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.
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. …