Too much, too young
April 7, 2011
When most labour was agricultural, people generally toiled in the fields until they dropped. The idea of formal retirement did not become feasible until work moved from farms to factories. In 1889 Otto von Bismarck famously introduced the world’s first (modest) pension scheme in Germany. In the 20th century, when universal suffrage became widespread, a period of retirement after work was seen as a mark of a civilised social democracy.
After the second world war pension provision increased markedly, but the number of elderly people was still quite small (see chart). In the 1970s and 1980s caring for them seemed easily affordable. Many countries even reduced their retirement ages.
The demographic picture looks different now that the baby-boomers are starting to retire. In 1950 there were 7.2 people aged 20-64 for every person of 65 and more in the OECD. By 1980 the ratio had dropped to 5.1. Now it is around 4.1, and by 2050 it will be just 2.1. In short, every couple will be supporting a pensioner.
Europe and Japan are facing the biggest problems. The average dependency ratio in the European Union is already down to 3.5, and is heading for 1.8 by 2050. In Italy it is forecast to be nearly 1.5 and in Germany nearly 1.6 by then. Japan is on track for a startling 1.2. Since the average pensioner currently draws a total of about 60% of median earnings, from government and private sources, the system is likely to become unaffordable. In a sense, it does not matter how the benefits are paid for. If they are unfunded, they come from workers’ taxes; if funded, they come from investment income. But the income has to be generated by someone.
There are ways of reducing the burden. The current generation of workers could save more now. If they put more money into funded pension schemes, the extra saving might encourage more investment and thus boost economic growth. A wealthier society would find it easier to afford paying pensions. Countries with PAYG schemes could raise taxes now, reducing the deficit and thus the debt burden on the younger generations.
We want it now
But more savings or higher taxation now would require those currently at work to defer consumption. They may not be willing to do so. And given the weakness of developed economies in the wake of the financial crisis, governments may not want to see consumption go down in the immediate future.
In the OECD public spending on pensions benefits has been growing faster than national output, rising from 6.1% of GDP in 1990 to 7% in 2007. It is forecast to reach 11.4% of GDP by 2050. Those forecasts already take into account the planned rise in retirement ages and a likely drop in replacement ratios and thus assume that voters will approve of pension reform even as the baby-boomers become a potentially powerful voting block of retired people.
But that assumption may not be safe. Turnout in elections tends to be higher among the elderly than among the young. As Neil Howe and Richard Jackson of the Centre for Strategic and International Studies in Washington, DC, have written: “In the 2020s young people in developed countries will have the future on their side. Elders will have the votes on theirs.”