Have We Made Pension Promises
We Can't Afford To Keep?

The rapid ageing of the populations of all industrial countries over the next 40 years will be a vastly greater economic and social transformation than the 1970s oil shock or the 1980s recession, Paul Johnson told a CEPR lunchtime meeting on Thursday 6 July. Unlike such economic shocks, this transformation can be perfectly anticipated, but cannot be alleviated by manipulating the usual economic policy instruments fiscal policy adjustments have little or no effect on the birth rate.
As the proportion of pensioners to workers rises, public and private pension systems alike will be forced either to restructure their institutional arrangements or greatly to increase the contribution rates expected from workers. The falling labour force participation of older men in all developed countries over the last 20 years has exacerbated the financial pressure on state pension systems, Johnson noted, by reducing further the ratio of workers to pensioners. Policy-makers should now be looking at ways to raise the normal age of retirement.
These pressures suggest a growing social conflict, not between socio-economic or ethnic or occupational groups, but between generations. That cohort of people who reached adulthood in the 1940s and 1950s have been called `the welfare generation'. When they were young and having families the welfare state expanded to meet their needs. Now that they are reaching retirement, pension expenditure continues to rise while social security and education provision is under increasing financial pressure. As the ratio of pensioners to workers rises further, this intergenerational conflict over fiscal burdens and welfare entitlements may call into question the whole basis of modern welfare states.
Johnson's remarks were based on research reported in a new book from CEPR, WORKERS VERSUS PENSIONERS: Intergenerational Justice in an Ageing World, co-edited by Johnson with Christoph Conrad and David Thomson and published on 6 July by Manchester University Press for CEPR. The volume is based on an international conference organized by CEPR at Cambridge in summer 1988 on `Work, Retirement and Intergenerational Equity: The Social Economy of the Second Half of Life, 1850-2050'. The conference received financial support from the Anglo-German Foundation for the Study of Industrial Society, the Centre for Economic Policy Research International Foundation, the Department of Health and Social Security, the French Cultural Delegation and the Nuffield Foundation.
Paul Johnson is a Research Fellow in CEPR's programme in Human Resources since 1900. Funding for the meeting at which he spoke was provided by the Economic and Social Research Council, the Centre for Economic Policy Research International Foundation and Manchester University Press. The opinions he expressed were his own, however, and not those of any of the funding organizations or of CEPR, which takes no institutional policy positions.

Can Pension Systems Survive Population Ageing?
In all the industrialized countries the average age of the population has increased and the number of pensioners has risen, as a result of increased life expectancy, the postwar baby-boom and the subsequent dramatic decline in fertility rates. In 1950 around 12% of the population of Western Europe was aged over 65, but by 2025 this will have increased to 25%. In addition, the rise in the real value of pension, welfare and health provision for older people over the last 30 years has increased the share of national resources consumed by this section of the population significantly faster than the increase in their overall numbers.
In all modern societies there is a net flow of resources from the young to the old, a flow that operates primarily through the institutions of the welfare state. As John Ermisch, Co-Director of CEPR's research programme in Human Resources since 1900, shows in his chapter in the book, this flow of resources between generations can benefit everyone if the population is stable. But when the age structure is changing rapidly, intergenerational transfers can run into problems as the necessary contribution rates for workers increase to pay for the large number of pensioners. Even if there is no further improvement in the real value of pension and welfare payments to the retired population, the decline in the UK worker/pensioner ratio from 2.3 national insurance contributors per pensioner in 1985 to 1.6 contributors per pensioner in 2025 implies that national insurance costs per worker will need to rise by as much as 50%. Few believe that this sort of fiscal burden is politically sustainable.
Winfried Schmähl, Chairman of the German federal government's advisory board on pensions, shows how the exact cost of an increasing pensioner dependency ratio is related to the institutional arrangements of each country's state pension system and to the scale of its demographic change. The effect on the West German federal pension scheme is particularly dramatic. If its institutional arrangements remain unaltered, the contribution rate expected of workers will need to rise from its current level of 18.5% of income to 36-42% by 2030. Although the effect on the state pension systems of other OECD countries is less spectacular, Johnson noted the irony of current pressures, generated by hopes of a `social Europe' as part of `1992', to harmonize EC pension rights up to German levels.
In another chapter, W Andrew Achenbaum reports on the strains facing the US public pension system. There are growing fears for its solvency and genuine potential for intergenerational conflict over its perceived inequities. But it is important to realize, Johnson argued, that this sort of funding problem is not confined to state pension systems transferring the burden of pension provision from the public to the private sector will not solve the problems of population ageing. In his chapter in the volume, Steven Sass describes how US trade union schemes have come since the 1960s to enrol almost 50% of all participants in US private pension institutions. He shows how these schemes are also facing a serious funding deficiency in the 1980s, resulting both from the increase in early retirement since the 1960s and the shortage of young workers joining trade unions. Sass concludes that large, collectively negotiated pension institutions are products specifically of the immediate postwar period, and will make a smaller contribution to US old age income in the future.

Conflict Between Generations
Achenbaum reports that the battle between the generations is already being fought in the United States. The American Association of Retired Persons campaigns for the rights of pensioners, while Americans for Generational Equity (AGE) calls for an end to social insurance programmes that cosset the rich elderly and penalize the poor young. David Thomson, in his chapter in the volume, argues that unjust treatment of successive generations is an almost inevitable consequence of the way welfare systems have developed in the postwar period. Both he and Norman Daniels emphasize the importance of examining competition not between age-groups but between birth cohorts, who pass through different age-groups as they get older. Johnson also stressed the need for such `processional', rather than cross-section analyses.
If welfare states are analysed in this way, says Thomson, it is evident that one generation has always drawn first prize. These people, `the welfare generation', are those who reached adulthood during or just after the second world war. Their lifetime social insurance contributions have been relatively low, but they have consistently benefited from the subsidized housing, im- proved health care and expanding education of the 1950s and 1960s. When they were young and had growing families, Thomson argues, the welfare state was a `youth state'. Now this generation is close to retirement, the pension improvements of the 1970s have turned welfare states into `old-age states'. Tax allowances and benefits for children, the next generation of workers, are falling and the real levels of subsidy for property purchase are lower than during the 1970s; children receive less education, less health care and are suffering more malnutrition and poverty. Expenditure on pensions, however, continues to rise.
In his chapter in the volume, Denis Kessler examines alternative explanations for the growth of publicly provided pensions in the middle of this century. A full definition of intergenerational transfers should include investment in human capital in the firm, public debt, care within the family and bequests, as well as public health, education and pension provision. In the postwar period the majority of transfers have flowed from young to old and have been mandatory and public; transfers in the other direction have tended to be discretionary and private. Now this balance is changing. As Kessler points out, there is nothing in theory to prevent transfers within the family from parents to children from offsetting welfare state transfers from young to old, though in practice it would require a major change in social attitudes and a redefinition of established family ties.

Increasing Affluence in Old Age
The image of militant pensioners as `fiscal muggers', who use their accumulated pension and health care entitlements to squeeze additional tax revenue from already overburdened families, may seem absurd in Britain today, given the widespread degree of poverty among the pensioner population. But pensioners are becoming richer, Johnson insisted, as more people enter retirement with higher incomes, personal or occupational pensions, private savings, and owning their own homes.
In recent years this transformation has been marked. In her study of two cohorts of Parisians who retired in 1972 and 1984, Françoise Cribier finds that whereas the first group received financial support from their working children, the second group were on average better off than their children, and continued to help them financially. Already in France, the average income of pensioner households is greater than the average for all households, and an improving trend is clear in the United Kingdom, despite state pension levels that are miserly compared with most EC countries. Affluence in old age will be taken for granted, Johnson argued, by those who retire in the 1990s and the early decades of the next century with full accumulated pension rights.
While there is nothing wrong with affluence in old age, he noted, it will involve substantial costs to other sections of the community. The arguments that AGE have put forward about generational inequity in the United States today will be equally relevant in the United Kingdom over the next 30 years. The newly-retired population of the 1990s, having lived all their working lives protected and supported by Beveridge's welfare state, will not easily forgo what they have come to think of as their rights to pensions, welfare and health care. Younger workers may well be struggling with high mortgage payments, compulsory pension contributions, necessary private health insurance, `voluntary' contributions to underfunded schools and support for adult children in full-fee universities, as well as paying the high taxes needed to fund the welfare benefits enjoyed by a well-off retired population.
Committed to paying very high social security contributions in the future to fund the accumulated pension entitlements of an expanding retired population, they will be conscious of the fact that their own welfare entitlements are being eroded, that when they are old or ill or poor there will no automatic welfare system to which they can turn. In these circumstances there will be a strong incentive for the young to break the implicit welfare contract which, since the second world war, has ensured that each generation of workers supports the current generation of pensioners through the institutions of the welfare state. The inequity of this arrangement is obvious, Johnson noted, but he argued that until there is more awareness of the growing conflict between generations an inevitable consequence of the ageing of our welfare society there will be little progress towards a rational solution to the problem.

Policy Options
Is there anything governments can do to remove the causes or alleviate the problems of intergenerational conflict? There are possibilities for reform in both labour market and welfare policy, Johnson argued. First, since part of the problem stems from the shifting numerical balance between workers and pensioners, an increase in the normal age of retirement would at a stroke increase the workforce and reduce the financial burden of pensions. In practice, however, the trend of the last 20 years has been to reduce the average age of retirement rather than to increase it. In a seven-nation comparative study reported in her chapter in the volume, Anne-Marie Guillemard shows that since 1970 employment activity rates for men aged 55-64 have fallen from 87 to 57% in the UK, from 81 to 51% in Germany and from 74 to 47% in France.
Labour force changes have therefore served to exacerbate rather than relieve the financial problems associated with the funding of state pensions a problem which Johnson has also explored for the United Kingdom in CEPR Discussion Paper No. 284. He suggested that people should begin to see their fifties and sixties as a period in which to relax from the intense work activity of middle age, but to continue contributing to the labour force in different ways. Given the reduced marginal product of older workers, this also called for a reconsideration of conventional, seniority-based systems of remuneration. Despite some recent attempts by employers to recruit older workers as replacements for scarce juvenile labour, however, there are still few signs that there has been any major change in attitudes towards full-time employment of men or women in their sixties.
The second approach would be to limit the future cost of pension schemes by restricting entitlements and reducing the real value of payments. The merest hint of any such change can generate a storm of opposition, Johnson noted, as the UK Chancellor of the Exchequer has discovered, and that opposition could be a massive electoral liability. Already in Britain people over the age of 50, who are likely to be more interested in the size of the pension received than the size of contribution paid, account for 41% of the electorate, and by 2025 will hold the balance of electoral power.