Fixed retirement ages make no sense for ageing populations
A SPECTRE haunts finance ministers in the world's rich countries. Looming ever closer is the retirement of the big baby-boom generation born after the second world war. In France, where the retirement age is 60, the demographics start to turn sour as early as 2006. In most other countries, with a retirement age of 65, the date of reckoning is 2011. As the outlook deteriorates, so too will these countries' public finances. Fewer workers will pay contributions into pay-as-you-go state pension systems; more people will be drawing a pension from them.
The shock to state pension systems is not caused only by past fluctuations in fertility—the ageing of the baby-boomers, as they become pensioners, and their replacement by a smaller generation of younger workers. It also arises from the rapid advance in life expectancy at older ages. Although naturally welcome, this is extremely costly, so long as retirement ages remain fixed. Company pension plans, for example, have been undermined not only by falling stock prices in the bear market, but also by rising liabilities as a result of increased longevity.
As if this were not enough, the effective retirement age (a weighted average of the ages when people actually withdraw from work) is often a lot lower than the official retirement age. For example, the effective retirement age for men in Germany is 60.5, whereas the official age is 65. Only half of 55-64-year-olds in the OECD group of rich countries are in work, compared with three-quarters of 25-54-year-olds. Only 39% of 55-64-year-olds in the European Union are still in work.
Early retirement compounds the effect of population ageing, since it increases the number of pensioners and cuts the number of productive workers. Recourse to state welfare increases. Meanwhile, the tax base is whittled away. In 1998 the OECD said that the adverse impact of early retirement on future living standards could be as large as that of population ageing itself.
That message was intended to spur reform of the various incentives in pension and welfare systems that promote early retirement. So how have governments been doing? In a new report*, the OECD says that, in general, state pension systems do not encourage retirement before the age of 60. But in many countries they do create significant incentives for people to retire in their early 60s. And there are other exit routes into early retirement. For example, people in their late 50s may draw generous benefits through special unemployment schemes. Disability benefits offer another exit route, with take-up often reflecting not poor health but incentives to retire early.
Even if the tide of early retirement can be stemmed, which seems improbable on the basis of the evidence in the report, there are other pressures. Projections of age-related spending for a group of OECD countries show that total spending on old-age pensions, early retirement programmes, and health and long-term care, now 15% of GDP, will rise to 22% of GDP by 2050. If life expectancy rises faster than these forecasts assume, the eventual bill could be higher.
Stemming the tide of early retirement, even though it will not be easy, is too modest a goal. In an ageing world, the ambition has to be to encourage later retirement. Indeed, the whole idea of retirement at a pre-fixed age needs to be put out to grass. This vision of an end-chapter to people's lives was born when manual labour was the norm and life in retirement was much shorter. Now most people work in jobs in which physical fitness is no longer paramount, and they can expect to live for nearly 20 years after the age of 65. Why should people living longer, healthier lives also feel they are automatically entitled to spend less time working and ever more time in retirement?
Population ageing poses an economic problem only because the normal retirement age for state pension benefits has become ossified. Politicians know that they raise it at their peril, so any increases are small, and delayed as long as possible. What is needed is an automatic way of adjusting retirement to rising life expectancy. The solution is to get rid of the idea of a normal retirement age and to link state pension benefits explicitly to life expectancy, so that they retain their value only if taken later rather than at the current retirement age. This sends a clear message: save more if you want to retire earlier, or work longer.
Define and fall
A response to population ageing also requires a rebalancing of pensions away from defined benefits, where the pension provider promises a given pension at a given age, towards defined contributions, in which pensions depend on the amount saved and the investment returns it generates. The case against defined-benefit pensions is that they encourage people to leave work at the earliest eligible age. The case in favour of defined-contribution pensions is that they encourage later retirement, since every extra year worked increases the pot of pension money. Defined-contribution pension plans are genuinely funded, but the approach can be extended to state pay-as-you-go schemes, by creating “notional” accounts. This concept, pioneered in Sweden in the 1990s, has been adopted by several other countries, including Latvia and Poland.
Preparing ageing societies for a new age of longer life will take more than remodelling pension systems. If older people are to work longer, they need to retrain and to update their skills and expertise for longer. Lifelong education should be turned from a political slogan into a reality. And employers need to think hard about providing new, more flexible forms of employment for older workers. More than anything, a leap of the imagination is needed to meet the challenge of population ageing.
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