The fear that the EU's 370 million citizens are not setting aside enough money for their retirement is nearing reality, writes Francesco Guerrera

In a week that saw the first bombs dropping on Iraq, European Union leaders could not be expected to worry too much about an explosion in 2015.

But despite more pressing concerns, the presidents and prime ministers gathered in Brussels for last week's summit had to deal - albeit briefly - with the pensions time bomb ticking under the EU economies.

With every passing year, the often-voiced fear that the EU's 370 million citizens are not putting enough money aside to pay for their retirement is closer to becoming a reality.

Unless urgent reforms are implemented, the pensions time bomb will affect large swathes of Europe's population. With pension spending already accounting for 10 per cent of the EU's gross domestic product, retirees, governments, pension funds and financial markets are all set to be hit by the swelling of this bill.

According to a recent study by the European Commission, an expected rise in pension expenditure from 2015 in most EU countries gives "rise to concerns as to the capacity of pensions to ensure decent living standards for the retired and for the financial sustainability of the pensions system".

Europe has got to such a perilous position through a mixture of demographics and public policy.

The "baby-boom" generation will reach retirement age in the next few years. And to compound the problem, the "baby-boomers" are expected to spend longer in retirement than any of their predecessors. Life expectancy is constantly increasing and it is estimated that by 2050, Europeans will live at least five years longer than they do today.

That increase alone will raise the cost of providing the same level of pensions by up to 30 per cent.

To make matters worse, the number of people who are supposed to pay for the retirement of these baby-boomers has been shrinking for the past three decades as a result of falling birth rates.

This has led to a dangerous mismatch between pension contributors and beneficiaries.

According to the Commission, over half of the EU's adult population will be made up of over-65s by 2050, compared with only a quarter in 2000.

If the workers cannot pay for the retired, governments could make up the shortfall by borrowing more. But with economic growth nearing a standstill amid an uncertain global outlook, EU governments cannot afford to place an extra burden on already stretched finances.

Even if they tried, there are rules in place that force the 12 euro-zone members to contain budget deficits and public debts.

As the Commission puts it: "Adequate pension provision cannot be financed indefinitely through government borrowing."

Given this situation, policymakers and experts agree that the only viable way to defuse the pensions time bomb is to undertake a radical reform of labour markets and welfare systems.

The Commission has no binding powers on these matters, so the initiative rests with national governments. EU leaders have repeatedly pledged to work on three main areas. One is to get more people to work - and therefore pay contributions - for longer.

Countries such as Denmark, Italy and Germany have announced reforms of their tax and benefit systems to do just that. And all EU member-states have signed up to the target of having 70 per cent of people of working age in employment by 2010 - up from the current 63 per cent.

Particular challenges will be to increase the proportion of women in work and to reverse the trend towards early retirement.

There is a serious danger that the difficult economic situation will derail these efforts. When the employment target was set, the EU predicted that its gross domestic product would grow at 3 per cent a year for the foreseeable future.

Last week, the Commission indicated that it did not expect the EU economy to grow at much more than 1 per cent in 2003.

But even if the employment rate does rise to 70 per cent, this would only cut the expected increase in pension costs by a third.

A second option for alleviating the financial burden of pensions is to encourage more people to take up private or occupational schemes.

The importance of such schemes varies greatly across the European Union. In the Netherlands, 91 per cent of all employees are covered. In Britain and the Republic, half of the workforce is a member of an occupational scheme.

But in southern European countries, private pensions are uncommon. In Italy, only 8 per cent of the workforce is covered by non-state schemes.

In Portugal, the figure is just 4 per cent.

Several countries have promised changes in the structure of their welfare systems to encourage people to shift to private pensions. But the fact is that they are unlikely to have much impact for several years.

"The Italian government talks incessantly about the need to overhaul the country's sclerotic labour market," says Mr Alasdair Murray of the Centre for European Reform, a UK think-tank, "but it has only succeeded in introducing modest reforms."

The third option for relieving the public purse of part of the pensions burden is the introduction of rules to make it easier for pension funds - which manage assets worth €2,500 billion - to operate across the EU.

A new law or directive - expected to be approved in the coming weeks - would enable companies to offer the same pension scheme to all their EU-based workers. This should reduce costs for companies and encourage more people to join occupational schemes.

According to Mr Frits Bolkestein, the EU commissioner behind the new rules, "pension funds can play a useful role in helping to tackle the pensions time bomb".

But the decisive push must come from national governments. Once talk of explosions over Iraq has subsided, action on the time bomb with the longer fuse will become a pressing issue.