Think tank Bruegel has proposed what it describes as a form of “shock therapy” involving the deployment of assets equivalent to 25% of gross domestic product (GDP) to establish a critical mass of pension assets and accelerate the development of funded pension systems.
The proposal would involve creating “a debt-financed, decentralised sovereign wealth fund”, according to Jacob Funk Kirkegaard, senior fellow at Bruegel, speaking at an event organised by the think tank this week.
Assets held in the fund would be allocated to individual accounts within a Swedish-style centralised second-pillar system, with investment choices guided through government-managed funds, Funk Kirkegaard said.
He argued that governance could be strengthened through mandatory annual or biennial reviews conducted by external advisers, similar to arrangements around Norway’s sovereign wealth fund.
Under such a framework, the ministry of finance or prime minister would be required to respond publicly to the reviews, while the reports themselves should contain direct strategic advice for the fund, he added.
Funk Kirkegaard acknowledged that issuing debt on such a scale would be particularly challenging for countries such as Italy and France, whereas the costs would be lower for Germany and smaller countries in Central and Eastern Europe.
“You will increase debt for a government, but in reality, it is only accounting, because you are taking unfunded pension liabilities and moving them on the balance sheet, and hopefully getting better investment capital opportunities,” he explained.
Proposal meets scepticism
Axel Börsch-Supan, director of the Munich Research Institute for the Economics of Ageing and SHARE Analyses (MEA), expressed scepticism about Bruegel’s proposal.
The market would struggle to absorb debt issuance equivalent to 25% of GDP in a large economy such as Germany, while issuing debt would neutralise much of the intended capital market effect, he argued.
Building a funded pension system in Germany is particularly challenging because the baby-boom generation is entering retirement, the younger generation is comparatively small, and economic stagnation persists, he added.
In the meantime, pension reforms proposed this week by Germany’s pension commission are intended to improve the sustainability of the pension system while remaining politically acceptable, according to Börsch-Supan.
Henrik Munck, political adviser at Insurance & Pension Denmark (IPD), said he “would be afraid” of what he described as a “big bang” approach based on borrowing to fund pensions, particularly when the burden would ultimately fall on future generations.
A blueprint for Europe
Denmark, the Netherlands and Sweden provide a blueprint for other European countries seeking to develop strong, funded pension systems, according to preliminary findings from a Bruegel paper examining successful and unsuccessful pension reforms across the European Union.
The three countries have converged towards broadly similar models based on funded defined contribution (DC) second pillars, while retaining distinct national characteristics.
Well-designed second-pillar systems can provide income security while supporting investment and risk capital, Funk Kirkegaard argued.
Contribution rates in Denmark currently range from 13% to 20% of salary, while roughly two-thirds of pension fund assets are invested in arrangements without guarantees.
“This has a tremendous impact on the asset allocation”, Munck said.
According to Munck, Danish pension funds without guarantees allocate 60-65% of their assets to equities, generating annual returns more than two percentage points higher than schemes with guarantees.
Marie-Sophie Lappe, a researcher at the European Central Bank, said capital market development depends on pension funds investing “in a way that is productive, that can generate returns”, while maintaining diversified portfolios and avoiding being “insanely risk-averse”.
