International Comparisons
The Politics of Structural Pension Reform in Advanced Industrial Countries: Common and Distictive Challenges
Speech
March 2004
R. Kent Weaver
Georgetown University and the Brookings Institute
A
Balancing Act: Achieving Adequacy and Sustainability in
Retirement Income Reform
Brussels, Belgium
Public old-age pension programs in the advanced industrial countries have been buffeted by a number of common pressures for change in recent years--most notably an aging population and uneven economic growth. In my remarks, I want to stress that while there has been substantial commonality in the pressures and policy responses, there are—and will continue in the future to be—many areas of remaining difference. I will focus on three differences--in economic-demographic challenges, in the current policy “baselines” from which countries are making their changes, and in the political institutions and social environments that guide and constrain policy change. As a result of these differences:
- fundamental restructuring has been limited in most countries;
- different groups of countries face distinctive policy challenges and opportunities for structural reform in the coming decades, and
- the likelihood of convergence around a single model of public pension provision is quite slim.
Let’s begin with the demographic challenges that countries confront. All countries face aging populations in coming decades, and the ratio of the elderly to the population of working age is expected to increase everywhere. But these changes will pose a particular problem in many of the continental European states, where life expectancy is generally highest and fertility rates and immigration are lower than in the United States and Canada. There is also wide variation in the burden of Social Security payroll taxes, with payroll tax rates as a share of GDP that are at or above 15 percent of GDP in a umber of West European countries—a level that is almost certainly near the peak of what can be sustained economically and politically. Comparable payroll tax rates in the U.K. and North America are far lower, potentially leaving more room for adjustment on the revenue side. Finally, the OECD countries vary dramatically in labor force participation rates of older workers. Men aged 60-64 are only about one-third as likely to be working in France and Belgium as in the United States and Sweden, for example.
A second area of important differences among the wealthy OECD countries is that they undertake pension reform from very different starting points. These countries can be roughly divided into “Bismarckian” social insurance countries (e.g., France, Germany) with relatively generous replacement rates, “Bismarckian Lite” regimes that also rely heavily on social insurance, but with relatively low replacement rates and payroll taxes (U.S., Canada), a small new group of countries that have adopted Notional Defined Contribution Pension systems (Sweden, Italy, Latvia), a group of countries with “mixed” pension systems where both public pensions and mandatory individual defined contribution accounts play a substantial role (e.g., U.K, Denmark, Switzerland, Netherlands), and a few countries that continue to rely primarily Universalist flat-rate pension countries (New Zealand, Ireland).
Policymakers can employ three very broad sets of strategies for responding to the increased funding demands of their pension systems. First, they can cut back on the generosity of specific provisions of their pension programs through what will be referred to here as retrenchment in benefits and/or eligibility. Second, governments can refinance their pension programs by, for example, increasing contribution rates, broadening the contribution base (e.g., by requiring contributions above ceilings for which no pension rights are accrued), adding more general revenues to finance the pension system, or devoting other dedicated taxes to the financing of pensions. Third, they can attempt to restructure their pension programs in fundamental ways. For example, governments may phase out a universal flat-rate pension financed by general revenues. They may also add a “defined contribution” pension tier, in which workers each have their own individual pension account, with final benefits depend on contributions made to that account over the entire course of their working lives as well as the return on investments accrued on that account’s funds.
Despite the difference in policy starting points noted above, a common repertoire of incremental pension retrenchment strategies has been widely used throughout the wealthy OECD countries in recent years, including less generous benefit indexation mechanisms and ad hoc indexation cuts, while leaving the principle of indexation intact; phasing in higher retirement ages (usually 65), and equalizing them on gender lines; restricting pension benefits for upper income retirees; increasing the earnings period over which initial benefits are calculated to lower pension replacement rates; and moving to a closer linkage of contributions and benefits. There have also been some common patterns of pension financing strategies: most countries have increased their pension payroll tax contribution rates over the past 20 years, with the United States as a very notable exception. But several countries have also increased efforts to stabilize contribution rates in recent years, notably Germany’s attempts to cap pension contribution rates in the short- and medium term, and the fixed payroll tax rate of 16 percent in the new NDC-based Swedish income public tier.
The similarities across countries are les notable when it comes to fundamental restructuring, however. Most wealthy industrialized countries have at most undertaken modest restructuring. Only a few countries have moved to an NDC-based system, although “quasi-NDC” reforms like Germany’s “sustainability factor” to adjust pension benefits as populations age are getting more widespread attention. Unlike Latin America, where mandatory individual accounts have been widely adopted to replace social insurance pensions, within the wealthy OECD countries, mandatory individual accounts have been added on top of a still-dominant state system (Sweden) or as a major tier in countries that previously did not have a public earnings-related pensions (e.g., Australia, Denmark). And restructuring has not led to convergence around a single model of pension provision across countries.
A third broad area where countries differ is in the political and social conditions that affect the likelihood of successful restructuring of pension systems. In particular, countries differ in the number and structure of veto points within government, the way in which organized labor and seniors groups are incorporated into politics, and the availability of mechanisms to “depoliticize” pension decisionmaking.
In short, the advanced industrial countries continue to face distinctive challenges and are likely to have very different futures. Pension policy starting points are particularly important in determining the challenges different countries face. For Bismarckian social insurance systems, for example, central challenges include keeping pension payroll taxes at politically sustainable levels through a combination of retrenchment and refinancing, addressing problems of low labor market participation among older workers, and considering a restructuring public tiers (e.g., a full or partial move to NDC and adding mandatory or quasi-mandatory private tiers) when those options are exhausted. “Bismarckian Lite” social insurance systems, on the other hand, need to adapt to changes that are occurring in their large supplementary occupational and personal pension sectors (notably a shift to DC-based occupational pensions), and figure out how to address long-term public pension funding problems in the absence of an immediate funding crisis. And the United States in particular needs to develop adequate mechanisms to deal with pockets of (mostly female) senior poverty. “Mixed” Pension systems face important challenges in integrating public and private tiers while providing transparency, equity and universal coverage, as well as controlling administrative costs and market risks in private tiers.
In short, some commonalities in the direction of pension policy change are likely to continue as a result of common challenges and cross-national learning. But convergence of pension regimes in the wealthy countries is likely to remain limited because different policy regimes pose distinctive policy problems and opportunities for change, different political and social environments pose different opportunities for policy restructuring, and the European Union has limited leverage to integrate basic pension regimes even in member countries.