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The European Pension Crisis by Estelle James Two Europes • First Europe has been unable to come to grips with the pension crisis (France, Belgium, Germany, Austria, Spain)-- PAYG, unsustainable benefits, large IPD • Second Europe has mandatory pre-funding with private management + modest public safety net (UK, Switzerland, Denmark, Netherlands, Sweden, Poland, Hungary) • We can learn what to avoid from first Europe and where to go from second Europe Basic demographics • Populations old now, baby boomers retire over next 20 years, increased longevity • Support ratio (age 20-59/>60) will halve, <2, everywhere. But policies will determine impact of demographics. 2000 2030 – – – – – France Germany Switzerland US Unwtd. Av. 2.7 2.5 2.9 3.4 2.8 1.6 1.2 1.3 1.7 1.5 • • • • Characteristics of pension plans in first Europe Generous replacement rates > 60% Early retirement (< age 60) Mandatory plan is 100% PAYG Therefore high % of GDP & treasury spent on pensions and health--may be inflationary or crowd out other important public spending • High IPD--above EU criteria if explicit • Contribution rate > 25% in most countries, > 30% in some; will have to double in next 30 years if no changes--nonsustainable Relationship Between Percentage of the Population over 60 Years Old and Public Pension Spending Pension spending as percentage of GDP 16 Austria Italy Poland Luxembourg 12 Greece France Sweden Uruguay U.K. 8 Panama U.S. Costa Rica 4 Israel Japan Australia China 0 Jamaica 5 10 15 Percentage of population over 60 years old 20 Public Health and Pension Spending versus Population Aging Spending as a percentage of GDP Austria 20 Czechoslovakia Sweden Poland 15 U.K. New Zealand Iceland Canada Switzerland Spending on health and pension 10 Brazil Trinidad & Tobago 5 Japan Australia Cyprus Spending on health China Jamaica Swaziland Zambia S. Korea Indonesia 0 0 5 10 15 20 Percentage of population over 60 years old 25 Implicit Public Pension Debt, 1990 Explicit debt Canada Implicit public pension debt France Germany Italy Japan United States 0 50 100 150 200 250 300 Reliance on PAYG in first Europe • Public plans are generous and fully PAYG-big burden on future generations, threatens future fiscal stability, strength of euro • Few private plans and those that exist aren’t funded (PAYG in France, book reserves Germany)--how will companies pay these future debts in competitive market? • Lack of funded private plans means few institutional investors, weak financial markets and corporate governance • But difficult to shift to pre-funding while paying off high IPD Early retirement in first Europe • Labor force participation rates of men over age 55 has been falling rapidly: – age 59: < 50% in Belgium, France, Italy – 60-64: < 20% (>50% in US) • DB plans, early retirement not penalized on actuarially fair basis, drain on common pool • Bad for system: more expense, less revenue • Bad for economy: less experienced labor • Considered antidote to unemployment but may raise labor costs and unemployment • But politically very difficult to raise retirement age--shift to DC would help Redistributions • Large public plans are not redistributive to poor--may pay higher lifetime benefits to high earners • Biggest gainers were those who retired in past. Future retirees will get low rate of return due to high contribution rate, high dependency rate, uncertain benefits--losing faith in system. First Europe will have to change • Will have to increase funding, shift to partial DC, raise retirement age • But difficult politically, very slow • In 1990’s rate of growth half that in US, unemployment double that in US • Postponing increases problems--security for pensioners, wage growth and employment for workers Second Europe: the way forward • (1) UK, Switzerland, Denmark, Netherlands (2) Sweden, Poland, Hungary--more recent • These countries have modest public PAYB pillars--redistributive: flat or compressed in (1), earnings-related with minimum in (2) • + (quasi) mandatory funded private 2d pillar – group plan with investment manager chosen by employer and/or union in (1)--historical reasons; – but movement toward individual accounts in some cases (UK, Switzerland) – individual accounts with worker choice in (2) Results: • Lower projected public expenditures, IPD, contribution rates; higher retirement ages • Large build up of pension assets committed for the long term; institutional investors, corporate governance, financial instruments • More secure pensions, healthier economies • Protection for lower income groups • If improves use of capital and labor, expands size of pie, all generations can gain Comparisons: unemployment rates • Non-reformers • • • • • – 1994-97 Austria 5.3 Belgium 9.0 France 12.3 Germany 9.8 Spain 20.6 Reformers 1994-97 Australia Denmark Netherlands Switzerland UK 8.4 5.4 5.5 4.1 7.1 • Average 11.4% 6.1% • UnE rate of non-reformers was almost double that of reformers • Source: World Bank, World Development Indicators, 2000 Comparisons: average annual growth rates • • • • • • Non-reformers • 1980-90 1990-8 Austria 2.2 1.9 Belgium 1.9 1.6 France 2.3 1.5 Germany 2.2 1.5 Spain 3.0 1.9 Reformers 1980-90 1990-8 Australia 3.4 3.8 Denmark 2.3 2.9 Netherlands 2.3 2.6 Switzerland 2.0 0.4 UK 3.2 2.9 • Average 2.3% 1.7% 2.6% 2.5% • Non-reformers declined, reformers forged ahead in 1990’s • Source: World Bank, World Development Indicators, 2000 What do these tables tell us? • Of course many policies besides pensions are at work • But pro-market, pro-competition, proefficiency policies seem to pay off--lower unemployment, higher growth • Social security reform with pre-funding and private control of the funds is an important part of that policy package Lessons for the US? • We can avoid problems of first Europe and learn from second Europe • The US already has a modest public pillar, voluntary private plans • But our public benefit is not sustainable; and our private plans mainly cover upper 40% • We can reform system while problem is still manageable, and benefit economy at same time (long term savings, later retirement)-this will keep retirement income secure, help economic growth, potential gains for all