Solving the Pensions Puzzle

1. Introduction

Reforming pensions is one of the biggest challenges of the 21st century. All OECD countries have to adjust to the ageing of their populations and re-balance retirement income provision to keep it adequate and ensure that the system is financially sustainable.
Experts have been warning us for some time that population ageing is looming and that, when it strikes, changes will be rapid. But many governments preferred to ignore the need for reform and cling to the hope of being able to postpone reforms beyond the next election. Immigration of younger workers, more women in work and higher productivity were put forward in the hope that more painful solutions, such as cutting benefits or working longer, could be avoided. All of these factors can certainly help to cope with ageing and the financing of pensions, but the increases in each of them necessary to compensate for ageing are so large that one cannot rely on them alone.
OECD countries have woken up to the need to adapt to an ageing society, and reforms have taken place. But pension reform is a difficult task. Not only does it lead to heated ideological debates, it can result in street protests that force governments to retreat from urgently-needed reforms. Recently, however, public opinion on pensions has been changing. People are realising that a shrinking number of young workers will have trouble paying for more and more pensioners. The time has come to open a frank debate among all members of society and finally address the question of how the cost of ageing should be shared between the different groups of society. In order to launch an informed debate, however, it is necessary to understand the reform options and their likely consequences. Cross-country comparisons are an important tool for this debate and the OECD is helping to provide them.

2. Is there a perfect pension system?

Can a government create a perfect pension system, and if so, how? Some of the most frequently asked questions include: which country does it the best way, which country is doing the worst job, which systems are the most generous, will it be possible to reform without increasing pensioner poverty, and will countries be able to pay for the promises they are currently making?
There are no simple answers to any of these questions. National retirement-income systems are complex and pension benefits depend on a wide range of factors. Differences in retirement ages, required years of service, benefit calculation methods and adjustment of paid-out pensions make it very difficult to compare pension systems across countries. Another problem is that life expectancies at retirement differ from one country to another, which means that some countries will have to pay pensions for a much longer period than others. As a result, national debates are often full of misleading claims regarding the generosity and affordability of other countries’ pension arrangements.
International comparisons to date have focussed mostly on the fiscal aspects of the ageing problem. The OECD has published projections of age-related expenditures, including public pensions. Much less attention has been paid to the social sustainability of pension systems and the impact of reforms on the adequacy and distribution of pensioners’ incomes. But these aspects are also crucial if countries want to attain the dual objective of promising affordable pensions and preventing a resurgence of pensioner poverty.
The OECD has developed a framework to assess the future impact of today’s pension policies, including their economic and social objectives, and to compare them between countries. The models consider someone starting work today in each of the 30 OECD countries. It then assumes that current rules remain the same for the next 40 years or so, until the person reaches retirement age.
The framework takes account of the detailed rules of pension systems but summarises them in measures that are easy to compare. Pension benefits are projected for workers at different levels of earnings, covering all mandatory sources of retirement income for private-sector workers, including minimum pensions, basic and means-tested schemes, earnings-related programmes and defined contribution schemes. Another novelty is the inclusion of the large effects of personal income tax and social security contributions on living standards in work and in retirement: all indicators are presented gross and net of taxes and contributions. These are presented in the new series, OECD Pensions at a Glance, which will be updated every two years.1

Monika Queisser: Director of the Division of Social Policies, OECD, Paris.
Edward Whitehouse: Director of Research on Work and Social Affairs, OECD, Paris.
1 OECD (2005) Pensions at a Glance. Public policies across OECD countries, OECD, Paris.

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