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Doc. 10937
23 May 2006

Demographic Challenges for Social Cohesion

Opinion1
Social, Health and Family Affairs Committee
Rapporteur: Mr Michael Hancock, United Kingdom, Alliance of Liberals and Democrats for Europe (ALDE)


I.       Introduction

1.       First of all, the rapporteur wishes to congratulate Ms Oskina on her excellent report on demographic challenges for social cohesion.

2.       Indeed, a new vision of the purpose of social policy is needed today as society is undergoing profound upheaval. Ageing populations are increasing pressure on workforce. By 2050 Europe could have lost nearly 55 million people of working age (even in the 1990s, 90 of Europe’s 266 regions were already experiencing a decline in their population).

3.       Demographic decline is therefore not an abstract and distant event. It is already transforming society, the economy and relationships between individuals and generations.

4.       It is therefore a matter of urgency to establish a common approach to meeting the three major challenges of globalisation, technological change and demographic change. The crux of the matter is clear: the European social model must demonstrate its ability to respond effectively to these challenges.

II.       Population ageing and challenges to social policies : the example of pension systems

5.       As plummeting birth rates and increasing lifespans rapidly raise the percentage of oldsters in countries around the world, ageing is becoming one of the most crucial policy issues of the 21st century. Those who spent their youth in the 1970s fretting that overpopulation would drive humanity to extinction may now spend their old age worrying whether the world has enough young people to support them.

6.       But though the writing has been on the demographic wall for some time, retirement systems have been slow to adjust. In the rich world, particularly, pay-as-you-go (PAYGO) pension schemes are in dire fiscal straits as the ratio of workers to pensioners narrows.

7.       The problems in Europe are even worse, thanks to more generous benefits and birth rates well below the rate of replacement. By 2030, for instance, Italy is expected to have a mere 0.7 workers for each retiree — ie, more people collecting benefit than paying taxes. Other European nations, along with Canada and Japan, are not far behind.

8.       PAYGO systems also, by setting a one-size-fits-all retirement age, encourage capable workers to leave the workforce when they reach that age rather than lose benefit. And politics makes it hard to raise the retirement age, even though people are staying healthy longer than ever.

9.       Attempts to trim state pensions in recent years have aroused the anger of workers across Europe. On 3 June 2005 France was virtually closed by a nationwide strike against the government's proposed pension changes, on the same day that Austrians brought their country to a halt over pension reform.

10.       Normally a model of cosily consensual industrial relations, Austria saw more than a million people take to the streets to demonstrate their grievances over pensions.

11.       Europe's state-administered pension systems are, for the most part, financed on a pay-as-you-go (PAYGO) basis. There is no huge pot out of which future obligations can be met. Those in work pay (via a tax on their current wages) for the pensions of those who have retired. In Italy and Austria, public pensions gobble up as much as 15% of GDP annually; in France and Germany the figure is about 12%.2

12.       The outlook for state pensions is not equally dire across Europe. Britain, the Netherlands, Scandinavia and Switzerland, for example, have already shifted much of their pension burden from what is known as the first pillar (the state) to the second pillar (the employer), and even in places to the third pillar (the individual pensioner-to-be). In Britain and America, government spending on pensions accounts for only 5-6% of GDP a year.

13.       Pay-as-you-go systems were introduced as long ago as 1889 by Otto von Bismarck, Germany's chancellor. They worked well for as long as the active workforce vastly outnumbered the retirees—as they did in Bismarck's day. The retirement age then was 70, and the average life expectancy was 48.

14.       But life expectancy has been rising now for 300 years, and it rose particularly quickly in the second half of the 20th century. Between 1950 and 1995, average life expectancy in Britain increased from 69.2 years to 76.2, and in France from 66.5 to 77.1. Moreover, it has not stopped rising yet. Between 2000 and 2020 the remaining life expectancy of a 65-year-old male in Germany is expected to increase from 12.1 years to 14.9.

15.       This ageing of the population is being combined with falling birth rates, a relatively new phenomenon. During the baby boom of the 1960s—between 1960 and 1965—the overall birth rate in the European Union was 2.7 children per woman, comfortably above the rate of 2.1 required to maintain the size of the population. By 1995, however, that rate had fallen dramatically to 1.5 children per woman. In Italy, the figure is even lower. In other words, Europe's pension problem is not life expectancy. It is birth rates. Europe's working-age population is set to fall by 40m, or 18%, by 2050.3

16.       Germany and Austria illustrate the remorseless consequences of this demographic pincer movement. Seven-tenths of Germans' pensions still come from the Bismarckian state system. Last year the levy on wages to pay for this, half of it from workers and half from employers, was 19.1%. Today, fewer than three workers support each German pensioner. But if current ageing and fertility trends continue, that figure could be halved by 2030.

17.       In Austria, had Mr Schüssel not fought for his government's reform, workers would have been obliged to channel almost half of their wages into the state pension scheme in 20 years. Under those circumstances, any Austrian with portable skills would almost certainly choose to take them elsewhere.

18.       As the pension time-bomb has ticked away, European governments have become more imaginative in finding methods to cut back on the promises of the state pension system. Their main aim has been to make the cuts seem as painless as possible, and to encourage people to save on their own for their retirement.

19.       Governments are, for instance, prolonging the number of years that a person has to work in order to qualify for a full state pension. This is proving to be one of the least unpopular reforms—people are more unhappy about increases in contributions or cutbacks in benefits—except in France. There the increase in the number of years that public-sector employees must work in order to qualify for a pension (from 37.5 to 40, and later to 42, the same as the requirement in the private sector) was the most controversial part of this year's reform bill.

20.       A more simple reform is to raise the retirement age. This year Austria decided to increase its retirement age for men gradually from 61.5 to 65 years, and for women from 56.5 to 60 years. Italy is now planning to raise its retirement age to 65. And Germany, which has already raised its retirement age from 63 to 65, may yet go further. One proposal is that it be raised in monthly increments to 67 between 2011 and 2035.

21.       As the extent of the pensions crisis began to unfold, a number of countries set up reserve or buffer funds to help them pay the bills. The earliest funds were created in the 1960s and 1970s in America, Canada and Japan, but they were designed as a safeguard for the social-security system as a whole, not specifically for pensions. The funds set up by Belgium, France and Ireland over the past decade, on the other hand, were specifically intended to back their PAYGO schemes.

22.       The French buffer fund, the Fonds de Réserve pour les Retraites (FRR), was set up in 1999 with the aim of raising as much as €150 billion ($172 billion) by 2020 to help finance public pensions for the following ten years. September 2005 was the closing date for applications from private-sector firms to manage the 27 separate pools into which the €16.6 billion that the FRR has so far managed to accumulate has been divided. (There was no shortage of candidates for the jobs.)

23.       Governments in Europe have also tried to encourage their citizens to save for themselves by sweetening new individual savings schemes with tax breaks. In 2001, for example, Sweden allowed its workers to put 2.5% of their wages (out of their 18.5% payroll-tax contribution) into an individual account.

24.       In the same year, Germany introduced the so-called Riester pension, named after Mr Walter Riester, the labour minister responsible for the reform. This gives German workers the option of putting 1% of their pay into their own retirement account, a percentage that is to rise in steps to 4% by 2008. The Riester scheme has failed to take off as planned, though, despite generous subsidies to encourage low-earners and parents with dependent children to take part. Some say the scheme is too hard to understand; others claim that savers are still too scarred by the recent bear market.

25.       Occasionally governments are more blunt. Either they increase the mandatory contributions to the pensions scheme — in 1997, for example, the Netherlands increased the pensions levy on wages from 15.4% to 18.25%, and Finland introduced an employee contribution in addition to the existing employer's contribution in 1993—or they reduce the pension benefits, a move as detested as any increase in the tax. In Austria, for example, benefits for new pensioners will be cut by 13.5% next year, and Austrians retiring early will suffer cutbacks in their pension benefits.

26.       With the expansion of defined-contribution plans, which lumber the individual with the investment risk of his or her pension, the distinction between the second and third pillars of support is blurring. So it makes more sense for people to organise their own pension plans instead of leaving them up to an employer, with whom they are less and less likely to remain for the whole of their working life. What's more, with an individual private retirement account people are free to decide for themselves when to stop working. Every extra year of work increases their pension pot.

27.       If private contributions to retirement savings accounts are not mandatory, as they are – for instance in some Latin American countries - there is concern that, left to their own devices, individuals may not save enough for their old age. The Association of British Insurers warns that there is a £27 billion gap between what people in Britain are saving and what is needed for them to enjoy a comfortable retirement. (About one-third of Britons are not saving anything at all, while a good part of the rest save for holidays or cars but not for their long-term welfare.)

28.       One solution would be to introduce an element or two of compulsion. In Britain, for instance, the government could make its stakeholder pensions, a new low-charge private investment scheme, compulsory for all employees. Likewise, Germany's Riester pension could become mandatory for employees there.

29.       Of course, the transition from the first to the third pillar cannot happen overnight. The longer a PAYGO pension system has been going, and the more generous its benefits, the bigger the build-up of implicit debt in the system. Because of this heavy transitional burden, no country with a large PAYGO scheme can make a rapid switch to a privatised alternative. For one thing, that would impose a double burden on the current working generation. They would have to build up their own funded pension at the same time as they pay today's pensioners for previous governments' promises.

30.       When younger members of the workforce feel the full weight of the burden they are being expected to carry, they may start to protest, and so provide a political counterweight to the ageing voters who are determined to protect their own entitlements at the expense of those coming after them. Alternatively, of course, younger people could remove the need to fund a pension for themselves by returning to the oldest pension plan on the planet—a large number of children. That, of course, would solve the birth-rate problem too.

31.       European governments hoping that corporations will solve the pensions crisis for them will be disappointed. The problems experienced by American and British companies' pension funds in recent years are a stark warning to countries trying to make the switch from public- to private-sector pension provision. 4

32.       Recent reforms in old-age pension systems have gone in the direction of reducing the incentives to early retirement by changing several of the basic parameters determining pension benefits. The removing the incentives to early retirement might pose a considerable challenge to European labour markets. It might be difficult to absorb the increased labour supply of older workers in countries with high structural unemployment. The adjustment would be eased if reforms of pensions and other income support systems for the elderly were to be accompanied by measures to increase job opportunities in general, including elimination of measures and practices that discriminate against older workers.

33.       In any case, most European countries need to introduce more active social policies, which means getting people off benefits and into work instead of keeping people in a state of dependency. It is not enough getting people into jobs; more efforts need to be made to help people keep jobs and to develop careers.


Proposed amendments to the draft resolution

The rapporteur proposes the following amendments :

Amendment A:

In the draft resolution, after paragraph 8.2.2., insert the following new paragraphe :

“to recognize conciliation of professional and family life as a guiding principle for each policy and strategy dedicated to the improvement of social cohesion and demographic increase”

Amendment B:

      In the draft resolution, in paragraph 8.2.3, after the first sentence delete the end of the paragraph.

*****

Reporting committee : Committee on Migration, Refugees and Population

Committee for opinion : Social, Health and Family Affairs Committee

Reference to committee : Doc. 10371, Ref. 3039 of 24 January 2005

Draft opinion approved by the Committee on 18 May 2006

Secretaries to the committee : Mr Mezei, Mme Nollinger, Mme Meunier


1 See Doc. 10923 tabled by the Committee on Migrations, Refugees and Population.

2 By 2040, says Commerzbank, a German bank, some governments' overall unfunded pension liabilities will be three times their country's GDP, if nothing is done before then. The bank goes on to say that the PAYGO schemes underlying most state pensions would see their practitioners thrown in jail if they were private operations.

3 Low birth rates are an old-world phenomenon. America has a much higher birth rate and a higher rate of immigration. At the moment, the EU's population is some 90m greater than America's. But by 2050 America could have 40-60m more people than today's EU member states.

4 Most American and British companies' employee pension funds were set up as defined-benefit schemes, schemes that promise to pay a given pension at a given age. This left the companies to assume the risk if the funds' returns proved insufficient to meet those defined obligations. And sure enough, after the prolonged bear market, huge holes have been appearing in companies' pension funds. Not surprisingly, companies have been scrambling to convert their existing pension plans into so-called defined-contribution schemes, where the full pension cost is predictable.