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Barron's

Monday, January 28, 2002

Editorial Commentary

Pension Poverty: European social insecurity
makes the American crisis look mild

By Robert Moffit

President Bush's Social Security commission has taken a lot of flak from critics for pointing out that the nation's premier New Deal program is rushing headlong toward financial crisis. The facts, detailed in the trustees' most recent report, speak for themselves: In 15 years or less, Social Security will start paying out more than it takes in. By 2075, it will be $22.2 trillion in the hole. Absent fundamental reform, lawmakers will be forced to hike payroll taxes or slash benefits.

But potential retirees should be grateful to live on this side of the Atlantic. Much of Continental Europe -- particularly France and Italy -- is on a pension-driven collision course with economic disaster, one that threatens to engulf many of its citizens, as well as others within the economic orbit of the European Union.

Europe's government-pension problems are similar to those confronting the United States. But Europe has them in spades:

-- Graying Populations. On both sides of the Atlantic, life expectancy is up, fertility rates are down, and the largest chunk of the workforce is marching into retirement. However, Western European countries, with birth and immigration rates far lower than ours, are aging at a faster pace.

-- Early Retirements. In the United States, more and more workers are retiring early, thanks largely to a combination of government and private retirement programs, such as corporate pension plans or individual retirement accounts. In Europe, private pension accounts are relatively rare. Instead, "premature" retirements there are sparked and bankrolled by overly generous government pensions, which levy minimal financial penalties for retiring early.

In the 1990s, the average retirement age for Germans actually dropped below 60 (due to various early-retirement schemes). Only recently have German officials moved to address their country's generous retirement provisions, raise the retirement age and promote private pension coverage. In France, the situation is simply ridiculous. French locomotive drivers, for example, can retire at 80% of final pay upon reaching their 50th birthday.

-- Shrinking Tax Bases. Government pension systems are "pay-as-you-go" operations, with taxes levied on current workers paying benefits to current retirees. To remain economically viable, the number of current workers must remain in reasonable proportion to the number of beneficiaries. But, with more people retiring, doing it earlier and collecting benefits longer, the ratio of contributors to beneficiaries becomes skewed in favor of the beneficiaries. Ultimately the system becomes unsustainable.

In the United States, the worker-to-retiree ratio has plunged from 16-to-1 in 1950 to just over 3.4-to-1 today. By 2030, it will fall to roughly 2 to 1. Most of Europe will reach that unsustainable ratio sooner, and then continue to drop. Italy, for example, will have only three workers for every two pensioners by 2030.

These troubling demographics leave workers in the European Union, who are already cursed with an 8.5% unemployment rate, with a bleak retirement future. They will either face savage cuts in future benefits -- or huge tax hikes piled atop tax burdens that are already very heavy.

An analysis by PricewaterhouseCooper shows that, by 2050, France will have to tax workers' pay at 28% to keep its system solvent. The same goes for Germany. Italian workers will face a 46% tax rate. And that's just to prop up their pension systems; taxes for other important programs -- including health and defense, for example -- would come on top of these rates.

Already, the taxes extracted to fund government pension largesse in Europe have left most companies and individuals unable to afford private pension investments. As a result, virtually no funded private pension programs exist in Italy. The same holds true for France. Unfunded government programs account for 84% of all retirement benefits paid within the European Union.

Conversely, Europeans depend on government pensions to fund their retirement much more than Americans do. The amount of mutual funds under management in Europe has risen to $3.5 trillion -- less than half the $7.2 trillion invested in the United States. (The EU population is 379 million versus 278 million in the U.S.) Private pension assets average a mere $23,780 per person in the United States, compared with only $3,800 per person in Germany and $1,600 in France.

The two bright spots on the European retirement horizon are Britain and Ireland -- where demographic patterns are different from the Continent's. An estimated 40% of the Irish population is 25 years old or younger. More importantly, the British and Irish governments have adopted serious policies to address the future retirement of their citizens.

Since the early 1960s, British officials have taken prudent steps to let workers divert part of their social security taxes into private, employer-based pensions. Today, while virtually all British workers participate in the government's basic pension system, more than two-thirds have opted out of Her Majesty's second-tier pension program and into private pension plans.

Britain's private pension funds now total more than $1.4 trillion -- that's more than the pool of private pension funds of all other European nations combined.

Ireland, too, is addressing pension reform -- even though its blazing economy and favorable demographic patterns have produced the "highest living standards for pensioners" and the "lowest overall tax burden" among European countries, according to a report from Merrill Lynch.

Pension payments in Ireland, which is blessed with a young and dynamic workforce, amount to only 2.9% of GDP today, and the country should continue to enjoy prosperity for the foreseeable future, provided it is allowed to follow its present course without outside interference. Such outside interference, however, is likely to come -- from the European nations that refuse to address their own pension problems.

While Britain and Ireland may be islands of fiscal sanity in a sea of entitlement madness, they also are part of the EU, and their economic fates now are inextricably linked to it -- Ireland even more so than Britain, which has not yet embraced the euro. The value of that common currency will be determined by one monetary institution, whose policies will respond far more to the combined chorus of France, Germany and Italy than the maverick voice of little Ireland.

France and Italy, in particular, appear to lack the political will to do what they really need to do in order to avert the coming pension crisis: They are not likely to cut benefits dramatically or to impose the huge payroll tax hikes that would cover the real costs. So far, Continental Europe's efforts to promote a greater reliance on private pension plans are generally too little, too late. Only the Netherlands seems to be making progress.

Continental European countries could easily be tempted to try inflating the euro to cover pension costs. What easier way to make good on unrealistic retirement promises than simply to devalue the currency, using 10-cent euros to pay off IOUs made when euros were worth nearly a dollar?

An inflation gambit would let the French and Italian governments make out like bandits. But it would leave the Irish -- especially those who have paid into funded private retirement plans -- with a bag of wooden euros and raging inflation not of their own making.

Americans may weep because our Social Security system has no shoes. But we should pray for our European brothers and sisters, whose pensions don't have a leg to stand on.

---

Robert Moffit is the director of domestic policy studies for the Heritage Foundation in Washington.

 

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