30 Nov 2015

Who's going to pay for my pension?

Steven writes*

The German population is growing older. The peak of the people born during the babyboom after the Second World War are aged today around 52. This means that they will start to enjoy their pension in 13 years from now. As the number of retired people increases, the number of younger working people decreases due to a decline in fertility and mortality or expressed otherwise: less children that live longer. In Germany the public retirement policy requires the working class to pay premiums for those who are retired. If this [pay as you go, as in the US] system is to continue the younger individuals will have to pay more and more premiums to finance the pensions. This puts a high pressure on the system as it requires the solidarity of the younger generation for the older generation. Generational solidarity is under pressure. The question: ” Who is going to pay for my pension when I am 65 (or maybe 70)?” is heard more and more.

The more this question is asked, the more insecure individuals feel and as human beings have a desire to reduce uncertainty and avoid (financial) pain, they try to solve this. The people already retired will build up more reserves, just in case pensions are reduced. The younger working people just want to make sure they will have funds available when they retire will also put money aside.

Money that will not be spent in the economy reducing the growth rate of that same economy providing the wealth to the nation. In the graph this effect is very clear: Where in the major western countries like the UK, the US and Japan the personal savings rate is falling up to the economic crisis of 2008. In Germany it is growing from 2000 onwards. The year 2000/2001 is not a coincidence as in this period the political discussion about the funding of the pension system was very actual leading to the introduction of the “Riester Rente” in 2002.

The German Government provided tax relieve for people who were putting money aside for their pension, exactly for the reason mentioned above to be less dependent on the social security system and have more personal control. Clear enough that the increased savings by the individual Germans could not be spent in the economy thereby reducing the economic growth.

Bottom Line: Intergenerational solidarity is great but it is better to have more control with regards to your pension. We just trust ourselves more than others and as a precaution we will build in security regarding our pension when taking the demographic development into account. A pity for consumption today, but better to have some funds of your own when retiring. Also here the “better safe than sorry” applies even if it is at the cost of personal consumption today.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.


Unknown said...

A great wrap up of the discussion! I think the way this is handled in Germany is much better than in Japan, US and UK. After all, economic crises are bound to happen every decade or so.

I'm not sure to what extent does the increased savings rate hinder economic growth since it is just investment capital for the banks. Especially in the case of Germany which is the second biggest exporter in the world. What I mean is that its GDP growth is not as dependent on domestic consumption as in many other countries, due to its large exports. Did you find any figures on how much has the increased savings rate affected the growth of GDP versus the general economic downturn that decreases exports?

Also I was wondering that what did the savings rate exactly include? Is it the money in the account that is just sitting there, or does it include savings that are intended for purchasing homes. In the Nordic countries (a generalization) purchasing your own house is seen as an insurance for pension, since you wont have to pay rent anymore and you can sell it if needed. What I'm getting at is that I don't think savings for housing, which must be a large proportion of the savings rate if they are included, shouldn't be seen as savings, but rather, an investment. If they are not included in the fugure nevermind this.

-Erkki Piipari-Kokko

NM said...

Steven is right to think about the aging population. But raw numbers won’t ever tell the full picture.

Output is a function of the number of people working, but also of their productivity.

If the Japanese population ages, but people work longer in their lives, and have higher productivity, then their output may well stay the same, producing as much revenue to government as needed for the support of older people past working age. Remember that “When Otto von Bismarck introduced the first pension for workers over 70 in 1889, the life expectancy of a Prussian was 45.“ http://www.economist.com/node/13900145 Think about the productivity gain there!

So the demographics of developed economies isn’t entirely doom and gloom based on the raw numbers of age bands.

Also, the money that Germans put away for their pensions may not have been of use to them for consumption, but it wasn’t lost, it was all the while of use to others for investment, to increase the productivity of German and other workers, to create speculative housing bubbles in the US, Ireland, Spain, and lots of other useful things.

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