Clock is ticking on pension time-bomb

Date: 28/09/00

By Tim Jones

FORGET the plunging euro. Europe will soon have a real problem on its hands: a full-blown pensions crisis.

Within 30 years, the proportion of the European population aged 65-plus will rise from 16% to 25% and will top 28% by 2050. By then the ratio of the working-age population to those over 65 will fall from four today to 2.4 in the UK, 2.3 in France, 2 in Germany and a mere 1.5 in Italy.

Since EU countries operate state-funded pay-as-you-go (PAYG) systems, under which pensions are effectively paid by the contributions of active workers and companies' payroll contributions, these demographic trends portend a serious problem - so serious that it has got more than just the think-tanks thinking.

John Hawksworth's macroeconomics unit at PriceWaterhouseCoopers caused a splash in March when it published a report entitled New Europe: The European Pensions and Savings Revolution.

According to the PwC model, the German and Italian state pension schemes would require an increase in the retirement age to 70 and 72 respectively if they continue to be linked to earnings and contribution rates remain the same. "Ultimately the choice for all European countries is stark: higher taxes and social security contributions, or less generous state pensions," concludes the report.

In its European Pensions: An Appeal for Reform report published in February, the European Round Table - a forum of 48 top industrialists - points out that by 2030 employees in Italy will need to contribute 48% of their salaries to balance the pensions budget.

Instead, say ERT and PwC, the real solution is more affordable state pension schemes, encouragement of private pension provision, labour market reform to boost participation rates and wider pro-market reforms. For this reason, the European Commission has revived its long-delayed plan to remove the remaining barriers to occupational pensions investment funds.

In a speech to German industrialists last week, Internal Market Commissioner Frits Bolkestein lamented that pension funds are "the only major financial institutions unable to provide their services in a member state other than their own on the same conditions as banks, insurance companies and investment firms".

This position is vigorously supported by the European Federation for Investment Funds (FEFSI) in The Future of Supplementary Pensions in Europe, a paper produced for the Pensions Institute at London's Birkbeck College.

Yet the argument is far from one-sided. For example, The Future of Pensions in Europe, a paper for the London-based Centre for Economic Policy Research written by economists Michele Boldrin, Juan Dolado, Juan Jimeno and Franco Peracchi, turns the PAYG time-bomb theory on its head.

The authors argue that the crisis, if it comes, will be a direct result of high unemployment in many European countries and the wrong-headed policy of forcing elderly workers to retire to make room for labour-market newcomers.

In their view, PAYG schemes are an "essential component in a sustainable pension system" since they balance out the "educational transfers" made by parents to their children when they were working.

In their forthcoming book Quel Avenir pour Nos Retraites?, Gaël Dupont et

Henri Sterdyniak, economists at the Observatoire Français des Conjonctures Economiques (OFCE), take a similarly defensive line towards the 'European model' of retirement provision.

Arguably the most generous and popular state-led systems are to be found in the Nordic countries; a fact reflected in the hard-fought campaign over euro-zone membership which ended today (28 September) in Denmark. Yet Nordic Council governments know they cannot go on as they are. For this reason, the council commissioned a joint study from Tryggvi Thor Herbertsson of Iceland's Institute of Economic Studies, Peter Orszag of Sebago Associates and Michael Orszag at Birkbeck College.

When they presented their report in May, the three specialists called on the council to take the radical steps of pegging the minimum early retirement age to economic conditions, increasing payments into the system up front to ensure that more of the schemes were funded, and allowing cross-border investment.

The simple solutions are politically the toughest. Merrill Lynch, the US investment bank, once famously calculated that Europe's pensions time- bomb would be defused at a stroke if the minimum retirement age were raised to 70. Alternatively, as several think-tanks propose but with little expectation, governments could follow the British path and scrap the link between average earnings and state pensions.