IF volunteer Connor McCarthy reports on how demographic changes across the OECD have forced governments to use a variety of strategies to reform pensions, with varying success
Ageing OECD
The world’s demographic structure is changing like never before in human history.
In developed countries, particularly members of the Organisation for Economic Co-operation and Development (OECD), low birth rates and rising life expectancy are leading to demographically imbalanced populations. In 2013, the average old-age support ratio (the number of those aged 20-64 divided by the number of those over 65) of the OECD was 3.8; by 2050, this average is expected to drop to just 2.1. In the long-term, lower births and increasing life expectancy are welcome, as they help lead to a more stable and balanced population. But in the short-term, the uneven demographic transition poses an array of policy problems, most prominently in terms of pensions.
Work hard, save hard
One of the key policy challenges facing OECD countries is trying to ensure that pensions provide a financially sustainable and adequate income without burdening future generations. Three main policy routes have been attempted in response to this dilemma.
The first is to encourage saving among people who are of working age. Many OECD countries have promoted the use of private pensions, and/or established defined contribution schemes. The UK created the National Employment Savings Trust (NEST), a defined contribution scheme where employers and employees pay money into a savings fund to be used in retirement. Ireland will soon follow this idea, and countries like Israel and South Korea also have similar mandatory occupational plans.
Other countries, like Poland, are increasingly encouraging citizens to take up private savings schemes, but these voluntary schemes often lead to smaller savings than opt-out or mandatory schemes.
Defined contribution schemes such as NEST can be very useful, as they enable individuals to build up a private pension income which should reduce their burden on the state during old-age. However, they also have their drawbacks: encouraging private pension saving can negatively entrench growing inequalities, as more affluent groups will be able to save more than poorer ones. Low-paid workers or unemployed people are likely to save less, leaving them worse-off. ,
Moreover, this move could make it seem like younger generations are effectively paying twice: for their own pension via contributory schemes, and for the pensions of older generations through tax. This is intergenerationally unfair, and is likely to diminish popular support for the pension system.
Grey pound to pennies
A second policy trend is to making pensioner benefits less generous. Lowering pensions is the most obvious way of doing this, but this could reverse good steps to reduce pensioner poverty. Between 1997-2005, pensioner poverty decreased from 27% to 18% in the UK, and lowering pensions could have unfair negative impacts on the elderly, especially the less affluent.
Instead, steps are being made to reduce intra-generational inequalities between the elderly. Pensions and benefits are being increasingly means-tested, most notably in Australia, as well as Greece and Mexico. Furthermore, Norway has replaced their flat-rate contribution pension with an income-tested pension, giving extra weight to those who rely on the state pension most.
Mean-testing state pensions helps to return pensions to their primary purpose: to provide a social safety net for older generations so they can enjoy an adequate standard of living. Universal state pensions can end up merely topping-up the incomes of pensioners who are already affluent, so means-testing is a justifiable method of helping governments to save money.
But the state pension is often also supplemented by a range of other old-age benefits, which there are strong arguments in favour of means-testing; in the UK these include free TV licenses and Winter Fuel Payments. By also means-testing additional pensioner benefits, this can prevent what Lord Baker described as “absurd” gifts to rich pensioners, and instead target those that depend on the assistance the most.
OAW – Old Age Worker
The third and most common policy is to extend the number of years that people spend working, in order to try and stabilize the ratio of workers to those who are retired.
Most OECD countries have plans in place to increase retirement ages, with the OECD male average expected to increase from 64 in 2013 to 67 in 2050. However, there are two notable exceptions. France reduced the official retirement age back to 60 in 2012 (though plans are in place to increase it again to 62), and Germany is preparing to lower the pension age for certain workers to 63. Given the demographic profile of these countries, lowering the state pension age looks highly questionable.
Regardless of what happens to the state pension age, higher life expectancy should mean that people are generally healthier for longer, and therefore should work longer – and many already do. Over 1million over-65s now work in the UK, 10% of the age cohort, which is the highest figure ever recorded. However, it can be argued that the pension age should rise faster than is currently planned in many OECD countries to help reduce the burden on younger generations. Of course, this needs to go alongside providing adequate support for workers with health problems, or those in more physically demanding jobs, who may not be able to extend their careers into their 70’s, for whom retirement may still have to come earlier than it does for their more able-bodied counterparts.
Spreading the cost
Pension systems always involve governing the interests of people who belong to different generations. The key to a sustainable and fair pension system is ensuring a sufficient balance between intragenerational (within generations) and intergenerational (between generations) aspects of justice.
Many OECD countries are primarily pursuing just one type of policy. However, a mix of all three appears to be the most fair to all. Despite many flaws in the UK pension system, the OECD has praised the UK’s pension reforms for attempting to mix all of these policy routes together, and attempting to plan fairly for the future. By spreading the reforms across generations, it will help reduce the burden until a demographic rebalance naturally occurs.
Ultimately, it is only fair that younger generations should not be burdened to an excessive degree by the costs of the older generation. Nonetheless, it is also only fair that cuts and compromises should not affect the less affluent or less fortunate, regardless of how old they are.