The Political Economy of State-Based Pensions: A Focus on Innovative Reforms

1. Introduction

The phenomenon of population ageing will have profound consequences for governments and societies all over the world, and not just for pension systems. Capital flows are likely to shift dramatically, as older societies sell their assets to younger ones to finance consumption in retirement. Worldwide immigration flows may accelerate, as older, developed nations become more dependent on workers from abroad to perform jobs that cannot be filled with domestic employees alone. The balance of geopolitical power may also shift over time, as emerging and younger powers become more dominant economically, allowing them to demand a greater say in world political affairs.
But it cannot be denied that the implications of population ageing are seen first and most clearly in the long-term projections of state-based pension systems. In a sense, actuarial projections of pension systems were, and are, canaries in the coal mine, providing advance warning of the coming demographic shift that will fundamentally alter the political and economic landscape.
In the 1950s and 1960s, population ageing was not a concern. With a post-war baby boom underway, in varying degrees, in most countries, political leaders were unconcerned that the new retirement promises made by their governments were dependent upon an ever-growing population and thriving economy. The widespread optimism about the future was captured succinctly by Konrad Adenauer, the post-war German Chancellor, who, in 1957, said ‘people will always have children’, thus dismissing the population risks associated with a pay-as-you-go approach to pension financing.
But, of course, Adenauer was wrong. Birth rates fell dramatically, beginning in the 1960s. Germany’s total fertility rate (TFR) — which measures the average number of births to women in a country during their lifetimes — fell from about 2.5 in the early 1960s to about 1.4 today2. And people began to live longer — much longer. In the United States (US), the average 65-year-old man could expect to get Social Security benefits for 12 years when the program first started. Today, he can expect to get benefits for about 16.5 years3.
By the 1980s, some countries began to take steps to prepare for the long-term challenges posed by an ageing population. In 1983, the US raised the Social Security normal retirement age — on a gradual basis — from 65 to 67 years old. The United Kingdom (UK) switched pension indexing from wages to prices, dramatically cutting the Government’s long-term pension commitments. And Australia began building a more universal system of retirement provision on employer-based savings accounts (these accounts became mandatory in the 1990s).
Continental Europe, however, largely did not act on pension reform in the 1980s, as the constituencies in favour of large, state-based systems opposed strenuously any retrenchment of their hard-earned pension rights. At the same time, Japan’s strong economic performance and overly optimistic population assumptions masked the need for prompt attention to its pension crisis.
By the early to mid-1990s, however, the momentum for reform began to build, largely due to the economic pressures associated with open global trade, economic integration in Europe, and Japan’s long period of economic stagnation. Political leaders throughout the developed world began to see that state-based pension reform was an important component of economic reform in a competitive global marketplace. In particular, the crushingly high payroll tax rates for state-earned pensions — 20-30% in some countries — were seen as directly contributing to high unemployment and reduced opportunities for younger workers.
And so, beginning in the early 1990s, many developed nations began to seriously pursue public pension reform. While there are notable examples of failed efforts, a surprising number of countries have successfully navigated the treacherous political terrain of pension provision and implemented significant changes in their state-based schemes. Along the way, a few countries have pursued truly innovative and creative solutions to their pension crises which are deserving of mention and study. These approaches, which are summarized below, can provide models for other nations to follow even while recognising that political leaders must tailor their pension solutions to the unique historical and political circumstances found in their respective countries.

1 The New Welfare: The Counter-Ageing Society Conference, Turin, Italy, October 8, 2007.
* James C. Capretta is a Fellow at the Ethics and Public Policy Center and an Adjunct Fellow with the Center for Strategic and International Studies’ (CSIS) Global Ageing Initiative. He is the author of “Global Ageing and the Sustainability of Public Pension Systems: An Assessment of Reform Efforts in Twelve Developed Countries”, a report published by CSIS in January 2007.
2 World Population Prospects: The 2006 Revision (Population Database), United Nations Population Division (h).
3 The 2007 Annual Report of the Board of Trustees of the Old Age and Survivors Insurance and Disability Insurance Trust Funds, Table V.A3, p. 81.

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