The Future of Pensions in Europe

Pay-as-you-go pension systems in Europe are being held responsible for a financial crisis which has not yet occurred. But the view that such PAYG programmes will inevitably generate an unsustainable financial burden on European economies is contested in a paper by Michele Boldrin, Juan J. Dolado, Juan F. Jimeno and Franco Peracchi. Their paper is published in the October edition of Economic Policy. They argue that the supposedly inevitable crisis would actually result from other factors such as the high-level of unemployment in Europe and the forced retirement of elderly workers. “[I]t is not the PAYG nature of the system that is leading to its financial collapse, but rather the behaviour of the political pressure and rent-seeking behaviour of special interest groups.”

The pressures involved mean that governments raise pension levels excessively and force the elderly to retire in the mistaken belief that this creates vacancies for the young.

The four economists do not say that existing PAYG schemes should stay as they are but that they can and should provide an essential component in a sustainable pension system. They argue that in fact such PAYG plays a natural role in a wider system of intergenerational transfers which are essential if the failures inherent in the operations of financial markets are to be overcome. Working people help pay to educate the young even though they do not necessarily receive any direct benefit from that investment. In this respect, PAYG provides an efficient, intergenerationally ‘fair’ scheme by establishing an ‘actuarial balance’ between the educational transfers received from parents when one is young and the return to their investment in terms of contributions/pensions when they get older.  There should be some kind of comparability between the tax share of GDP devoted to education and that devoted to pensions.

If there is to be a PAYG element in a viable pension system, the growth in new pensions would be below the projected growth rate of productivity to ensure sustainability. There should also be an attempt to ensure that by 2050, the male labour force participation rate should return to the levels of the early 1980s. And female participation rates should rise to 80% of that of men by the same date. Finally, unemployment rates have to be cut in half while ensuring male and female rates are equal. Fulfilment of these conditions would ensure that the ratio of pensions to GDP would be below or equal to the current level.

In arguing against attempts to replace PAYG with a fully-funded pension system, the authors point out that such a transition cannot be beneficial to everybody. “It must, inevitably, imply some loss for the generations currently alive. Careful analysis shows that the benefits will accrue only to generations not yet born. Such a reform is not politically feasible.”

Notes for Editors :

Economic Policy is published in association with the European Economic Association for the Centre for Economic Policy Research, the Centre for Economic Studies of the University of Munich and the Département et Laboratoire d’Economie Théorique et Appliquée (DELTA), in collaboration with the Maison des Sciences de l’Homme.

For further information about CEPR, please contact Rita Gilbert, Tel: (44 20) 7878 2917 or email: rgilbert@cepr.org, or contact James Morgan, Tel: (44 20) 8225 7262.

The Authors : 

Michele Boldrin and Juan J. Dolado are Professors of Economics at Universidad Carlos III, Madrid; Juan F. Jimeno is Professor of Economics at Universidad de Alcalà de Henares and FEDEA; Franco Peracchi is based in the Faculty of Economics at the Universitá Tor Vergata, Rome.