washingtonpost.com
Pensions Threaten European Economies
By Anne Swardson
Washington Post Foreign Service
Wednesday, April 26, 2000; Page A01
ROME ?? Elisabetta Valle, 50, is on the leading edge of an oncoming European financial crisis that threatens to bankrupt nearly every major government on the continent.
Her daily schedule doesn't show it, to put it mildly. Valle spends her days ferrying her 11- and 14-year-old children to school, running errands, shopping for groceries, making snacks, taking the kids to swimming practice, then bringing them home to the family's apartment along the Tiber River and cranking up the homework.
But once a month, her routine varies a tad: She cashes her pension check.
Like 5 million other Italians under the age of 65, Valle is a youthful retired pensioner. She receives the equivalent of $800 a month from the government pension plan. If she lives to be 80, her tiny pension will have cost Italian taxpayers $316,800.
Retirement was a rational choice for Valle nearly three years ago, when the school where she worked eliminated the architectural-drawing classes she taught. In Italy, her sort of early retirement was not only permitted but common. Like everyone else, she paid in and now she gets to take out.
Still, she said she feels a little guilty. "I know there is not going to be enough money for everyone," she said. Added her husband, Guido Rasi: "It's a crazy use of public money. Our children will pay for this."
By 2025, an estimated 113 million Europeans--nearly one-third of the population--will be pensioners, Romano Prodi, president of the European Commission, warned recently in a speech urging member governments to take action. Nearly all will be covered only by government-financed pension programs.
These aging baby boomers will be an unprecedented drain on their governments and their children, creating enormous pressure to raise taxes or cut spending, and presenting a serious threat to the euro, the new single European currency adopted by 11 nations. While the United States faces similar demographic challenges, European countries--especially Italy, Germany and France--are in far bigger trouble and have been slower to enact reforms.
The looming retirement crisis is the result of three major factors:
* Women are having fewer children. No country in Europe is producing enough children to replace its current population, which will lead to a decline in the base of workers contributing to the pension systems. The last time Italian women bore more than two children on average was in 1945, before Valle was born. In 1997, the average number was 1.22.
Because of the declining birthrate, Italy's population will shrink 28 percent, to 41 million from 57 million, between 1995 and 2050, according to the United Nations. The European Union, which now has 105 million more people than the United States, will have 18 million fewer as Europe shrinks and the United States grows during this period. Widespread European hostility toward immigration makes it unlikely that people from other countries will fill the gap.
* Workers are retiring early. Although the legal retirement age is 65 in most European countries, the financial penalties for early retirement are so minimal that men retire on average at age 61, more than two years earlier than in the United States. The average for European women is 58. Fifty years ago, European men and women worked seven years longer than they do now--and lived 11 years less.
The pension schemes "are so generous it's almost like giving money back to the government if you work longer," said Jan Mantel, a consultant to the brokerage firm Merrill Lynch and Co., which published a report on European pension reform last year. "The trend toward early retirement is the biggest problem in the system in Europe for the last 50 years."
* There are few private alternatives to supplement taxpayer-financed systems in most countries. Private pension funds such as corporate pensions or 401(k) plans are weak, do not exist or are just starting up in much of Western Europe. In France they are illegal; a 1997 law permitting them was never fully enacted because of union objections. Italy is just starting tax-favored savings funds. Corporate pensions cover half of German workers, but the funds' financial solvency is questionable.
According to Merrill Lynch, only 7 percent of European Union workers are covered by corporate pensions and only 0.9 percent by private savings plans equivalent to 401(k)s. Thus, nearly all workers will be entirely dependent on government-paid retirement benefits, similar to Social Security in the United States, when they retire.
As a result, the burden of the retiring baby boom generation, which will hit in earnest in about 10 years, will weigh upon working, taxpaying Europeans far more than their American counterparts. In the United States, there will be one person older than 65 for every three of working age in 2030, according to International Monetary Fund estimates. In Italy and Germany, by contrast, the ratio will be one to two.
In both those countries, experts believe, the official figures hide the full impact because so many people retire before 65. In all likelihood, experts say, Italy and Germany will have one worker for every retiree in about 30 years. By some calculations, taxes will rise so much in Germany and Italy that half of workers' incomes will go to taxes to support retirees, with taxes for other purposes on top of that.
To be sure, the United States is also facing a demographic crisis for which it is not fully prepared. But some reforms have been implemented: The retirement age for Social Security is being raised from 65 to 67 over the next 22 years, for instance, and a higher rate of immigration means the U.S. population is growing and is younger than Europe's.
In Europe, the time bomb has been ticking for quite a while. But as it comes closer to exploding--and none of the major European governments has enacted anything close to sufficient reforms--a new factor has raised the stakes: the euro.
The new European single currency has locked the economies of 11 European countries together. Because all 11 are now governed by one monetary institution, they are effectively one economy.
Thus, a demographic crisis that requires the Italian government to pay pensions to more people could raise inflation in Ireland--even if the Irish government can take care of its own retirees--because higher government spending in one country can raise the general inflation rate. Similarly, if France spends its way into a deep deficit to support an aging population, Dutch home buyers may pay higher interest rates on their mortgages, because big government budget deficits tend to raise interest rates.
Should such a crisis erupt, experts say, it's hard to imagine the euro union holding together. European Commission President Prodi has been sounding warnings about the coming crisis since he took office last fall, but only national governments have the power to change their own retirement rules.
"The bottom line is that generational imbalances across the euro zone gravely threaten the single currency's medium-term viability," wrote historian Niall Ferguson and economist Laurence J. Kotlikoff in this month's Foreign Affairs journal. "The choice for nearly all . . . members is between tax hikes on a scale unprecedented in peacetime or drastic government spending cuts. Given the political weakness of most national governments, it is hard to see either choice being made."
The looming retirement crisis is at odds with the picture of a "new Europe" portrayed by many leaders on the continent, who boast that Europe is as competitive and dynamic as the United States. In fact, experts say, the pension situation reflects the defects of the old Europe, the Europe of the welfare state and of center-left governments unwilling or unable to scale back programs, enact unpopular reforms and turn to private-sector solutions. They are continuing instead to rely on overly optimistic forecasts and are putting off the day of reckoning.
"There's a great deal of hope [among European governments] that birthrates will turn around and we won't live as long, but from the standpoint of sound fiscal policy, they are whistling past the graveyard," said Paul Hewitt, project director for the Global Aging Initiative of the Center for Strategic and International Studies in Washington.
In France, for instance, Prime Minister Lionel Jospin has been delaying a decision on retirement reforms for nearly two years. In Italy, reforms have been postponed until at least 2001; in Germany, 2002. The reason, though officials rarely admit it, is sheer politics. Raising the retirement age or reducing benefits is extremely unpopular.
"In Europe, the right to a public pension is deeply rooted," said Italian Labor Minister Cesare Salvi. "People consider their pension as a property right, so they see it as an expropriation when you change the rules."
Early retirement on this side of the Atlantic also reflects a European outlook. It is based on the view--outdated now, in the minds of many economists--that there is a fixed amount of work and if older people are eased out of jobs there will be more available for younger workers. On a continent where unemployment still runs above 10 percent, that argument still has wide public resonance.
"It's not reasonable to let old people work when they find it hard going and to see young people get into trouble because they have no jobs, falling into alcohol, bad company and the like," said Karl-Heinz Vorbrucken, head of the Bonn branch of IG Bau, the main German construction union.
Over the years, the pension problem has been compounded as special coverage has been extended to certain groups of people to achieve political or social ends.
Germany's pension system is under stress, for instance, in part because it was extended at reunification 10 years ago to cover all the people from East Germany. Vorbrucken was working in a small eastern town then, helping new German citizens who had grown up in an uncertain, disaster-prone economy obtain the new benefits available to them.
He recalls walking into a farmhouse just after the elderly farmer and his wife had cashed their first monthly pension. The man had the bright, crisp 100-mark bills laid out on the table in front of him, and he was crying. Reunification "was the best thing I have ever experienced," Vorbrucken said. "But it cost us tremendous amounts of money."
In France, some workers--train drivers, electrical workers, sailors, miners--have for more than 100 years been able to retire at age 55 or even 50. They were granted this relief when those kind of jobs were dirty and dangerous, but even now, despite automation and modernization, the benefits remain.
The "special regimes," as they are called, chew up 27 percent of all retirement spending in France and are heavily subsidized by general revenue. In 1995, when then-Prime Minister Alain Juppe tried to cut them back, the ensuing strikes shut down Paris and much of France for three weeks. There have been no further proposals for reductions.
In Italy, reforms were enacted in 1995 and 1997, including the termination of the program under which Elisabetta Valle retired. Union and government officials say Italian pensions are safe into the future, though the new system may have to be phased in faster than current law allows.
Many European experts disagree, as do many Italians. Numerous young Romans interviewed here expressed profound skepticism that retirement benefits would be available for them.
"I know the public system will not work," said investment banker Donato Savatteri. "The only way to have a nice retirement is invest now." Flight attendant Antonio Pennacchio, 32, said he was tucking away as much money as he could because his elders would bankrupt the public system.
As for Valle and her husband, they worry about the future financial burden on their children, Virginia and Ricardo. Do the children worry?
"We haven't told them yet," she said.
The Pension Crunch
By 2025, one-third of Europe's population will be pensioners, creating a heavy burden for workers paying taxes into government pension systems. Financing pensions will become more difficult as populations age in Europe as well as in the United States. The situation is worse in Europe, where more people depend solely on government pensions and officials have been slow to enact reforms.
The number of elderly will grow compared with the working population.
Population over 65, as a percentage of population aged 15 to 64
More and more people are retiring before age 65.
Effective retirement ages for men, in years
U.S. 63.6
France 59.2
Germany 60.5
Italy 60.6
Public pension and health-care spending will continue to grow.
In percentage of gross domestic product
Raising taxes to finance pension systems is an unpopular solution, since contributions are already quite high.
Contribution rate, in percentage of wages
SOURCES: IMF; Rodolfo De Benedetti Foundation, Milan; Global Aging: The Challenge of the New Millennium, report by CSIS and Watson Wyatt; OECD; ILO |
