Why private pensions can’t fix the ageing problem
Across Europe, politicians increasingly tout private pensions as a cure-all for reviving stagnant stock exchanges, fostering entrepreneurship and curbing ballooning public spending as populations age. But any governments that bet on this solution may be disappointed. A proliferation of individual piggybanks will not solve the deeper challenges that flow from having purchasing power ever-more concentrated in older hands.
According to the United Nations, Europe’s population aged 20 to 64 will shrink by 31% between now and 2100, while longer lifespans will increase the size of the over-65 population by 21%. Because of this shift, the National Transfer Accounts project estimates, opens new tab that older adults will go from consuming 30% of what the economy produces through labour – after subtracting that cohort’s own contribution – to 57% by 2100. In North America, the same numbers go from 25% to 52%.
Meanwhile, measures to keep people working longer are stalling. France’s parliament just suspended a plan to raise the retirement age to 64 from the current 62 years and nine months. And while Germany recently introduced tax breaks for those who choose to keep working beyond 67, it failed to address the underlying rise in early retirees.
All of this adds up to a budget problem, since taxpayers are on the hook to fund citizens’ retirement income in most European countries. Over-65s in France, Germany, Italy and Spain, for example, receive more than two-thirds of their income from so-called pay-as-you-go transfers, which are funded by taxing workers rather than through individuals’ savings pots. These systems, inspired by the 1880s model of German Chancellor Otto von Bismarck, offer generous, earnings-linked pensions. But their current unfunded commitments often exceed four times annual GDP, Bruegel estimates.
Hence why policy experts including the Centre for European Policy and the European Court of Auditors recommend boosting employer-sponsored private pensions instead. The European Union launched a pan-European personal pension in 2022 and pledged to promote auto-enrollment of workers in these plans, though uptake has been tepid.
The basic idea is that state-funded systems should shift to something close to the plans in Denmark, the Netherlands and the United Kingdom. Those countries follow the tradition of British economist William Beveridge, who in 1942 advocated universal, flat-rate pensions, alongside strong employer-sponsored and voluntary pension savings schemes. They have accumulated vast financial assets for participants’ retirement. Many of these plans traditionally promised “defined benefits,” risking shortfalls if returns disappointed, but countries like the Netherlands and Britain have shifted over time to “defined contribution” plans. If all countries’ pension systems were exclusively based on this structure, fiscal sustainability would be guaranteed: retirees would be paid whatever their equity and bond portfolios returned, with no recourse to the state.
But this only underscores that financial sustainability is a poor economic metric for the problem at hand. The commonsense argument for private pension pots rests on a misleading analogy between households and the state. For individuals, setting aside money each year leaves a nice nest egg for retirement. At the national level, however, that’s the wrong way to think about it.
Equities and bonds are only valuable because they represent a claim on future economic activity. In an ageing world, the dwindling proportion of workers means that those claims have less value relative to the actual goods and services an economy produces. The mismatch between retirees and producers could manifest in different ways. One possibility is that asset prices fall or stall in ageing societies, as economic growth falters and younger people can’t afford to buy financial securities, opens new tab from income-hungry seniors. Another is through inflation, with more pension-pot cash chasing the output of a smaller cohort of wage earners. In other words, private savings can’t change the fact that Europe is going from 49 workers per 100 consumers to just 40 by 2100, according to NTA projections.
There’s another, more nuanced argument in favour of individual piggybanks. Economists reckon that nations with higher savings rates are more productive later on, meaning that private pension pots should lead to a bigger future pie for seniors to take a bite from. This rests on the idiosyncratic use of language in economic theory. Textbooks render “savings” as an absence of consumption. A new data centre, for instance, expands GDP by adding an investment that can’t be consumed, so the economy has saved more by definition. But this hypothetical company saw a profit opportunity and paid for it with a combination of retained earnings and debt, regardless of, opens new tab the country’s pension design. It’s the investment, not the private pension system, that raises output per worker. Bigger retirement piggybanks need not lead to more investment: if households buy less and revenues for firms fall, they may instead cut back on capital spending.
To be sure, a big pension fund industry can still lower the cost of capital for companies if it makes savers embrace risk. On the other hand, ageing will increasingly limit pension funds’ ability to take such risks. Many in Canada already have more payouts than contributions, the IMF has noted, opens new tab, raising their need for safer assets. Overall, countries with big pension pots don’t visibly invest more: gross fixed capital formation is roughly 23% in both France and Denmark, yet their retirement assets stand at 11% and 192% of GDP, respectively, according to the Organisation for Economic Co-operation and Development.
What the data does show is that seniors face more income inequality in places where public pensions are smaller. Private pension systems, in addition to having hefty management fees, won’t alleviate the need for old-age subsidies, because citizens’ ability to invest is so lopsided. In large developed economies, the top 10% of households hold more than 50% of wealth. There is also a danger that, if pension piggybanks get too large, richer people stop working early even as the statutory retirement age increases. Denmark’s threshold is now set to gradually rise to 70 by 2040, leading the way among rich nations. Yet its effective retirement age is 64.5, as fat domestic savings pots allow people to hang up their boots earlier.
An alternative would be to place most schemes under something like the Canadian Pension Plan (CPP), a national contributory program that mixes pay-as-you-go with funded pensions and keeps direct control of when benefits can be claimed. By having a single pool of money serving a single client, the CPP is also less exposed to redemption risks and can make longer-term investments. Or officials may need to start means-testing pay-as-you-go schemes, like Australia does. For excessively large private savings, generous tax advantages may eventually need to be scaled down.
The takeaway is that no pension redesign can avoid the need to prolong working lives. Even without a national budget crisis, seniors potentially consuming half of the economy is a problem.
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