optimistic that the projected numbers will be achieved, however. "[People like [former Labour first minister] Jack McConnell and Alex Salmond have said rightly that immigration is critical [to solving the problem]. However that's the opposite to what they want down south. The politics are getting in the way," he says.

Instead the Government has turned to other means of addressing the issue. One change, which starts coming into effect tomorrow, is automatic enrolment, which will mean that people will automatically become members of their workforce pension schemes unless they choose to opt out in future. Faced with record-breaking low levels of people with pension plans, the Government is aiming to have most employees in the public and private sectors in pension schemes by 2017.

Another substantial change was switching public-sector employee pension indexation in England and Wales from retail-price inflation to the slightly lower consumer-price inflation, which means pension entitlements rise more slowly each year. This cut the country's pension liability by £126 billion last year, although there are no signs of it being introduced in Scotland.

More controversially, the Coalition, following the Blair-Brown government, has raised the retirement age. Retirement for women will hit 65 in 2018 and then start rising to hit 68 for both sexes by the mid-2040s.

There is also a new White Paper in the offing from the UK Government that is expected to tighten the screws a bit further by entitling everyone to a number of retirement years proportionate to whatever life expectancy is at that time. In other words, if the entitlement was 15% and life expectancy was 85, people would be entitled to 12.5 years of retirement and would have to work until they were 72.5.

Wright dismisses these changes – all but the latter of which were factored into the IFS projections and are therefore not reckoned to be enough to solve the problem and advocates decisive actions to tackle the effects of the demographic shift. He says: "The population is ageing now. The Government is not prepared to bite the bullet on this because the backlash at the ballot box will be quite severe."

Rowena Crawford believes this is a medium-term problem that you would not expect solved yet, especially when making the national debt manageable is the first priority. She believes that demographics will not lead to a debt crisis until the 2030s.

Wright says that the UK Coalition is in "cloud cuckoo-land" about the scale of the problem and will get the "biggest shock" in future. He is more complimentary of the Scottish Government, which has been taking steps for a decade to reform social care by putting much more emphasis on care at home.

Assuming this policy finally bears fruit – it has had difficulties – it is predicted to cut the burden on health costs across the board. Further south, in contrast, pensioners pay for personal care, and are more likely to end up in institutional care and cost the state more money.

Wright adds: "The Scottish Government is also trying to convince the Government in London to give it more control of immigration. That's a positive step too."

This is unlikely to be enough to impress Johann Lamont. Labour's policy shift in Scotland looks set to ensure that the ageing population becomes a major talking point up to the referendum and beyond. Nicola Sturgeon has already possibly created a hostage to fortune by saying "bring it on".

To make matters worse ... we're retiring earlier

SCOTLAND'S demographic troubles echo those being felt across the developed world.

Another common phenomenon, highlighted in a recent report by Russia-based consultancy Renaissance Capital, is that the "effective age" of retirement fell in many countries from the 1970s onwards. In contrast to the legal retirement age at which people can start drawing state pensions, this is the average age at which people stop work. From this point on, most of them stop making meaningful contributions to their country's tax income. In the UK this age is reckoned to be 64 for men and 62 for women – not bad compared to some countries. In places like France, Belgium and Austria, it is below 60.

Another key statistic that experts use to analyse ageing populations is dependency ratios: the number of active workers compared to the number of pensioners in a country. The UK is about four to one, which is projected to deteriorate but is again not as bad as in some countries. One of the reasons for this is that we don't enjoy such long life expectancy. The worst, in descending order, are Japan, Italy and Germany – all of which have barely two workers for every retired person already and also have much higher state pension liabilities as a proportion of GDP than the UK. We treat our pensioners more poorly but also have more developed private pension systems.

The fact that Germany is in this group is bad news for the eurozone, given that it is Germany that is having to bail out the Mediterranean strugglers. This might help explain why Berlin has dragged its heels so much over negotiations. As for Japan, which also has stratospheric debt levels, Renaissance Capital predicts it is heading for a major fiscal crisis before the end of the decade. This will happen if its public coffers can no longer cope with paying for both pensioners and all the other demands on the budget, leading to the possibility of a major sell-off of foreign currency reserves and perhaps severe inflation.