The European Social Pension: A Theoretical Exercise


The innovative work of Atkinson et al. (2002) put forward the idea of establishing a European Minimum Pension, which required that all current pensioners with incomes below this minimum standard would be brought up to the limit by a supplementary pension, financed by the corresponding Member State. In this article it is suggested that the supplementary pension be named European Social Pension and be provided by the EU, with a corresponding increase in the EU Fiscal Budget.
The basic characteristics of the proposed scheme are described in detail. It is argued that the proposed scheme could eliminate poverty among the retiring generations of European pensioners who were the founders of the Union, and at the same time it would send the message out across the Continent that a ‘New Beginning’ is underway in the EU, with beneficial effects on the social acceptance of its political evolution.

1. Introduction

In the European Union social policy remains firmly a national responsibility, under the principle of subsidiarity. Even harmonization of nationally conducted policies appears a long way off. Yet the Lisbon European Council in March 2000, stressed the need to promote social cohesion of the EU by eradicating poverty. The procedure proposed for doing that was the benchmarking policy of the Open Method for Coordination.
Atkinson et al. (2002) have suggested an innovative approach to reduce poverty in retirement, by establishing a ‘minimum standard’: the European Minimum Pension. This would be a supplementary benefit to be offered to each pensioner by member-countries to meet the shortfall, when his/her income from pension sources falls short of the European minimum standard.
The aim of this paper is to set out on a theoretical exercise. That is, to propose the financing of the European Social Pension (the supplementary benefit required to reach the European Minimum Pension standard) by means of the EU Fiscal Budget, even though such a prospect may appear far removed from current policy concerns.
At the level of constitutional reform the EU is at a stalemate. There is no consensus on the direction of the Union’s political evolution. Therefore, the EU has become a common currency area where national governments have been deprived of any monetary policy tools, whereas the Fiscal and Stability Pact has effectively eliminated the possibility of using fiscal policy measures. In such an economic environment, the relative competitiveness of the member-states determines the real distribution of incomes and, moreover, all adjustments take place at the level of employment. But labour market integration, which has been attained in all other common currency areas (U.S.A., Australia, Canada), is a very remote goal for the EU. The situation is exacerbated by the forces of globalization. The most likely outcome of this process will be increased social tensions and endangerment to social cohesion in all member-states.
Despite the fact that a federal union appears remote, it is argued that the establishment of a European Social Pension will be viewed across the continent as the first step in shaping the Union’s missing core identity: cooperation on a continent-wide level to improve people’s lives.
The next section reviews the limited literature that deals with the issue of harmonization of pension systems in general in the EU and the issue of the European Minimum Pension in particular. The third section provides the basic arguments for the establishment of the European Social Pension and describes the basic characteristics of the proposed scheme. The last section contains the conclusions.

2. Review of the Literature

Dréze in a seminal paper (2000) argues that the goal of alleviating future uncertainties can be fostered through mutual insurance. Such a system, whereby the lucky ones who will do well tomorrow help out those who will do poorly, enhances ex ante the prospective welfare of all, at a gain of overall efficiency. The ex ante viewpoint suggests a high degree of ex post equality, driven by considerations of risk-sharing efficiency. But ex post equalizing transfers raise issues of moral hazard, productive efficiency, fiscal competition, etc. Reconciling the two conflicting efficiency motivations brings us into the realm of second-best analysis.
This analytical framework may be applied directly to the European level, by suggesting guidelines for a Union-wide social security system for pensions or disability allowances or unemployment benefits (Dréze, 2000, p. 336). This would result in substantial redistribution between member-states — exactly the kind of transfers which the union has so far rejected — limiting itself instead to the targeted programs covered by the so-called structural funds.
In this framework, two more points are relevant. The first is about fiscal competition. The process of European integration carries the threat of depriving national member states of the ability to pursue autonomous social insurance policies (Sinn, 1990, 1998; Atkinson, 1995, ch. 14). For example, a member- country implementing a social insurance scheme which redistributes income from highly skilled workers to less skilled workers induces at equilibrium a more compressed wage distribution in the Union as a whole, thereby reducing the cost of implementing similar policies in other member countries. That is, there is an externality, not captured by the first country. Superior equilibria require cooperation, either in the form of an integrated Union-wide social insurance scheme, or in the form of lump sums or matching grants from the Union to member- states. Sooner or later the EU will have to face the problem of promoting efficiency in markets for private goods while accepting inefficiency in the area of social insurance.
The second point is a direct result of Dréze’s analysis. Risk sharing at the European level could be achieved on a two-tier basis, with the countries sharing macro-economic risks in addition to organizing domestic social security. He proves, however, that efficient risk-sharing is not feasible, because of moral hazard and adverse selection problems. In such a case, one might look for a second-best solution. But then there are serious practical problems, such as: choice of instruments, estimation of parameters, and concerns regarding political feasibility. In this framework, Dréze states a benchmark of second-best policies, with reference to federal nations, like the U.S.A. and Canada. In these nations the federal tax-and-benefit systems imply a form of mutual insurance among the member states. A standard reference figure for the US is that 30-35% of idiosyncratic shocks affecting value added in an individual state are absorbed by the federal tax-and-benefit system. In other words, there is a mutual insurance scheme pooling 30-35% of state incomes. In EU-15, it has been estimated that some 45% of medium-income risks could be eliminated through mutual insurance (Forni and Reichlin, 1999).
Holzmann (2006) makes the case for a coordinated pension system in Europe. He argues that the current trends in pension reforms in the EU are based on the Open Method for Coordination, which is inadequate because: a) it takes the diversity of European pension systems as given, and b) it is still limited to fiscal issues at national levels. His main argument is that a Pan-European pension reform approach resides in European economic integration. The objective of common markets for goods, services, and factors of production under a common currency, has implications for provision of retirement income: a) budgetary implications, b) the need for more labour market integration, and c) the need for enhanced labour supply in an ageing population.
The first implication of the operation of pension systems is on the ‘growth and stability pact’ which requires a structural budget deficit of zero%. But many countries will not be able to achieve a zero budget deficit in a sustainable manner, unless the pension system is reformed and explicit or implicit transfers from the budget are curtailed. In a common currency area there is a need for budgetary adjustments to deal with asymmetric shocks hitting some member-states and not others. Given the limited effectiveness of fiscal policy and the non — availability of exchange rate and interest rate policies, the only other main policy instrument, labour market flexibility, has to come into play.
The need for labour market flexibility is very important in the European economic integration framework. Labour market flexibility implies wage flexibility and migration. Both of these factors are of little importance in the EU because of rigid labour markets and cultural and linguistic barriers. One important mechanism to support a common currency and adjustments after shocks is a pension system that does not lock persons into sectors and countries, but instead supports full labour mobility across professions and states. Such a harmonized pension system characterizes other economically integrated areas under a common currency, such as Australia, Brazil, Canada, Switzerland, and the United States. Finally, the long-term value of the euro is likely to be determined or at least co-determined by the growth expectations of the EU. If falling population and ageing are not better compensated for through increased labour supply, resulting from higher labour market participation, delayed retirement, and increased external migration, the impact on GDP growth will be substantial.
Having made his case, Holzmann admits that while a Pan-European pension system would help remove current constraints on labour mobility, by reducing the relative transaction costs, in and by itself it would be insufficient. Other national social programs must be harmonized, as well.
Atkinson et al. (2002) have made the strongest case, so far, for a European Minimum Pension (EMP). Assuming that the process of harmonization of the European pension systems is a long way off, they adopt the benchmarking approach of the Open Method for Coordination and suggest that the European Union sets a ‘minimum standard’ requiring the member-states to provide a minimum old-age pension, the European Minimum Pension. The aim of such a pension is to ‘target’ public spending on the elderly in order to reduce poverty among this group. If income from pension sources in a member-state falls short of the specified level, then a pension supplement is paid to meet the shortfall. A pension guarantee would be provided and financed by national governments. The role of the EU is purely in setting the minimum standard. The redistributions that take place within each national economy are estimated on the basis of a prototype Europe-wide tax-benefit microsimulation model. The model is applied to five countries (France, Germany, Ireland, Italy, and the United Kingdom). The results have demonstrated the sensitivity of the conclusions about the effect of the anti-poverty reform to assumptions made in determining a common poverty line and in identifying poor households. It was proven that the use of a common instrument does not necessarily lead to the uniform achievement of a common objective. The most important aspect of the innovative work of Atkinson et al. is in the completeness of the methodology. All possible parameters of such an anti-poverty scheme are identified and evaluated in a Pan-European context. We use most of the findings of this study to formulate our proposals in the next section.

Milton Nektarios: Associate Professor of Insurance, Department of Statistics and Insurance, University of Piraeus, Greece, e-mail:

Pages: 1 2 3

Tags: ,