EUROPEAN PAPERS ON THE NEW WELFARE

The Global Aging Preparedness Index: A New Tool for Assessing How Well Prepared Countries are for Global Aging

Overview of the GAP Index Results

Figure 4 presents the overall results for the fiscal sustainability and income adequacy indices. What’s most striking is that very few countries score well on both indices. Three of the seven highest-ranking countries on the fiscal sustainability index (Mexico, China and Russia) are among the seven lowest-ranking countries on the income adequacy index. Four of the seven highest-ranking countries on the income adequacy index (the Netherlands, Brazil, Germany, and the U.K.) are among the seven lowest-ranking countries on the fiscal sustainability index.

Figure 4: GAP Index Country Rankings

The emerging markets generally score much better on fiscal sustainability than income adequacy. In the developed countries, with their expansive welfare States, the trade-off is precisely the reverse. There are, however, a few notable exceptions. Brazil, which spends more on pensions than many rich countries, scores spectacularly on adequacy, but dismally on sustainability. There are also two developed countries that score near the bottom of both indices: France and Italy. To rein in the rising cost of their pay-as-you-go old-age benefits, these countries have enacted pension reforms that dramatically reduce the generosity of the public “deal” that future retirees can expect to receive. Yet France and Italy have such expensive old-age benefit systems that, even after the reforms, they remain on a fiscally unsustainable course. In short, both countries are moving towards retirement systems that are all at once inadequate and unaffordable.

The few countries that score well in the GAP Index on both dimensions of aging preparedness generally have modest pay-as-you-go State benefits, large funded pension systems, and high rates of elderly labor-force participation. Australia, which combines a low-cost, means-tested floor of public old-age income support with a large, mandatory, and fully-funded private pension system, ranks well into the top half of both indices. So does Chile, which has a similar mix of retirement policies. Canada and the United States, with their well-developed private pension systems and large numbers of working elderly, also do a better job of balancing fiscal sustainability and income adequacy than most countries.

Several other countries, moreover, are clearly moving in the right direction. Like France and Italy, Germany and Sweden have scheduled deep reductions in the future generosity of their public pension systems. But unlike France and Italy, they are on track to fill in the resulting gap in elderly income by increasing funded pension savings and extending work lives. Although their fiscal burdens remain high, they have been cut well beneath what they would otherwise be without undermining adequacy.

This contrast points to a crucial lesson. Most of the world’s developed economies—as well as a few emerging markets—will have to make large reductions in the generosity of State retirement provision to stave off fiscal Armageddon. But unless reforms also ensure income adequacy for the old, the reductions are unlikely to be socially and politically sustainable. This is especially true in Europe, where State benefits make up a huge share of total elderly income. In France, Germany, Italy, and Spain, over 70 per cent of the income of the typical elder comes in the form of a government cheque.

The example of the U.K. should be heeded. In the 1980s, the U.K. switched the indexation of its basic State pension from wages to prices, flattening the projected growth in old-age benefits as a share of GDP. However, as price indexing caused benefits to decline steadily as a share of wages, concerns about the reform grew. In 2007, amid an emerging consensus that current policy would impoverish the elderly, the government re-indexed benefits to wages. The U.K. now scores much better on income adequacy than it would have ten years ago, but it also scores much worse on fiscal sustainability.

One might object that the better prepared countries have more favorable demographics than the worse prepared countries. This is generally true, though it is worth pointing out that the demographic outlook in Australia, Canada, and the United States gets a big boost from immigration, which is a matter of policy choice. Nor is demography necessarily destiny. The aging trend in France, which has the highest fertility in Europe, is no more severe than in Australia or Canada. Yet it ranks near the bottom of both indices. Japan, despite its massive age wave, ranks in the middle of both indices, thanks to its relatively modest per capita public pension benefits, which help to minimize the fiscal burden, and its high rates of elderly labor force participation and multigenerational living, which help to boost old-age income. In short, policy matters.

Conclusion

Clearly, global aging poses a daunting economic and social challenge. Many fast-aging countries, especially in the developed world, face a difficult choice between relieving the growing fiscal burden on the young and maintaining adequate income for the old. In most developing countries, the choice is just the opposite: whether to impose a new fiscal burden on the young in order to relieve the growing vulnerability of the old.

Yet just as clearly, there are many strategies available to address the challenge—and not all involve painful trade-offs. The GAP Index includes a reform guide that assesses the urgency and potential payoff in different countries of seven key reform strategies, from reducing public pension benefits and healthcare cost growth to strengthening old-age poverty floors and increasing fertility rates and immigration. Two strategies in particular—extending work lives and increasing funded pension savings—are especially important, since they allow countries to escape, or at least to mitigate, the trade-off between fiscal sustainability and income adequacy. In fact, they are the only means by which aging countries can maintain or improve the adequacy of income for the old without imposing a new tax or family burden on the young.

With much of the world still reeling from the global economic crisis that began in 2008, many policy leaders may conclude that now is not the right time to address the long-term challenge of global aging. This would be a mistake. In fact, the economic crisis has made timely action even more urgent. It has drastically reduced the fiscal resources that most countries have to accommodate rising old-age benefit costs. At the same time, it has left many elderly people more vulnerable. There’s also the critical issue of confidence. The public and the markets increasingly worry that governments have lost control over their fiscal future. In this sense, taking credible steps to address the long-term aging challenge may be a necessary part of ensuring near-term recovery as well.

 


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