Tuesday, October 26, 2010

Old-age tension :Is Increasing the retirement age is inevitable and better than the alternatives ?

FRENCH workers have begun another round of strikes in protest against President Nicolas Sarkozy’s proposals to extend the minimum retirement age to 62. The protesters probably haven’t stopped to examine how demographic trends are set to devastate government finances in the developed world.

The bad news was spelt out in “Global Ageing 2010: An Irreversible Truth”, a report released by Standard & Poor’s, a ratings agency, on October 7th. As the baby-boomers (people born between 1946 and 1964) retire over the next two decades, the burden on the state will rise sharply.

This demographic problem has been coming for some time. But the boomers have not provided enough for their old age. And the credit crunch has made the sums look even worse.

It is not just pensions. Spending on health care and long-term care (ie, nursing homes) will have to rise too. If policies do not change, six European countries— Belgium, France, Greece, Luxembourg, Slovenia and Ukraine—will be devoting more than 30% of GDP to age-related spending by 2050. The median advanced country will be spending 27% of GDP on age-related items by then; state spending will absorb around 70% of some countries’ GDP.

As a result, at least in part, of this age-related spending, the median advanced economy will be running a deficit of 24.5% of GDP by 2050; 12 countries, including both America and Britain, will have deficits of more than 30%. Debt-to-GDP ratios in the G7 will have ballooned to more than 400%.

Merely to state these numbers is to grasp why policies will have to change. Countries cannot deal with this problem by raising taxes, since any tax increase on that scale will crush economic growth. Nor is it likely that governments could slash other forms of spending by enough to counteract the effects of ageing.

It would seem that countries will have to choose between two forms of default. They can break their promises to their creditors or they can break their promises to future pensioners. Some countries will do the former, either by an outright failure to repay their debts or via the more subtle approach of inflation and currency depreciation. But most will attempt to do the latter, despite the protests and the electoral power of the elderly.

Raising the retirement age is the most obvious reform. It is a fair adjustment given the increased longevity of the population: European life expectancy has increased by almost ten years since 1950. A later retirement age also increases the size of the potential workforce, and thus the number of taxpayers. Some argue that it is unfair on manual labourers, whose life expectancy tends to be shorter, but this bias has always existed.

And manual workers would surely suffer more if governments went off in the other obvious direction—cutting benefits. Britain has quite a stingy basic state pension because of a Thatcher-era decision (reversed by the new coalition) to link payments to prices rather than earnings. Fiddling with inflation-linking is a stealthy way of cutting benefits but would hit the poorest hardest, since they have no alternative source of income.

Is there a deus ex machina, a device that will rescue the rich world from its plight? One option might be to generate a second “baby boom” so that by the time 2050 rolls around, there are more workers to support the pensioners. This is by no means impossible. In France the fertility rate is already around two children per female, not far short of the “replacement rate” which keeps population numbers steady. But it is unlikely. In Europe as a whole the birth rate fell from 2.65 in 1950-55 to 1.42 in 1995-2000. Although the birth rate has edged up since then to 1.5, it would take a huge social change to push it as high as is needed.

Another option is immigration. Opening the borders would increase the labour force, creating more taxpayers and more potential carers (in hospitals and nursing homes) to look after the elderly. Immigrants also tend to have more children, one reason why the British birth rate has rebounded over the past decade.

However, for this solution to work at the European level immigration would have to come from outside the continent, probably from Africa. European far-right parties have already surged in electoral popularity. Imagine what would happen to their support if countries tried to increase the flow of immigrant workers.

Raising the retirement age may not be popular, but it will be more popular than the alternatives. Get used to it: we are heading towards a pension age of 70.

Source: http://www.economist.com/node/17254452

Forget yourself for others, and others will never forget you.

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