TIME EUROPE
May 29, 2000 VOL. 155 NO. 21
Stayin' Alive
By CHARLES P. WALLACE Frankfurt
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The second factor is that people are living longer. While medical breakthroughs extend life expectancy, pension programs have to pay out far longer than anticipated. Peter Hicks, administrator of the social policy division at the Organization for Economic Cooperation and Development (O.E.C.D.) in Paris, says one statistic summarizes Europe's problem: in 1960 a European worker lived an average 68 years, with 50 of them spent working. The other 18 years went first in schooling, then in a couple of years of retirement. Today, the average worker lives 76 years, with only half the time in paid employment and almost two decades in retirement. "The most dramatic demographic change one can conceive of has happened in only four decades," says Hicks.
This daunting actuarial calculus helps explain why Germany has avoided grappling with a solution to its pension problem. Even today, when the number of workers is still relatively high, payroll deductions cover only two-thirds of Germany's annual pension obligations of $193 billion, with the rest made up by value added taxes, levies on gasoline and transfers from the general budget. With pension insurance already claiming 19.3% of a worker's wages, Germany doesn't have much room for maneuver. One private study suggested that contributions will have to rise to between 23% and 24% by 2030. Germany already has a crushing income tax burden. The Bundesbank, the German Central bank, says the only logical answer is to cut benefits. But when the government of Chancellor Gerhard Schröder proposed last year to merely slow the rise in benefits, his party lost five straight state and local elections.
The French government has succeeded in pushing the retirement age in the private sector to over 60 by increasing the minimum time at work to qualify for a full state pension to 40 years. But a landmark 1999 study of the French pension system by economist Jean-Michel Charpin warned that unless further reforms are made, pension payments will balloon from 11.6% of GDP to 16% in the year 2040. Charpin proposed an increase in the pension qualification period to 42.5 years worked, and its application to France's 4.5 million public sector employees — who currently work just 37.5 years to qualify for state pensions representing 75% of their final pay.
Successive Italian governments treated the state pension system as a pork barrel, with most employees able to retire in their mid-50s with 35 years service, and state workers getting a pension after only 19 years in the job, until the rules were changed early this year. The minimum was further reduced by military service, college, even maternity leave. "A women with a college degree, a government job and a couple of kids could have the right to a pension after seven or eight years," complained Giulio de Caprariis, deputy director of the research center of Confindustria, the Italian employers' association.
With evidence of the demographic change abundantly available for two decades, why has it taken European governments so long to respond? The answer is a lack of political will to take away one of the most popular government benefits. Few politicians have forgotten the massive protests and strikes that convulsed Paris in 1995. "By failing to react immediately," warned French President Jacques Chirac in September 1999, "we're accepting the question will be treated at the last minute by brutal increases in taxes, reduction of pension payments, or both at once."
Most experts recommend that governments adopt a "multi-pillar" approach to pension reform using a combination of the traditional pay-as-you-go state pension and so-called funded pensions, in which workers save by contributing to a retirement account. Some degree of self-funding gives incentive to work longer, and helps bolster a country's financial markets by creating a large pool of invested savings. An example of how a multi-pillar system works can be found in Hungary, where three years ago the post-communist government found it had no choice but to scrap the old system (see box).
But apart from Switzerland, which has a mandatory private pension system, Britain is the only West European country that has tried to move away from dependency on a state pension. Successive British governments, beginning with Margaret Thatcher's, have guaranteed only a minimum retirement benefit. It now stands at $430 a month, compared to $492 in France. Additional options allow people to select from an occupational state pension scheme, a pension provided at work, and a private pension plan such as an insurance policy or investment account. Overall, the average monthly pension in the U.K. stands at $850.
This means Britain is not facing the same financial crisis confronting Continental nations. Another benefit is the impact on financial markets: pension fund assets are over 75% of GDP in Britain, but a mere 6% in Germany and just 1% in Austria. Countries that encourage private pension funds tend to have more money available to finance new companies, helping expand economic growth.
In spite of the demographic and fiscal pressures facing them, for most European countries a switch to a largely private system is ruled out for ideological reasons. In France, they call state pensions "generational solidarity" and the idea is broadly popular in most other countries. When Sweden began working on pension reform, for example, privatization was never given serious consideration. Perhaps for this reason, Swedish political parties, from nearly all points of the political spectrum, were able to agree on the terms of the reform, which is being phased in over 20 years. It's probably the most far-reaching change yet implemented in Europe.
The Swedish plan increases the tax burden: to pay for it, pension contributions rose from 13% of wages to 18.5%. What is revolutionary, at least for Europe, is how those contributions will be handled. The first 16 percentage points of the pension contribution will be used to finance the existing pay-as-you-go system. But while funding stays the same as under the old system, contributions will be recorded as if they were financing an individual account of a funded pension system. This mathematical conjuring, known as a notional account, will encourage people to stay in the job longer by offering bigger pensions for each extra year of work. The rest of the contributions will be placed in an investment account for each individual, who will have more than 500 mutual funds to choose from. "We got it right, it's a very sound system," boasts Anna Hedborg, director of Sweden's national social insurance board.
Italy was an early convert to the Swedish system of notional accounts. But unlike the Swedes, the Italians adopted a very long transition period and built in a deficit to their new pension, almost ensuring a financial crisis later on. Germany has embraced the idea of putting a mandatory 2.5% of wages into individual savings accounts as the foundation of a funded system. Unlike the Swedes, the Germans haven't yet admitted that the other pension contributions will also have to rise. A pension summit of all political parties is scheduled to be held in Berlin next month to try to reach a compromise that will allow reform to get off the ground next year.
Because the real crunch is two or more decades away, it's tempting to leave the problem for another government and another day. As the Swedish example has shown, there will be pain in the transition. Yet it also shows that for the next few years a non-radical, gradual solution is still possible, one that that makes the system fairer and more transparent. But if politicians in countries like Germany and France remain too scared of voters to bite the bullet on pensions, then when the final reckoning inevitably arrives, it will be more painful — and the political fallout far worse. The time bomb is ticking louder by the day.
— With reporting by Greg Burke / Rome, Bruce Crumley / Paris and Jennie James / London
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May 29, 2000
COVER
Beyond 2000: A New World of Work
EUROPE
Shell-shocked
Angry Dutch residents want answers after a fireworks factory explodes in the middle of their neighborhood
Power Grab
Putin reveals his leadership plans
Rebel Yell
Serb protests against Milosevic's media crackdown kick-start opposition leaders into action
Campaign of Terror
Greece is second only to Colombia in its number of anti-American terrorist attacks
Viewpoint
The E.U. needs a constitutional framework
AFRICA
Ray of Hope
A warlord's capture sparks jubilation in Freetown
BUSINESS
BooHoo.com
A much-hyped dotcom has gone belly up. How many more will follow?
TIME FINANCE
The Pension Problem
As the number of workers to support retirees dwindles, Europe's governments must face a looming financial crisis
Your Money
Rules for planning your retirement
Viewpoint
The early bird can't always expect success
DEPARTMENTS
To Our Readers
World Watch
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