The 'pensions crisis' is not a result of an ageing population, but of a mean-minded political and business class.
Barely a day passes without another published report or conference focusing on the threatening ‘pensions crisis’.
Without wanting to pander to today’s over-anxious sense that we are being buffeted from one ‘crisis’ to another, there is certainly a problem with pensions. But it is a problem, not of an ageing population, but of the mean-minded and fearful people who are making decisions to limit what pensions will provide in the future. Cutting back on pension payments is bound to impact adversely on the living standards of future pensioners. That is a genuine problem – and a consequence of the risk-averse actions taken by cost-sensitive decision-makers.
Policymakers in Europe and beyond assume that, due to ageing, the pension systems established and expanded in industrialised countries over the past century are no longer affordable. In mid-October 2003, Germany’s Social Democratic government imposed the first cut in pension benefits since the Second World War, while proposing to raise the retirement age by two years and increase the level of employee contributions. Other European governments are similarly engaged in promoting ‘reforms’ to their public pension schemes.
Britain stands out only because it started making changes to limit state pension liabilities much earlier, during the 1980s. Most significantly, the link between earnings and the basic state pension was abolished here in 1980, and the value of pensions has been falling relative to average earnings ever since.
So the discussion is slightly different in Britain. There is still talk of a pensions crisis, but the argument is that the current state package is contributing to the crisis. Critics from across the political and institutional spectrum argue that a low basic pension supplemented by means testing does not just cause pensioner hardship – which it does – but that it discourages people, especially lower earners, from saving for their retirement.
But why, some challenge the government, would people have the incentive to make individual provision when the state makes up for non-savers via means-tested benefits, including the new pensions credit? Such questions may be well-intended – but in arguing for the necessity for personal pension provision through saving, many of the government’s critics accept the starting point that an adequate public pension is unsustainable in the face of ageing populations.
Such fears are unfounded. Every argument about the burden of ageing resorts to the ‘dependency ratio’ – the ratio between the number of old people, usually defined as 65+, and the size of the working-age population, people aged between 15 and 64. With more older people, because of more individuals getting to old age and then more of them living longer, and with fewer working-age people, aggravated by recent low fertility rates, this dependency ratio is bound to rise. Across the European Union, the average ratio is projected to double over the next 50 years from 1:4 to 1:2. Many take it as self-evident that relatively fewer working people cannot financially support greater numbers of older people.
But this is not a self-evident truth – for two reasons. First, labour productivity will increase significantly over that time, meaning that each average worker will be producing a lot more wealth. Second, the crude ratio between the numbers of people in these two age groups tells us nothing about the ratio between ‘dependent’ people and ‘productive’ people – the economic dependency ratio.
The historical picture suggests that there is no determinate relation between age structure and economic productivity. Most industrialised populations have been ageing pretty consistently for the past 150 years, with average life expectancy growing about 2.5 years every decade – mainly due to falling infant, youth and adult mortality, and more recently some decline in elderly mortality.
The crude dependency ratio has also grown fairly steadily over the past century. This long-term record of relatively constant ageing has coexisted with all sorts of economic performance. So there is no age-related reason why productivity should slow over the next 50 years from its long-term average of about two percent a year. The compound effect of this annual growth is to double productivity and wealth production every 35 years. So every worker could hypothetically ‘support’ double the number of dependents in 50 years’ time, with enough left over to sustain higher living standards for all. If productivity were to fall much below this we could conclude we have an economic growth problem to address, but not one that has anything to do with demography.
But the likely scenario is that even more of this productivity growth will go to expanding living standards because the economic dependency ration will nowhere near double. The ‘old age dependency ratio’ is misleading and has very little to do with the relationship implied by its name – between two real groups of people: elderly dependants and people in work. Rather, it is a measure that assumes everyone over 64 is dependent, even though a significant and growing minority work (in Britain about 10 per cent of men over pension age), while about 40 per cent above this age pay income tax either from earned or investment income, or have built up their own savings to at least partly live on. They are not 100 per cent economic ‘dependants’.
Also, many people of ‘working age’ do not work – about nine million in Britain, and this represents between a quarter and a third of the working age population in most industrialised countries. So the age dependency ratio is about as meaningless as someone saying the employment ratio is 100 per cent because all people within the working age group work, even though the actual rate varies across Western countries from about 55 per cent to 80 per cent.
What matters more for future wealth and prosperity is the economic dependency ratio measuring the relationship between the number of productive people and the number of dependent people. On the same population projections, estimates for this ratio are usually of a modest rise of 10 to 20 per cent over the half century. (For example, the European Commission reports that, ‘Whereas the old age dependency ratio for the EU is projected to double in coming decades, the economic dependency ratio [defined as inactive persons aged 15+ as a percentage of number of persons employed, therefore excluding dependent children] will only increase by one-fifth’ (1).
It is even quite possible that the economic dependency ratio might not increase at all, depending on assumptions made about future employment rates – especially a continuing rise in female employment rates and some reversal of the sharp falls seen over the past 30 years in the employment rates of older men (2).
Much of these increased employment rates could happen spontaneously if more work was available for people. It is one of the irrational ironies of those who bemoan the ‘shortage’ of workers in an ageing population that they rarely even acknowledge the large numbers of people, especially older people, who would like to work if only they could find suitable jobs. As we continue to grow older with better levels of fitness and health, the numbers of aspiring older workers will likely increase, both below and above the state pension age.
So the problem with state pensions, and with providing decent healthcare and long-term support for older people in need, is not a financial one. Rising productivity and higher employment rates should mean that wealth production is far in excess of what is required simply to pay for an ageing population. At the most, even on fairly modest assumptions about productivity growth and employment rates, the extra amount of national output that would be required over the next 50 years to fund all ageing-related public spending would be between four and eight per cent in most European countries (3).
That only seems a lot if it is conceptualised as being needed tomorrow. But this increase is a gradual one over half a century, during which time all these countries will grow to be between two and three times as wealthy as they are now. It is worth remembering that over just about any half-century span you choose from the past hundred years, public spending as a share of GDP rose about 20 per cent, roughly three times this age-related projection. Eased by the simultaneous expansion of national wealth and prosperity, such an increase in the past proved to be both financially, and electorally, feasible. Any age-related increase in public spending needed – and it is quite possible it will turn out to be less than even four to eight per cent – could be too.
The problem we confront is not financial; it is ultimately a failure of political leadership. Western politicians have not only assimilated an exaggerated concern about the economic burden of older populations, but they refuse even to attempt to argue for decent social arrangements for the elderly today and in the future. The implications of ageing are treated as yet another big uncertainty, which in risk-manager mode they perceive as something to be controlled and contained as much as possible.
Retreating in the face of their own, and other people’s anxieties, about an ageing society, they take the easy option of saying: we have no choice – demography forces our hand. In justifying their mean-minded, cost-cutting risk containment by repeating the economic and social myths about ageing, they only makes things worse by fanning popular anxieties about the future.
This risk-minimising agenda applies also to the other much-discussed facet of the UK pensions crisis – the employers who have been cutting back on occupational pension schemes. In many cases, employers have closed to new entrants their ‘defined benefit schemes’, pensions which pay a guaranteed percentage of an individual’s final salary. Whether one approves of the way past governments have passed their social responsibilities on to business by encouraging them to set up occupational schemes, hence making it easier to curtail public pensions, is not the key issue today.
The reality is that employers are panicking into closing down schemes that would potentially make a big difference to the living standards in retirement of today’s, and tomorrow’s, workers. In some scandalous cases, people on the verge of retirement are now being told that they will get a pittance compared to what they had been expecting
The background here is a little different to that with state pensions, but the outcome is similar. Most of these occupational funds – about 70 per cent – are invested in the stock market. Hence the assets in these funds have been riding the same rollercoaster over the past few years that other equity investors have. Corporate bosses who have been schooled over the past decade to prioritise cost cutting and risk management have treated their company pensions accordingly.
Booming stock markets during the 1990s, especially in the latter half, meant that the pension funds were in healthy surplus compared to anticipated future requirements. This was a gift horse for business at the time. Accounting standards permitted these paper gains to be used to improve the companies’ financial statements. Moreover, companies took advantage of ‘contribution holidays’ to reduce their expenses and better their profit figures, to the extent of almost £19billion between 1988 and 2001.
However, when stock markets fell by about one third from 2000, the surpluses quickly turned into what seemed like enormous deficits – estimated earlier this year to reach over £160billion. The low interest rates that accompanied these stock market lows this spring impacted too, by producing a ‘double whammy’ for the funds. Not only were the assets levels hit by falling share prices, but their liabilities were inflated because the discount rate used to estimate the current value of future expected payouts follows market interest rates down – a lower discount factor makes the present value of any future amount bigger today.
The size of the deficit seems extremely onerous to corporate Britain, but as with governments there is no financial reason for companies to overreact by bailing out of pension provision in the way we have seen. The calculated paper deficit is not the same as a cash call that businesses have to find tomorrow. Some quite modest recovery from those financial market lows earlier this year would more than wipe out the deficits. Keith Skeoch, chief investment officer of Standard Life Investments, recently estimated that ‘a 20 percent increase in the global equity markets over, say, the next two years combined with a one per cent increase in corporate bond yields would, all other factors being equal, eliminate the pension deficit to all intents and purposes as an investment concern’ (4). Given that the FTSE-100 is already up about 30 per cent this year since its mid-March low, and that interest rates are more likely to rise than fall, this does not seem such a tall order.
Anxious company boards, though, are not in the mood for taking any chances. They reckon they have enough business uncertainties already, and so jump at this pretext for getting out of defined benefit schemes and away from running what they see as the unnecessary risks of funding the increasing but indeterminate longevity of their scheme members. The limiting of occupational pensions is driven by risk aversion and cost containment rather than by a genuine liquidity problem. As with the political elite, the business class is being driven to undermine future pension provision by the fear of financial uncertainty arising from the supposed economic burden of ageing populations.
Phil Mullan is the author of The Imaginary Time Bomb: Why an Ageing Population Is Not a Social Problem, IB Tauris, 2000 (buy this book from Amazon (UK) or Amazon (USA))
(1) ‘Budgetary challenges posed by ageing populations’, European Commission Economic Policy Committee, Brussels, Executive Summary, 24 October 2001, p3
(2) See ‘The Challenge of Longer Life: Economic Burden or Social Opportunity?’ Report of the Working Group on the Implications of Demographic Change, Catalyst, December 2002
(3) ‘Budgetary challenges posed by ageing populations,’ European Commission Economic Policy Committee, Brussels, 24 October 2001, Executive Summary, p11
(4) ‘Bridging the Pensions Gap’, Standard Life Investments Global Byte, 26 September 2003. See also ‘Aon predicts end of top companies’ pensions deficits’, Financial Times, 20 October 2003
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