Can Industrialized Countries Afford Their Pension Systems?

In Moody's Sovereign Risk Unit, we spend a great deal of time studying and debating public-sector pensions in industrialized countries and their potential impact on total public-sector debt over the medium to long term. What we are really discussing is whether the industrialized countries can afford the pensions promised by their respective governments. In some ways, you might find our analysis surprising.

Moody's expects almost every industrialized nation to "default" on its pension promises. What do I mean? We have concluded that, with few exceptions, it is nearly impossible for almost every major developed nation to meet the public sector pensions currently promised, including health care for seniors, without significant adjustments to future benefits. In other words, future governments will probably not be able to meet pension and senior health care commitments as embedded in law today. Conceptually, what is most intriguing as a credit analyst is that if governments were to handle their bond obligations in the same way--that is, not fulfill the original contract--those government bonds would enter our famous default study. Fortunately for governments, the public does not generally view pension "defaults" as seriously as a breach of promise by a government on its bond obligations. Why this is so appears to be simply societal conventions.

For example, it can be argued that the United States "defaulted" on its social security obligations once it changed the tax laws on social security payments in the 1980s. Payments that were previously exempt from income tax suddenly became, for a large number of wealthier pensioners, taxable income. The government could have accomplished the same result by decreasing benefits to those same pensioners, but probably chose the tax route because it better obscured the final outcome--lower net payments to certain pensioners. This is just one example. The list of pension reforms involving reduction in present-day benefits, never mind future benefits, is long indeed.

We have looked at many of the most important academic studies that analyze future pension burdens and their potential impact on government debt. For many of the most highly advanced industrialized countries, one must almost inevitably conclude that the level of the public-sector debt needed to fund existing promises over the long term would raise serious solvency issues if these pension systems are not reformed. On balance, many continental European countries and Japan could not sustain the increased debt burdens implied by their existing pension systems when these future obligations are added to existing public-sector debt. Those countries that are in somewhat better shape over the long term usually have public-sector pensions that are less generous or relatively low initial levels of public-sector debt or both, or population dynamics that include higher levels of immigration and therefore more favorable dependency ratios.

I am reluctant to use any single set of estimates of these future debt burdens because each study has its own peculiar characteristics that can be altered significantly by slightly different assumptions. Nonetheless, in one study, a well-known working paper by the Organization for Economic Cooperation and Development (OECD) in 1996, ¹ worst-case estimates of debt levels in 2030 relative to gross domestic product (GDP) for a number of industrialized countries came out as follows (in percentages):

United States	115
United Kingdom	144
France	193
Netherlands	206
Italy	241
Germany	247
Japan	339
Austria	340

Although we recognize that these figures represent exaggerated estimates of future debt burdens, the estimates are not implausible in light of the historical record of worst-case debt loads for industrialized countries.

Not surprisingly, until the 1970s-1980s, the worst burdens of public-sector debt were always associated with fighting a war or dealing with its aftermath. Estimates of postwar debt levels relative to national income indicate wide variances among countries over time. Interestingly, after surveying the actual historical record, one is almost forced to conclude that debt levels, in and of themselves...