The wealth of ageing nations: People are living longer and we all face the bill, writes Hamish McRae

QUITE suddenly, it seems, the assumption of the majority of people in work - that, on balance, they are likely to see higher real take-home pay each year - has been shattered. It is a change as dramatic as the change in expectations for house prices: something that always seemed to go up may have stopped doing so.

This is partly an adjustment after the splurge of the late Eighties; partly a function of recession itself, in particular the cost of unemployment. But, even if the economy were growing at its full potential, the Government would probably have to increase taxes - and this from a Government determined to squeeze public spending. Nor is this just a British problem. The government of every industrialised country, with the possible exception of Japan, is under serious pressure to contain its budget deficit. Some, such as Italy and Sweden, have deficits of more than 10 per cent of gross domestic product, far worse than our own.

The reason for this goes beyond the recession: in the long term, it is the changing age structure of all industrial nations. The plunge in the birth rate since the Sixties is cutting the size of the workforce, while better medical care for the elderly is increasing the number of dependants.

Britain has hit this demographic wall early: after Germany, we have the oldest population of any industrial country, with some 15 per cent of our population over the age of 65, up from about 11 per cent in 1960. But we will age relatively slowly from now on. Japan and the United States, in contrast, have been younger societies, with at present about 12 per cent of their populations over 65, but in the case of Japan rising at an astonishing rate. A generation from now, in the year 2020, one quarter of Japan's population will be over 65. It will be the oldest nation on earth.

This raises a crucial question: are workers prepared to pay taxes to maintain pensions and medical services which the growing army of elderly people feel they deserve? Britain does at least have an occupational pensions scheme for half the population, where people save for their own pensions. Most of the rest of Europe operates on a pay-as-you-go system, where the pensions of one generation are paid by the workers of the next. One result is pressure on their social security funds.

The Treasury has had to top up our National Insurance Fund and contributions will go up next year, but social security charges elsewhere in Europe are enormous by our standards. Take someone earning pounds 40,000 a year in Britain and in France. Although we pay more income tax, we pay far less towards social security. Here the employer pays just over pounds 4,000 in contributions and the employee another pounds 1,700; in France the employer pays more than pounds 15,000, and employees a further pounds 6,500. Yet the French social security fund is in worse shape than the British one, and the French complain about jobs migrating to Britain.

It is self-evident that there is already a mismatch between what people expect from social services and what they are prepared to pay in taxation. But until now it has been possible, most years, to combine an increase in real take-home pay with a real increase in spending on health care and some real growth in state pensions. This is becoming harder, even in Britain which has less of a problem than the rest of Europe and much less than Japan.

People understand the effects of recession (even if economists do not understand the reasons for it). But eventually growth will resume. If the benefits of that growth have to be taken away from workers to pay for more expensive social services, the working population will not be happy.

We have had a glimpse of this in the reaction to the Budget, but there will be much more of the same across the industrial world. It is unpleasant to contemplate inter-generational tension, but if living standards of the young have to be held down to pay for care of the old, that is what will result.

There are solutions. These include a rise in retirement age (Denmark is up to 67), greater encouragement for people to save for their old age, and more part-time work. It might seem strange to suggest extending people's working lives when unemployment in Europe is at record levels. But an increasingly ageing population makes it all the more important that as many as possible contribute to a nation's wealth.

From next week, Hamish McRae's column will appear every Wednesday.