No soft landing - Page 2
From Griffith REVIEW Edition 25: After the Crisis
© Copyright Griffith University & the author.
Written by Ryan Heath
The size of Europe's monumental public debt is only surpassed by the hidden liabilities
accumulated in Europe's short-sighted public pension schemes.
– Dr Martin De Vlieghere, University of Ghent
EVEN POLITICALLY DIFFICULT policies to lower debt and raise the pension age to sixty-eight are the equivalent of treading water when it comes to pensions. European pension liabilities outweigh declared public debt, and for many countries they outweigh GDP. Indeed, the gap between liabilities and dedicated assets is so great that today's thirty-year-old Italians would have to contribute 127 per cent of their salaries to the state pension scheme to guarantee receipt of the current pension.
Some nations are making progress, almost all of them smaller nations. This year Latvia, under threat of national bankruptcy, cut pensions by a tenth, while Hungary cut them by nearly that much. Denmark is moving to a system where the official retirement age moves up with life expectancy, and the Finnish Prime Minister, Matti Vanhanen, warned in June that he will be forced to deliver years of ‘painful cuts' to meet the costs of ageing.
Germany is alone among the largest European countries in undertaking significant change. German-owned companies, under government pressure, now contribute an average of £3.27 for every pound of new pension benefits credited to employees (after years of covering less than two-thirds of their pension liabilities with dedicated assets). For its part, the German government is seeking constitutional limits on budget deficits and has allowed schemes that ensure almost a third of labour costs are devoted to building up pensions.
The heart of the problem is that most European pensions are pay-as-you-go schemes. Like Germany's formerly wayward private schemes, most public and private schemes are not funded by accumulated assets, as in Australia's employer-funded superannuation system or Norway's oil-driven Sovereign Wealth Fund. Nor do retirement savings follow workers through a career. Instead, current workers fund previous generations of workers, and each generation passes its bill to the next.
This will suffice if the workforce and economy grow strongly, but when they shrink, a nation's low birth rates or loose fiscal policy can no longer be masked. Now that retirements last twice as long as they did forty years ago, some of these systems face collapse. For European workers, who rarely have private savings to fall back on and own homes at lower rates than do Australians, this scenario could be devastating.
An example of particularly bad pension management is the UK's Civil Service scheme, of which I am a member. This is one of the defined-benefit schemes to which seven out of ten British workers belong (compared with just one in ten in the more affordable defined-contribution schemes). While high entitlements combined with a forced retirement at sixty are personally agreeable, this is certainly not sustainable when the UK spends four pounds for every three it now collects in tax. Yet it continues to rack up pension liabilities equal to paying 19 per cent super contributions to each civil servant.
While it has been running up this bill, Britain has chosen to use its North Sea oil revenue on anything but pensions, in sharp contrast to Norway, its oil-field neighbour. The Norwegians now have a fund so strong that they saw the 2008 share wipe-out as an opportunity to cherry-pick underpriced assets from scared investors. Spain – without oil, and desperate to catch up to Europe's front-running nations – also took the easy road. There, more than two-thirds of people believe the state should be ‘primarily responsible' for pensions, yet these same people encouraged a property bubble as their back-up plan, rather than save for retirement. Spain's state depended on that property bubble for income, and now that the bubble has burst it faces rapidly increasing deficits and unemployment already spiralling beyond 18 per cent.
Everyone knows the money has run out...we will not see such riches again until my generation has
paid off every last unfunded public-sector pension liability, every last bit of debt kept Enron-style off the books, and all the other components of the structural hole in the public finances. That hole is
‘recovery-proof' – it will still be there even when the economy recovers.
– Camilla Cavendish, 40, columnist for The Times
ONLY IMMEDIATE RADICAL reform will address these issues. Some favour even the abolition of formal retirement. While that is politically impossible, lower or delayed access to entitlements, higher taxes, higher employment rates and more working-age immigrants are essential. Leaving reform too late will mean massive social tension or a suffocation of economic growth as governments desperately struggle to maintain entitlements.
How then might attitudes shift? Assumptions about retirement entitlements need to be remoulded. Europeans may offer in-principle support for private retirement savings, but they also equate state pensions and low retirement ages with social progress. They must accept that comfortable retirement now requires private savings and working until the age of seventy.
The most pragmatic approach is to ensure the pension bill is paid by all, not only the workforce. With some European states sucking up half of GDP in taxes already, it will be easier and less economically harmful to redistribute the tax burden rather than increase it sharply. The OECD concludes that property and indirect (consumption) taxes are the least harmful to long-term growth, which dovetails neatly with the need to maximise the number of people footing the bill. Europe will also have to figure out its attitude to migrants: can it shoulder the social pain in return for the economic gain? Anti-immigration parties fared well in the 2009 European elections, and countries from Spain to the Czech Republic are already paying immigrants to return home.
Whatever route Europeans take to rebalance their pension books, Norway's disciplined use of public funds and, on the other side of the world, Australia's mobilisation of private funds – through compulsory employer contributions – will feature in policy discussions. Norway's strong incentives to work until seventy make sense when you realise that their choice is born out of a culture of responsibility, a tangible belief in the benefits of ‘generational accounting'.
If Europeans take one lesson from this crisis, it is not that capitalism is broken, or that governments should attempt to solve every economic problem. It is that in dealing with money – whoever is doing the dealing – planning, saving and discipline can save a great deal of trouble. The economist Dambisa Moyo offers a proverb for dealing with failed policies: ‘The best time to plant a tree is twenty years ago. The second-best time is now.' For Europeans, their eventual return to economic growth is also their final chance at effective pension reform. The economic clash between Europe's ageing population and a young, rising Asia already resembles the Titanic hitting the iceberg. Europe would do well to make sure the lifeboats are in order. ♦