As pension crisis looms, golden years fade to black
Public pension systems in advanced and emerging economies alike were already under stress before the Great Recession. The past few years' destruction of wealth and the likelihood of slower growth in the future have weakened them further and will put some under intolerable pressure. Getting pension systems to work as they should will be one of the toughest tests governments face in the next several decades. It demands something they are notoriously bad at: thinking ahead. I'm not saying governments don't understand the problem. Many have started to address it. The trouble is, they're framing the issue too narrowly, and adopting fixes that are unlikely to stick. Getting on top of this issue will require more radical thinking. In many countries, options that have been taken off the table will need to be put back on. At the moment, governments see pensions almost entirely as a looming fiscal emergency -- which, to be sure, they partly are. On average, according to the International Monetary Fund, aging populations will raise public pension spending in advanced economies by about four percentage points of GDP over the next 20 years. That is an enormous amount. Rapidly falling fertility also means that a diminishing base of workers will have to bear that burden. (The ratio of pensioners to workers in developed economies is expected to double by 2050.)
Reforms that have already been proposed will subtract about two and a half percentage points from that four percentage point increase in cost over the next two decades, mainly by raising the retirement age and by making pensions less generous. There are two concerns about this approach. The smaller one is that such measures only partly solve the fiscal problem. The real worry is that they won't be allowed to happen -- and with good reason.
With life expectancy increasing, a rise in the retirement age does make sense -- but it's a terrible idea to make public pensions less generous than they already are. Even if you disagree, ask yourself how plausible a decrease is.
Early reformers such as Sweden and Germany have had to reverse some of their planned cuts in pension benefits as they began to be implemented. The same is bound to happen elsewhere.
The crux of the problem, which has barely even begun to be recognized, is that projected incomes in retirement need to grow, not fall. Squeezing public pensions is a questionable goal at the best of times. When private provision for retirement is under greater stress than ever before, it's political fantasy.
Relatively generous occupational pensions began disappearing long before the recession, starting with countries like US and U.K. Defined-contribution saving for retirement -- in US, through 401(k)s (Retirement Benefit) and Individual Retirement Accounts -- has failed to fill the gap. For workers approaching retirement, balances in these accounts are typically far lower than needed to avoid a severe drop in income. Health costs in retirement are rising rapidly everywhere, another consequence of increased longevity. Governments are trying to shift some of this burden off their books as part of efforts to contain public debt. This will put new strains on incomes in retirement. Add low interest rates (hence meager returns on the safest forms of saving) and the collapse in home equity, which in many countries was a main form of retirement saving, and the financial prospects for many soon-to-retire workers are dire.
Against this background, plans to suppress public spending on pensions are questionable on their merits, and from a fiscal discipline point of view are just so much wishful thinking. As life expectancy improves, working longer is both financially desirable and politically feasible. But making public pensions smaller is neither -- unless it's part of a larger reform to raise overall retirement incomes.
What shape could this needed reform take? The short answer is mandatory private saving -- ideally, so far as rich economies are concerned, not in place of but in addition to the provision of public pensions. Take deductions from workers' pay and invest them in private accounts. These are not taxes: Workers own their savings balances, though they would be unable to access them before retiring.
There are many possible variants. Governments might subsidize the savings of those on low incomes, set a floor for payments or guarantee, within limits, minimum rates of return.
Such mandatory private saving is the path taken by many emerging-market economies, following the example set by Chile in the 1980s.
The approach has problems -- in Chile's case, inadequate coverage and high administrative expenses, which were addressed in a second big reform in 2008 -- but the basic principles have been widely adopted. Details matter, and these programs haven't matured, so it's too soon to declare them a success. But done right, the model looks promising.
By: Clive Crook