In Europe, politicians are increasingly promoting private pensions as a panacea to revive stagnant stock markets, encourage entrepreneurship and curb rampant government spending as the population ages. But they will not solve the challenges resulting from the growing concentration of purchasing power in the hands of the elderly.
According to the UN, the European population between 20 and 64 years will decrease by 31% between now and 2100, and the increase in life expectancy will increase the population over 65 by 21%. The National Transfer Accounts (NTA) project estimates that older adults will go from consuming 30% of what the economy produces through labor – net of that group’s contribution – to 57% by 2100. In North America, it will go from 25% to 52%.
Meanwhile, measures to keep people working longer have stalled: in France and Germany, for example. This all adds up to a budgetary problem, as in most European countries it is taxpayers who finance citizens’ retirement income. Over-65s in France, Germany, Italy and Spain, for example, receive more than two-thirds of their income from so-called pay-as-you-go transfers, which are financed by taxes on workers rather than individual savings. These systems, modeled after German Chancellor Otto von Bismarck’s late 19th-century model, offer generous earnings-related pensions. But by Bruegel’s estimates, their current unfunded liabilities typically exceed four times annual GDP.
For this reason the European Policy Center or the European Court of Auditors recommend promoting employer-sponsored private pensions instead. The EU launched a pan-European personal pension in 2022 and has pledged to promote the automatic enrollment of workers in these plans, although the reception has been lukewarm.
The basic idea is that state-funded systems should become similar to systems in Denmark, the Netherlands and the United Kingdom, which follow in the tradition of British economist William Beveridge, who in 1942 advocated universal and flat-rate pensions, along with robust voluntary and corporate-sponsored retirement savings plans. They have accumulated large financial resources for the participants’ retirement. Many of these schemes traditionally promised “defined benefits”, with the risk of shortfalls if returns were disappointing, but the Netherlands and Britain have moved to “defined contribution” schemes over time. If all countries’ systems were based exclusively on this structure, fiscal sustainability would be guaranteed: pensioners would be paid based on the performance of their stock and bond portfolios, without recourse to the state.
A poor metric
But this only underlines that financial sustainability is an inadequate economic parameter for the problem at hand. The common-sense argument in favor of private pension funds is based on a misleading analogy between households and the state. For individuals, saving money each year gives them a good cushion for retirement. But on a national level, that’s the wrong way to look at it.
Stocks and bonds have value only because they represent a claim on future economic activity. In an aging world, the declining share of workers means that such rights are less valuable than the goods and services an economy actually produces. The gap between retirees and producers could manifest itself in different ways. The first is for asset prices to fall or stagnate in aging societies, as growth weakens and young people cannot afford to buy financial securities from income-hungry older people. Another is inflation, with more pension money chasing the output of a smaller group of wage earners. In other words, private saving cannot change the fact that Europe will go from 49 workers per 100 consumers to just 40 in 2100, according to NTA projections.
There is another, more nuanced, argument in favor of individual piggy banks. Economists believe that countries with higher savings rates are more productive in the long term, so private pension funds should result in a larger pie for seniors to enjoy in the future. This is based on the peculiar use of language in economic theory. Textbooks interpret “saving” as the absence of consumption. A new data center, for example, increases GDP by adding investment that cannot be consumed, so by definition the economy has saved more. But this hypothetical company saw a profit opportunity and paid for it with a combination of retained earnings and debt, regardless of the country’s pension structure. It is investments, and not the private pension system, that increase output per worker. Increasing pension funds does not necessarily translate into greater investment: if households buy less and corporate income declines, they may reduce capital spending.
Of course, a large pension fund industry can continue to drive down the cost of capital for companies by forcing savers to take on risk. On the other hand, aging will increasingly limit the ability of pension funds to take on these risks. Many Canadians already receive more payments than contributions, the IMF notes, increasing their need for more secure assets. In general, countries with large pension funds do not visibly invest more: gross fixed capital formation is 23% in both France and Denmark, but their pension holdings are at 11% and 192% of GDP respectively, according to the OECD.
What the data shows is that older people face greater income inequality where public pensions are lower. Private systems, in addition to having high management costs, do not alleviate the need for old age subsidies, because citizens’ investment capacity is very unequal. In large developed economies, the richest 10% of families own more than 50% of the wealth. There is also the danger that if pension funds become too large, the richest will stop working sooner, even if the legal retirement age rises. Denmark’s threshold is set to increase to 70 in 2040. But its effective retirement age is 64.5.
One option might be to place most plans under something like the Canada Pension Plan (CPP), a national contributory program that combines the pay-as-you-go system with funded pensions and maintains direct control over when benefits can be claimed. By having a single pool serving a single client, the CPP is also less exposed to redemption risks and can make longer-term investments. Or perhaps authorities need to start testing distribution plans, as Australia does. If private savings are too high, it may be necessary to reduce the generous tax benefits.
No pension redesign can avoid the need to extend working lives. Even without a budget crisis, the fact that seniors can consume half the economy is a problem.
The authors are columnists for Reuters Breakingviews. Opinions are yours. The translation, by Carlos Gomez belowit is the responsibility of CinqueGiorni
