The long-term security of the national pension is already an issue in every country.
The replacement of the national currency by the euro now adds to the uncertainty. What will be the euro be worth 30 years from now? Will pensions be worth much less because of higher inflation or irresponsible behaviour in other countries? The concern is of course justified when looking at the past. Currency devaluations have occurred in all countries, some of them very severe, eroding the purchasing power of savings and pensions.
The focus is on countries where spending on pensions is already much higher than in others, and where the pensions are not funded and/or the savings rate is low. There is a fear that the euro will lead to a ‘Common European Pension Policy’, where countries with capital funded pension systems will subsidise those whose systems are financed on a pay-as-you-go basis. Or, as some say: “Some countries are putting in their assets and other countries are mainly pouring in their liabilities”. Pay-as-you-go systems will steeply increase in cost in the next decade for demographic reasons; 90% of pension outlay is on this basis.
The discussion is not new. The official answer on the subsidy issue is also known. There will be no subsidy. But there are conditions to be met, otherwise the answer could indeed be yes.
The answer is no because the Emu agreements contain the “no-bail-out” clause. Each country will have to pay its own debts. When, for instance, a far too generous pension system in one Emu country leads to an increase in its national debt, the other Emu members do not participate in that debt.
Membership of Emu also includes the acceptance of the so-called convergence criteria, such as a maximum budget deficit of 3% of GDP. Countries have to aim for a balanced budget and a reduction of national debt towards the level of 60% of GDP. It is here that credibility is low, because in 1998 various countries suddenly considered financial transactions with a material one-off impact on the budget deficit of that year only. (Many eyebrows were raised in Germany, for example, at certain Bundesbank transactions and in France there was a pension capital transaction.) This was also the case in 1999 when there was discussion in Italy about the question of eliminating the cost of investments in durable assets from the deficit limit of 3%. Italy already has twice the level of national debt (120% of GDP) at which Emu is aiming. It is exactly this kind of discussion that undermines the credibility of the Emu agreement. I hope these creative ideas will not return.
The second factor to consider is the functioning of the European Central Bank. This is fulfilling its role as the central authority on euro policies. The primary goal is price stability in Euroland. We have not seen yet much of the interest rate policies of the ECB, but what we have seen is generally accepted as being in the right direction. Inflation in most countries is still relatively low, so for the time being pension fund managers will wait to see if the ECB fills its role in a credible way. The external value of the euro has, of course, gone down substantially but as the proportion of external trade of Euroland is low, at about 10%, the effect on inflation is limited.
The third reassuring factor should be the pact for stability and growth. The intention is to support national governments in their decisions on budget discipline to bring them below the 3% maximum deficit, or otherwise a sanction will be issued. It is here that I have doubts whether the pact is strong enough, as there is too much room for interpretation. Exceeding the limits is tolerated when the situation is “exceptional” and of a “temporary nature”. What does that mean? Was the Asian crisis last year “exceptional”?
It really will depend on the presence of a political will in each country to avoid increasing deficits and to reduce debt. Is it present now? And will it be after new elections a few years later? And how fast does the system react?
It is important that we have a good insight into the future cost of pensions. We need to look far ahead, further than the five-year period looked at in the framework of the pact.
An EU report of 1996, “Ageing and Pension Expenditure Prospects in the Western World”, shows such longer-term trends for the 15 member states. It points out that, given the large demographic changes expected, in several countries the preservation of present benefit levels and eligibility rules require a substantial increase in the national resources devoted to pension systems. Alternatively the stabilisation of pension expenditure requires further severe cuts in benefit levels and substantial restrictions in eligibility – or, more bluntly, a lower pension and/or a later retirement date.
The problem is clear. The action, however, is still far too limited. Things are going into the right direction, in Italy, France, Germany and the Netherlands. But it is not enough and it is all coming too late. There is an interesting remark in the report: “differences in approach, in the period of reference, in coverage and in economy and demographic assumptions severely hamper the comparability of national estimates”. It seems that the data are not reliable enough to monitor the effect of present pension policies in a comparable way. Is that the reason that not enough is being done?
A more recent G10 report, dated April 1998, shows pension expenditure as a percentage of GDP under various scenarios. The table shows the data, which assumes pensions follow wage developments in the years to come.
France and Germany show expenditure levels between 10% and 12% of GDP today, while at the lower end we find UK and the Netherlands at a level of 4–6%. This is an enormous difference. If we look at the development between today and 2030, we find the UK with an increase of 3.3% of GDP, but all the others increasing their spending in a much more dramatic way, from between 5 and 7%, to levels of between 13% and 17% of GDP. Increases in pension expenditure of 5–7% of GDP could bring deficits to twice or three times the level allowed under the Maastricht treaty. This assumes no policy change in the meantime and that the figures are right.
Suppose there is no policy change in one high-risk country. In theory, the extra pension cost could be financed by issuing new state debt. The budget deficit would increase, well above the 3% maximum. However, as we have seen, this route is blocked by the stability and growth pact. An opinion issued by Ecofin states very clearly that the medium-term budget forecasts should take into account the costs of an “ageing society” and that the state budgets should show that they are durable. So debt financing is not possible and still there is this massive increase in cost. Does it matter for us, in the Netherlands, or for the UK? Suppose your euro-sceptics all suddenly see the advantages of the monetary union and join? Does it matter? Yes, it does!
Pension contributions would probably force up wage levels in that country. Increased taxation would be another way to pay for the high pension expenditure but higher taxes will also affect wages. So the cost of labour will go up, demand for labour will go down, the competitive position of that country will deteriorate and jobs will be lost. Devaluation is no longer possible – there is only the euro as common currency. The prime goal of the ECB is not to increase or decrease the euro’s external value but to keep prices stable in Euroland. The end result will be rising inflation in that country. Should two or three Emu countries show similar patterns it is very likely that inflation would rise everywhere within Emu. That of course would affect the funded pension capital system much more than the pay-as-you-go system.
I am sure the G10 figures, put together by experts, are right. But to be accepted by member states as a realistic indication of future pension expenditure, the cost in this report must really take into account all the recent policy changes in national pensions. The report is based on a study of 1996 and shows the cost as a percentage of GDP at 1994 prices. So I don’t know how up to date it is. I also hope that the actuarial, economic and demographic assumptions and methods are consistent and don’t distort the comparison. Only if we fulfil these conditions and develop this pension cost monitor for all Emu (and EU) member states, will the EU have an effective measure to monitor the developments.
One might ask how far it is a task for Emu to follow the cost of pensions in another country, to signal alarming developments in other member states or even to ask critical questions about these cost projections. Isn’t the national pension a matter of national policy that can only be decided within each national political environment? Yes, it is. But since we are linked with each other through the euro the situation has changed and we have become more dependent on each other. This gives Emu member states the new task of monitoring national budgets and, consequently, monitoring pension costs.
In the Netherlands, the pension fund associations, OPF and VB, have discussed these issues with the main political parties. Government reactions supported our concern that there is a real problem in the EU. It agrees that rising deficits or taxes and/or contributions cannot be seen as solutions. In its view the answers must come from rising employment, faster economic growth, a later retirement date for the present active labour force and a reduction of other expenses, among which future pension liabilities are prominent. They have also started initiatives that should lead to monitoring at European level, amongst others by ECB.
According to the Dutch government there is enough information available that provides an insight in the future costs. What is lacking is how to translate these ideas into actual reform proposals that will get parliamentary approval.
Much more must be done to make people aware of the problems ahead and to promote acceptance of the need for reform. We will all benefit if action is taken in time. If not, the younger generation will end up paying the bill.
This article is based on an address to the recent EFRP/NAPF international pensions conference in Monte Carlo. Jos van Niekerk is managing director of the Dutch Unilever Pension Fund. He is a board member of OPF