A Graying World Population Calls for Global Pension Reform
A crisis looms over our economic future. "Global graying" - the aging of the world's population - threatens to shake national budgets, financial markets, and politics across the globe.
From the 1940s through the 2020s, the worldwide average human life span will have risen by more than 50 percent, from 46 years to more than 72. The World Bank says 16 percent of the world's population - more than 1 billion people - will be 60 years old or over by 2030.
Continued global stability and prosperity will depend largely on how national public pension systems adapt to this inexorable growth in retirees. While many nations, including the United States, are struggling individually with this question, unilateral reform is neither wise nor sustainable. The process of globalization - where deep trade linkages and increasing cross-border flows of private capital mean that economic problems in one country can spill over into others - demands international coordination of pension reform.
Pay as you go
In the US, Social Security has always been funded on a "pay as you go" basis - meaning that obligations are paid out each year to beneficiaries from the revenues taken in from workers, a system of intergenerational transfers. While this arrangement was workable for half a century, it was only so because of cooperative demographics - short life spans, large families, steadily growing populations and work forces, and, in some cases, heavy immigration. Today, these assumptions are no longer valid, eroding the financial basis for pay-as-you-go systems the world over.
To remain solvent, such systems require an adequate ratio of workers to retirees. But for the US and other industrialized nations, the original pay-as-you-go pyramid - a large base of workers supporting a small generation of retirees - has been inverted. At Social Security's inception, the average life expectancy in the US was 63, yet people did not become eligible for benefits until they turned 65. Today, the average life span in the US is 77, while Social Security eligibility is seeing only a minor, gradual shift to an age 67 retirement norm. In the 1950s, nearly nine working people contributed to the fund for every Social Security recipient. Now, it is 4 to 1.
By the time the 76 million baby boomers begin to retire early next century, there will be two or fewer workers for each Social Security beneficiary. Longer life spans, early retirement, increasing political pressures to curb immigration, and low birth rates mean fewer workers will be supporting more retirees for much longer periods than ever before. By 2013, Social Security benefit payments will exceed taxes collected to pay for the program, according to the Bipartisan Commission on Entitlement and Tax Reform's 1994 study. By 2029, the trust fund will be used up, leaving $8.3 trillion in unfunded benefit obligations to future retirees.
Left unchecked, the Social Security problem will deepen federal budget deficits, as the government scrambles to meet its obligations through borrowing. The private sector will be competing more with the government for an already weak national savings pool. Further depletion of savings could drive up real interest rates, stifling private investment, productivity, growth, and domestic prosperity.
Some reformers advocate tinkering with the pay-as-you-go model through some combination of raising the retirement age, increasing the amount of benefits subject to tax, and "means testing" benefits. But an increasing and influential number of economists and pension experts - including all 13 members of President Clinton's Advisory Council on Social Security - are urging that some or all of the trust fund be invested in the stock market. These advocates say the higher yields delivered by stocks will mitigate, even eliminate, the need for painful tax increases or benefit reductions. They also assure pensioners that private investment will give them greater "control" over their retirement security.
But adopting such a system for its promise of greater returns and greater control could backfire. Privatization advocates may be making the same errors in foresight regarding the condition and sovereignty of modern financial markets that the pay-as-you-go founders did with respect to hospitable demographics.
The US is better poised than others to deal with its public pension financing problems. Greater challenges face Japan and other G-8 nations, where demographic changes will bring the projected over-60 population to 35 percent of their total populations over the next 35 years; Latin America, where the ratio rises from 7 to 24 percent by mid-century; and China, where the proportion grows from 6 to 26 percent, also by mid-century. These pay-as-you-go systems, too, are haunted by assumptions about late retirement, high birthrates, short life spans, and/or high immigration that today undermine a funded system.
Like the United States, other industrialized countries facing pension funding problems must contend with severe domestic implications. By 2010, Japan could have fewer than two people at work for every retiree. With a rapidly shrinking work force, Japan's savings rate (the highest in the world) of 12 to 15 percent of income may shrink by half in order to meet its pension obligations. This could erode the basis for Japan's great productivity and growth.
Our concern for the condition of pension systems such as Japan's should go beyond sympathy. There is a danger, for example, that if interest rates soar in the US as a result of its Social Security squeeze, they will rise in other countries, too. To remain competitive and attract investors, emerging markets in Latin America and Asia may be forced to raise interest rates. Imagine numerous countries trying to meet their huge unfunded pension liabilities by going to the debt market at the same time. Add to this mix the fact that as people retire, they tend to save less and consume more. This combined run on savings could dangerously inflate interest rates and upset financial markets around the world.
The coming global pension problem has particularly profound consequences for the US. The US is more dependent on international trade and foreign investment than ever before. More than one-third of America's economic growth today derives from exports. And its reliance on foreign-capital inflows has steadily increased to the point where it is now the world's largest debtor country. The possible combination of a shrinking domestic work force, high interest rates at home and abroad, diminished foreign purchasing power, and refusal by foreign creditors to refinance new notes or roll over new debt, could take a heavy toll on the US economy.
Now assume that reform of the US Social Security system involves some form of private investment of the trust fund. The disappearance of "individual" markets and the transnationalization of production by multinational corporations greatly complicates this approach, a fact to which privatization advocates seem oblivious.
Linked markets make private investment of Social Security trust fund money a global venture. After all, a large and increasing amount of the sales and profits of US multinational corporations are made abroad, in high-growth countries and regions such as East Asia and Latin America. Yet, the destabilizing economic effects these markets face because of their pension funding problems could undermine their ability to maintain their commitments to US multinationals and, indirectly, make American pensioners more vulnerable.
The communiqu issued from Denver following last June's "Summit of the Eight" called for increasing the participation of seniors in the labor force and raising national savings rates. These are worthy goals, but they don't go far enough in dealing with the coming global pension problem. The unavoidable conclusion is that there must be international coordination of public pension reform. The summit participants missed a golden opportunity to address this issue, especially since "aging" and "globalization" were high on their agenda.
Reform won't be easy
Public pension reform of any type won't be easy. Entitlement programs are the universal "third rail" of politics. From the numerical clout of the American Association of Retired Persons to the tens of thousands of workers who paralyzed France last winter to protest cuts in benefits, the politics of public pension reform are as daunting as the economics.
Still, a stable international consensus on the problem, its consequences, and policy prescriptions can help shape the agenda for domestic politics. There should be, at minimum, the development of a permanent consultative mechanism for public pension reform, through the Organization for Economic Cooperation and Development or another international organization. Regular consultation would represent a common commitment to providing stability and security to the global economy that each nation increasingly relies on.
As the primary guarantor of global stability, the US should take the lead in building and guiding this consultative arrangement. It's a burden worth shouldering, in terms of what can be achieved (continued stability and prosperity) and what can be averted (an economic crisis). The resolution of the problem depends on the will and actions of individual nations. Hopefully, world leaders will see that the risks of doing nothing are only slightly greater than the risks of acting alone.
* Michael Holtzman is the director of public affairs at the Council on Foreign Relations in New York. The views expressed here are his own.