Download Demographic Change and Europe`s Pensions Crisis Key Note Speech

10 November 2015, Brussels
Live Long and Prosper?
Demographic Change and Europe’s
Pensions Crisis
Key Note Speech
Dr. Jochen Pimpertz
Head of Research Unit
Public Finance, Social Security, Income and Wealth Distribution
Cologne Institute for Economic Research
Revisions reserved. Check against delivery.
When we first met in summer 2014 for a brainstorming about
old age provision in times of demographic change and the
need of fiscal consolidation, we discovered two aspects
which I would like to discuss separately.
Of course the first challenge is to identify adequate measures
to reform public pension schemes in order to handle the
demographic challenges the EU28 will have to face.
However, we quickly arrived to a full agreement that we
cannot expect a kind of blueprint for reform proposals,
because too many nation-specific aspects have to be taken
into account. At the same time the European Commission’s
role has changed significantly since the recent crisis
emerged. Today, the European Commissions’ analysis offer
an early warning of macroeconomic imbalances. Besides
reporting within the European Semester especially the EU
ageing report projects public pension expenditure in the long
term and thereby, reveals the influence of pension systems
on the governments’ ability to handle the aftermath of the
crisis.
In this way a second question occurs beyond the focal point
of reforming pension schemes: What part should European
institutions play in the reform process?
Demographic change within the EU28
Before answering these questions I would like to start with a
short review about demographic challenges in Europe. There
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
2
are three drivers of demographic change, which occur in
almost all 28 EU member states, which are
 rising life expectancy
 low fertility rates and
 the ageing of numerical strong cohorts followed by
smaller ones, which results from an abrupt shrinking of
the fertility rate in the past
These trends will lead to a rapid ageing of the European
society. The old age dependency ratio will nearly double by
2060. By reason of sustainability this development is not only
important due to the rising number of pensioners, but at the
same time the labour force will shrink dramatically. The
EU28’s labour force will decline by 45 million people to 290
million by 2060.
Certainly, the demographic challenge is not the same for
every member state – which is shown by the next figure. It
illustrates the development of the old age dependency ratio of
each member state in the coming decades. Magnitude,
speed and timing of population ageing vary significantly.
However, none of the member states will be spared of
demographic challenges.
If public pension schemes remain unchanged–especially
pension level and retirement age–the ageing of the member
states’ societies will cause significant increases in public
pension expenditures–illustrated by the next figure which
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
3
shows the development of public pension expenditures as a
share of GDP among the EU28 member states.
A solely fiscal perspective is too narrow
However, as the national pension systems differ in many
aspects, it is doubtful that suitable reform measures can be
based on fiscal indicators alone. I would like to explain this by
four aspects:
1. National pension systems are characterised by a
particular combination of PAYG and capital-funded
elements, whereas demographic change will affect both
elements differently.
As shown in a simplified model a PAYG pension
scheme is balanced if contributions paid by employees
in one period equal pension payments in the same
period. Thus, PAYG pension schemes organise income
redistribution between different cohorts within one
period. That is why any variation in the numerical size
of cohorts causes financial imbalances in the following
period–in the case of ageing numerical strong cohorts
as well as in the cases of low fertility rate or rising life
expectancy.
Capital-funded schemes also redistribute income, but
within the same cohort and over two periods. They do
so by saving premiums paid during the period of
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
4
employment and building up a capital stock, which will
be melt down afterwards during the period of retirement
in order to finance monthly payments. Therefore,
capital-funded schemes are not affected directly by the
ageing of numerical strong cohorts or by low birth rates.
Only in the case of rising life expectancy it becomes
necessary to adjust either the retirement age or the
premium level and/or the pension level.
2. Fiscal consolidation can also be achieved by other
reform measures. Concentrating on public pension
systems might neglect these alternatives, for example
cutting costs of public health care or long-term care
systems which are affected by demographic change in
a similar way.
3. Pension systems do not only differ in their specific
combination of PAYG and capital-funded elements, but
they also pursue different normative aims. Therefore,
alternative strategies might be suitable depending on
whether income maintenance or poverty prevention is
the main purpose of the system.
4. At last, nation specific preferences might lead to
different reform strategies. These differences cannot be
explained by the type of pension scheme alone, but by
the society’s choice which generation should mainly be
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
5
burdened with the effects of demographic change.
‘One fits for all’
In the light of these different criteria our first conclusion is that
public pension policy should remain a national issue. With
regard to nation specific preferences as well as to the
different purposes and designs of pension systems the
national governments are much closer linked to the societies’
preferences than any EU institution can be.
However, there is one measure that fits for all member states.
This is the adjustment of the effective retirement age in line
with the increasing life expectancy. This measure is able to
rebalance PAYG operating schemes as well as capitalfunded ones. Moreover, deferring retirement age is able to
strengthen the productive potential of the economy and
thereby will help to bear the burden of social expenditure in
general.
Different systems, different paths of reform
Nevertheless, beyond this one measure fitting for all we
found different reform paths in our four case studies. I would
like to present some of the most salient characteristics.
Germany and Italy represent public pension schemes that
pursue income maintenance. Both have established social
welfare systems separately with means-tested benefits.
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
6
 In Germany the pension reforms of the last decade lead
to a continuously shrinking pension level by 2030. This
becomes necessary in order to mitigate the expected
increase of the contribution rate. In this respect the
German pension reform can be understood as a
political compromise between the older and the
younger generation about bearing the burden of
demographic change.
The reform was accompanied by two additional
strategies–on the one hand eliminating incentives for
early retirement, on the other hand supporting voluntary
private pension schemes by supplements and tax
allowances.
 In Italy the established public pension scheme is quiet
similar to the German case, but a completely new
mandatory pension scheme was introduced for younger
cohorts in 1995–a notional defined contribution system.
This still operates like a PAYG scheme but it mimics the
effects of a capital-funded scheme. For each employee
the contributions paid are registered in an individual
account which generates notional interest. The virtually
accumulated stock is converted into an annuity when
pension age is reached.
As a consequence, the individual annuity, which is
nothing else than the monthly pension payment,
depends on the age of retirement which the employee
chose. The earlier an employee retires the lower his
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
7
annuity will be due to a smaller notional stock and a
longer period of time receiving pension payment. In that
way notional defined contribution systems prevent
incentives for early retirement in a similar way to
capital-funded schemes, but without accumulating a
stock actually.
By contrast, the Danish and the UK public pension schemes
only guarantee a basic protection. That is the reason why
public pension expenditure as a share of GDP will stay below
the German or Italian level although the Danish and British
population will grow old in a similar way. On the other hand,
private and occupational pension schemes are much more
important to achieve income maintenance in these countries.
 In Denmark, for instance, occupational pension
schemes become quasi-mandatory as pension plans
have been negotiated as part of collective agreements
by the relevant employer associations and unions.
Therefore, in 2013 almost 9 out of 10 full-time
employees were covered by an occupational pension
scheme.
 The UK pension system is quite similar to the Danish
one. In order to achieve income maintenance both
occupational and private pensions traditionally play an
important role in retirement income in the UK. In 2013,
about half of the working age population was enrolled in
a voluntary private pension plan.
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
8
In order to encourage individuals to save even more for
their retirement, automatic enrolment in an occupational
pension plan was introduced in 2012. Employers are
required to automatically enrol all employees who are
not already covered by a private pension. People can
choose to opt out within one month, but employers will
automatically re-enrol those who have opted out on a
three-year cycle so that there will be no way out of
additional private or occupational saving.
EU’s part to play
As reforming pension systems should remain an issue of
national responsibility and competence, the question left is
which part European institutions should play during the
reform process. The European Commission already supports
national reform strategies by monitoring public pension
systems and by evaluating reform measures which are
already introduced. Furthermore, the Commission might
simulate the effects of different reform strategies in the run-up
of reform debates. At last, a non-negligible issue is to foster
the single market strategy in other sectors.
 Monitoring public pension systems is helpful in
identifying conflicts which result from demographic
change and the need of fiscal consolidation. For
example, this is exactly what the EU ageing report
does. Transparency about these conflicts might force
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
9
national governments to evaluate their social policy in
general and their pension policy in particular.
Furthermore, the Commissions reporting might help to
induce necessary debates about intergenerational
justice within the member states.
 Additional to the existing method of the EU ageing
report, simulating of the effects of alternative reform
options might be helpful to enable national
governments to launch adequate reforms. Moreover,
this might be helpful to encourage more innovative
approaches.
 At last, one of the core responsibilities of the EU is the
promotion of other single markets. By carrying out this
task European institutions can also support the member
states’ public pension schemes indirectly. As economic
prosperity has a positive impact on fiscal sustainability,
a successful single market strategy can help to extend
the ability of the national governments to take action on
social policy.
Thank you for listing.
Key Note Speech, 10.11.2015: Live Long and Prosper? Demographic Change and Europe’s Pensions Crisis
10