David Kingman reports on recent research from the OECD which argues that delaying the start of working life has significant long-term repercussions for pension savings 
One of the worst features of being unemployed when you are a young person is that it can have economic repercussions that you feel for the rest of your life. Economists have already established that it tends to leave a “wage scar”, whereby someone who is unemployed when they should be at the start of their career can suffer from lower than average wages for decades afterwards. Now, recent research from the Organisation for Economic Co-operation and Development (OECD) shows that youth unemployment also does further damage by undermining pension saving, placing millions of young people across Europe at risk of having an inadequate income when they are older.
Pensions at a Glance
This was one of the key themes of the recent Pensions at a Glance 2013 report published by the OECD on 26 November.
Many European countries have been grappling with extremely high levels of youth unemployment ever since the start of the recession in 2007. In the UK, nearly a million people aged 16–24 are currently out of work, almost a third of whom have been unemployed for 12 months or more. Even though the British economy appears to be finally showing some signs of improvement following its long slump, a return to growth may well not be sufficient to help many of these young people by itself. Long-term youth unemployment is a complex problem, solutions to which also need to address related issues such as poor education, low aspirations, the lack of good advice and guidance and the decline of Britain’s traditional industries.
For the government, youth unemployment is an expensive problem. Almost 336,000 18–24 year olds are currently claiming Jobseekers Allowance, and there is a danger that too many of them will simply end up joining the ranks of adults who are long-term unemployed if they don’t manage to find work.
The OECD report makes the point that it will also prove costly for the government in the long term if it leads to these people having lower incomes in old age. OECD employment specialist Stefano Scarpetta offered the following judgment:
“It is of great concern that many countries are building contributory pension systems when they have large numbers of unemployed young people who cannot contribute and will have very low retirement incomes.”
The report highlighted that this is a particular danger in Britain because of the strong role played by private pension saving under the British model of funding old age. The OECD compared the typical “replacement rate” achieved by pension income across its different member states; this is the percentage of their annual pre-retirement income that a typical worker can expect to receive in retirement. The report emphasised that the UK is something of an outlier, especially compared to most of the countries in continental Europe, because state retirement benefits in the UK only replace 32.6% of a worker’s income on average, the second-lowest total in the OECD and well below the total average among member states of 54.4%. However, when you factor in average retirement incomes from private saving, replacement rates in the UK then become very similar to the OECD average; it is simply that people are expected to save more on their own and for the state to do less as a result.
However, if people are not working then it is much more difficult for them to save for their pensions. By default, someone who is unemployed cannot be contributing to an occupational pension scheme, and if money is tight then they are very unlikely to be putting anything aside in the form of private savings or investments. The timing of current high levels of youth unemployment is also unfortunate because they have coincided with the introduction of NEST, the mandatory occupational pension scheme which all employers have to offer their staff, which today’s unemployed young people have missed out on.
Catching up to do
The reason why this matters particularly is because of rising life expectancy: the OECD estimates in their report that today’s young people can expect to work until they are 70 and live to 100 on average. In order to fund a decent income in retirement, you need to put away a certain percentage of your salary each year; for example, NEST requires you to save 8%. If young people are contributing less than that at the start of their career then they will have some “catching up” to do if they want to achieve the same level of income, meaning they will need to put away more of their salary in the future.
The report notes that this has been exacerbated by pension reforms which have generally reduced the generosity of benefits for future retirees while leaving today’s older generation largely untouched:
“Pension reforms made during the past two decades lowered the pension promise for workers who enter the labour market today. Working longer may help to make up part of the reductions, but every year of contribution toward future pensions generally results in lower benefits than before the reforms.”
This has happened in the UK both in relation to state benefits (such as the introduction of the flat-rate basic state pension), and private ones (such as the decline in final salary private sector schemes). Now more than ever before, young people need to start saving for their retirement at the earliest possible opportunity – although in many ways it has also become harder than ever before for them to do this.