June 2004, Vol. 10, No. 2

Aging
Making Public Pensions Sustainable

Mortality and fertility declines inevitably lead to increases in the proportions of the elderly within populations. Demographers expect population aging to become a widespread phenomenon in all world regions in the next few decades. This trend has raised concerns about the sustainability of public pension systems, such as the U.S. Social Security system. Failure to address these concerns could have adverse economic effects on a national and international scale, according to the International Monetary Fund. Population Council demographer John Bongaarts recently examined the situation in Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States and offered policy options to make pension systems sustainable.

Pension crisis
Public pension systems in high-income countries have largely succeeded in their goal of protecting retirees from poverty. However, pension systems such as Social Security are in danger. Pay-as-you go systems rely on transfers of income from younger to older generations. In general, as fertility rates fall, younger generations have fewer and fewer individuals. As mortality rates drop, older generations survive longer and have more individuals relative to younger people than they did in the past. As currently structured, public pension systems are unsustainable in rapidly aging societies. The state of such systems is more dire in some countries than others.

One way of assessing the sustainability of a pension system is to examine the old-age dependency ratio. This ratio compares the number of people aged 65 years and older (who are frequently retired) to the number of people aged 15–64 (who are theoretically working and contributing to the public pension system).

The old-age dependency ratio is flawed, however, as an indicator of the rising societal burden due to population aging. The number of pensioners usually exceeds the number of people aged 65 and older, as people often begin collecting reduced pensions at a younger age. Moreover, the number of workers is substantially fewer than the number of people aged 15–64.

A more accurate way to assess the demographic aspects of pension systems is to compare the actual number of pensioners to the actual number of workers. This ratio varies widely in the countries Bongaarts studied. In the United States for every pensioner there are about four workers, but in Italy there are fewer than one and a half workers for every pensioner. “The pensioner/worker ratio is one of the key determinants of the overall level of expenditures on public pensions,” says Bongaarts.

Moreover, the value of pension benefits provided to each individual varies by country. Benefits are most generous in France, Germany, and Italy and least generous in the United Kingdom. The United Kingdom has the lowest benefits, with pensioners getting one-fifth the average worker’s earnings. Countries with high benefits tend to have a high number of pensioners per worker. Not only does a large pool of pensioners provide the voting power to ensure that benefits stay high, but high benefits induce workers to retire early, thus enlarging the pool of pensioners.

Projecting into the future
Bongaarts projected pensioner/worker trends for these countries to 2050. He assumed that pension benefits (relative to wages) would remain fixed, as would rates of employment and retirement by age and sex. He found that the number of pensioners per worker will rise sharply by 2050 in all the countries he studied. “In Italy the number of pensioners is expected to exceed substantially the number of workers by 2050, with about one and a half pensioners for every worker,” notes Bongaarts. Japan will have a nearly one-to-one ratio of pensioners to workers, while the United States will have about two workers for every pensioner.

Not surprisingly, large increases in pension expenditures are also expected in all seven countries. “These trends are clearly unsustainable over the next few decades for Italy and other continental European countries,” asserts Bongaarts. “Even the smaller projected growth in expenditures in the United Kingdom and the United States is often considered problematic.”

Policy options
Governments of industrialized countries around the world are now tackling this challenge to their pension systems. Bongaarts offers four policy options to offset these trends: counteract population aging, increase employment, raise the age at retirement, and reduce public pension benefits.

Governments can counter population aging by making it easier for women to reach their reproductive goals and by permitting more immigration. “Research has shown that women on average want more children than they actually have,” notes Bongaarts. “Often they are hindered from meeting their reproductive goals because of difficulties combining work and childbearing.” Governments could reduce these obstacles by subsidizing childcare, reducing taxes for families with children, and providing paid parental leave. Bongaarts’s projections show that, on average, for each increase in fertility of 0.1 births per woman, pension expenditures in 2050 decline by 4 percent. For example, if fertility in Italy increased from 1.5 to 2 children per woman, pension expenses in that country would be 20 percent lower than they would be if fertility remained unchanged.

Bongaarts also found that an increase of 1 migrant per 1,000 population in the annual net migration rate reduces pension expenditures in 2050 by 5 percent. In developed countries the average age of immigrants is typically lower than that of the resident population. Thus, increasing the number of immigrants reduces the average age of a population and the old-age dependency ratio. “If these immigrants participate in the workforce to the same extent as the average population does, which is usually the case,” says Bongaarts, “then there will also be more workers.” Pension systems in Canada, the United Kingdom, and the United States are in less jeopardy than in Japan and much of Europe, in part because of higher levels of immigration in the English-speaking countries.

Any increase in the number of individuals who are employed would directly reduce the pensioner/worker ratio. The percentage of people employed varies greatly from country to country. In the United States, for example, 76 percent of working-age people are employed, compared with only 55 percent of working-age people in Italy. One way to employ more people in many countries is to encourage greater workforce participation among women. In Italy, for example, 70 percent of men are employed whereas only 40 percent of women have jobs. “If future female labor force participation were to rise to equal that of males, the pensioner/worker ratio would be reduced by 21 percent,” asserts Bongaarts.

The average age at retirement in the industrialized countries has been decreasing over the last several decades. Pension benefits are often high, and there is little incentive to continue working once a person qualifies for a pension. Encouraging a later age at retirement by increasing the age at which pension benefits could be obtained would enhance pension system sustainability by reducing the number of pensioners and increasing the number of workers contributing to the pension system. Bongaarts estimates that, on average, a one year increase in age at retirement would reduce the ratio of pensioners to workers in 2050 by 6 percent.

Finally, reducing pension benefits would make pension systems more sustainable, says Bongaarts. Governments will have to combine a number of these strategies, and perhaps also raise taxes, to bring pension expenditures in line with contributions, asserts Bongaarts.

“My analysis suggests that demographic options for addressing the pension crisis, such as making it easier for women to reach their reproductive goals and increasing immigration, have been neglected,” concludes Bongaarts. “More attention should be paid to them.”

Source
Bongaarts, John. 2004. “Population aging and the rising cost of public pensions,” Population and Development Review 30(1): 1–23 (PDF). Also issued as Policy Research Division Working Paper no. 185. New York: Population Council. (PDF)

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See Also

• Aging