As pension crisis looms, golden years fade to black

Plans to suppress public spending on pensions are questionable on their merits and, from a fiscal discipline point of view, are just so much wishful thinking.

By MSN Money Partner Mar 8, 2012 5:20PM
Bloomberg on MSN MoneyBy Clive Crook

The resolution of every economic crisis sows the seeds of the next.

Public pension systems in advanced and emerging economies alike were already under stress before the Great Recession. The past few years' destruction of wealth and the likelihood of slower growth in the future have weakened them further and will put some under intolerable pressure.

Getting pension systems to work as they should will be one of the toughest tests governments face in the next several decades. It demands something they are notoriously bad at: thinking ahead.

I'm not saying governments don't understand the problem. Many have started to address it. The trouble is, they're framing the issue too narrowly, and adopting fixes that are unlikely to stick. Getting on top of this issue will require more radical thinking. In many countries, options that have been taken off the table will need to be put back on.

At the moment, governments see pensions almost entirely as a looming fiscal emergency -- which, to be sure, they partly are. On average, according to the International Monetary Fund, aging populations will raise public pension spending in advanced economies by about four percentage points of GDP over the next 20 years. That is an enormous amount. Rapidly falling fertility also means that a diminishing base of workers will have to bear that burden. (The ratio of pensioners to workers in developed economies is expected to double by 2050.)

Retirement Recedes


Reforms that have already been proposed will subtract about two and a half percentage points from that four percentage point increase in cost over the next two decades, mainly by raising the retirement age and by making pensions less generous. There are two concerns about this approach. The smaller one is that such measures only partly solve the fiscal problem. The real worry is that they won't be allowed to happen -- and with good reason.

With life expectancy increasing, a rise in the retirement age does make sense -- but it's a terrible idea to make public pensions less generous than they already are. Even if you disagree, ask yourself how plausible a decrease is. Early reformers such as Sweden and Germany have had to reverse some of their planned cuts in pension benefits as they began to be implemented. The same is bound to happen elsewhere.

The crux of the problem, which has barely even begun to be recognized, is that projected incomes in retirement need to grow, not fall. Squeezing public pensions is a questionable goal at the best of times. When private provision for retirement is under greater stress than ever before, it's political fantasy.

Relatively generous occupational pensions began disappearing long before the recession, starting with countries like the U.S. and the U.K. Defined-contribution saving for retirement -- in the U.S., through 401(k)s and Individual Retirement Accounts -- has failed to fill the gap. For workers approaching retirement, balances in these accounts are typically far lower than needed to avoid a severe drop in income.

Health costs in retirement are rising rapidly everywhere, another consequence of increased longevity. Governments are trying to shift some of this burden off their books as part of efforts to contain public debt. This will put new strains on incomes in retirement. Add low interest rates (hence meager returns on the safest forms of saving) and the collapse in home equity, which in many countries was a main form of retirement saving, and the financial prospects for many soon-to-retire workers are dire.

Wishful Thinking

Against this background, plans to suppress public spending on pensions are questionable on their merits, and from a fiscal discipline point of view are just so much wishful thinking. As life expectancy improves, working longer is both financially desirable and politically feasible. But making public pensions smaller is neither -- unless it's part of a larger reform to raise overall retirement incomes.

What shape could this needed reform take? The short answer is mandatory private saving -- ideally, so far as rich economies are concerned, not in place of but in addition to the provision of public pensions. Take deductions from workers' pay and invest them in private accounts. These are not taxes: Workers own their savings balances, though they would be unable to access them before retiring.

There are many possible variants. Governments might subsidize the savings of those on low incomes, set a floor for payments or guarantee, within limits, minimum rates of return. Such mandatory private saving is the path taken by many emerging-market economies, following the example set by Chile in the 1980s. The approach has problems -- in Chile's case, inadequate coverage and high administrative expenses, which were addressed in a second big reform in 2008 -- but the basic principles have been widely adopted. Details matter, and these programs haven't matured, so it's too soon to declare them a success. But done right, the model looks promising.

In rich countries, one trap to avoid is expecting such reforms to ease the fiscal burden of public pension systems. It's tempting to pay for the introduction of private retirement accounts by transferring payroll-tax contributions out of the public system. If governments do this and make up the revenue through public borrowing rather than by new taxes or spending cuts, public saving goes down, partly defeating the purpose. Public pensions need to be made fiscally viable with currently projected benefits by raising the retirement age and, if need be, by raising taxes. Then supplementary retirement accounts can be used to bring retirement incomes up to where they need to be.

Especially in the U.S., the politics of pension reform is toxic. George W. Bush's attempts to partially privatize Social Security were roundly defeated, and most Democrats still savor that victory. They see the idea of a mixed public and private system as anathema. Their suspicions are partly justified: Private pensions aren't a way to cut public spending or taxes, and they shouldn't be sold on the back of heroic assumptions about returns to private capital. They should be seen, simply, as a way to increase saving, as an alternative to poverty in retirement and/or acute fiscal distress down the road.


I'll come back next week with how a reform like this might work in the U.S.


Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.


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Mar 8, 2012 6:05PM

Save like a demon and hope that it is enough.  You have to depend on yourself.  Private companies consider you dead wood when you approach retirement.  The public sector is now no better.  Smile

Mar 8, 2012 6:33PM

No one has mentioned or discussed the fact that the so-called public and corporate pension problem was caused by NOT FUNDING the Pension Accounts each budget year per contracts.


The people to whom these are promised pensions / health / dental benefits are owed received such benefits from their employers in place of pay raises during past contract years.


The fact that the employers - public and private - Did Not Fund them during those contract years is the real issue and problem.


Now, the people to whom these pensions are owed are being vilified by the government, the media, and people who are being misled by the government and the media.


The retirees are, and were, not the problem.


The American public has been used by the government and media via twisted logic, if it can actually be called that, outright lies and deceit.


Now, please think these issues through, since, at some, not distant, point in your lives, you will be old enough to be looking forward to your well-earned retirement pensions and you do not want to be the recipients of tricks and deceit in order to deprive your of your pension.


Do You?

Mar 8, 2012 6:19PM
Keep voting for politicians who want to drive the country even deeper into the fiscal abyss, and you shall all reap what you sow in retirement. 
Mar 8, 2012 7:51PM
The gov took the 2.5 trillion dollars and gave us an IOU. They have done next to nothing to fix the problems. Yes removing the cap and increasing the contribution by 1 percent would have been an easy fix. It kills me they don't mind raising taxes for their good but wont raise a tax that is for our benefit. Oh and what about the disability fraud that is rampant through out the system. Now they want to say social security is breaking the bank They just don't want to pay back the money.
Mar 8, 2012 6:56PM

A lot of this is "on average". You need to find out real facts about the individual pension programs you are depending on. As an example, they make SSA sound disastrous by the sheer size of the numbers, but even  long-term just doing a few simple things would put it right. For example, hiking the deduction by a percent and removing the deduction cap would go a long way to evening it out. They could also do something like WEP to keep people who already have a high retirement income (say over $250,000 annually, or over $10 million net worth) from receiving it. I'm not saying it's right or fair--much in life and certainly in taxes is not--but it would end the so-called "SS disaster".

Mar 8, 2012 7:20PM
Defined pensions will never work. a promise is being made for forty years away. That is impossible. All pay should be up front , if your retirement account is doing poorly then you make adjustments.  Money should not be owed by a company or government that might be broke for many reasons over a period of time.
Mar 8, 2012 10:02PM
this hole system is rotten to the core, from congress to wall street , their only looking out for themselves. the middle class is nothing but a big fat cash cow, to theses people. n their comming , to privatizing our ss. were turning into a uneducated, defend for ourselft,  privatize , 3rd world country. wall street is stealing us blind n our children future. these's people should be in jail, for what they did to our country, att: holder, were are you ! stop voteing against your intrest. boycott the big banks n big oil, theirs alternatives, they need our money to survive another day to steal our money.
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