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The Washington Quarterly 23.3 (2000) 225-238



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Maintaining Prosperity

Nicholas Vanston

Global Aging

In the advanced countries of North America, Europe, Japan, and Australasia, the reform of public pension systems has been a topic of public debate for years, but not because these systems work badly. By and large, they are comparatively inexpensive to administer. They effectively prevent seniors from slipping into poverty. In several OECD (Organization for Economic Cooperation and Development) countries, seniors who qualify for full state pensions are able to maintain a comfortable standard of living during retirement, which now can last for 20 years or more. Therein lies the problem. High pensions for many years mean high taxes for those still working because public pensions are almost always pay-as-you-go (PAYGO). Pension contributions by employees are used directly and immediately to pay the pensions of those in retirement. There is no fund. Children pay the pensions of their parents. Because birthrates have fallen, there are fewer children and the burden on them will grow.

This demographic shift means that societies in the future will contain much higher proportions of retired people, and possibly very much higher proportions of frail elderly people. This raises a number of policy issues.

Counteracting the Economic Consequences of Aging

The important questions are these: What sort of reforms to public pension systems need to be implemented, and when? The answers vary from country to country, depending on demographics, the design of the public pension system, and any major reforms already legislated but not yet implemented. [End Page 225] Nevertheless, all desirable reforms address three objectives:

  • encouraging people to work longer,

  • implementing policies that make them more productive while they are working, and

  • encouraging diversification away from public PAYGO pension systems that are too generous.

Encouraging People to Work Longer

It is striking that although citizens of OECD countries live considerably longer and healthier lives than they used to, they also retire earlier and earlier. The desire for earlier retirement is understandable, and as long as the financial terms are fair--neither excessively burdening those still working nor excessively penalizing early retirees--there is no reason for governments to intervene. But in practice, public pension systems and other social programs positively encourage older workers to retire early, especially if they have worked long enough to qualify for a full public pension but are still a few years from the official retirement age. For example, many of those now in their mid-fifties in OECD countries who left full-time education in their mid-teens probably already have rights to a full state pension. If they continue to work until they reach the official retirement age (62-65 years), they must continue to pay pension contributions through payroll taxes, but their eventual pension will not be higher as a result. Indeed, OECD research, based on 1995 data, showed that someone of age 55 who had worked for 35 years would not get a higher pension by working an extra 10 years in 11 out of 26 OECD countries. In 10 other countries, the eventual pension would be only 10 percent (or less) higher. In effect, they are paying a tax from which there is no ultimate benefit.

Although retirement at an age below the official age carries a financial penalty in the form of a lower pension, the tradeoff in many countries is not "actuarially fair." The reduction is less than can be justified given the longer number of years that the early retiree will draw a public pension. In those countries, under the social security rules, there is a financial incentive to retire as soon as possible--and many do.

Older workers also have other ways of effectively financing early retirement. In many European countries, older workers who lose their jobs do not have to prove that they are actively searching for another one as a condition for drawing unemployment benefits. The rationale for this is that in countries in which structural unemployment is high, the chances of an unemployed older worker (older than 55, say) finding a job within a few months, or at all...

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