Keeping It Going
Keeping The System Afloat
The financial stability of a pay-as-you-go system requires that contributions keep pace with benefit payments. To understand the problems faced by these systems, consider the factors that affect contributions and those t hat affect payments.
The factors determining contributions and payments all have risen rapidly since World War II. Suppose our goal is to maintain the current systems without raising taxes or reducing the benefits. Is such a goal achievable? It is if we can maintain the ratio of contributors to retirees or boost the growth of real wages substantially. But how likely is either of these conditions?
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Will We Have Enough Contributors to Support the Beneficiaries?
The number of contributors relative to retirees can be roughly approximated by the working-age population relative to retirement-age population. Looking at the changes in these populations since 1950 and the projected ch anges through the middle of the next century will give you the first indication of the problems confronting public pension systems. As the figure below shows, the number of working-age individuals supporting each retiree has fallen in all seven countries in the past 50 years and is projected to continue falling.
While the pace of aging varies across countries, all are facing sharp declines in their working-age population relative to the retirement-age population. The most extreme example is Japan, where in 1950 there were 10 peo ple of working age for each retiree. By the year 2000, there will be only four possible workers per retiree, and this number is expected to decline to two workers by 2050.
The effect of these declines might be mitigated if employment rolls were to expand more rapidly than projected, or if workers were to delay their retirements. But the trends are not encouraging. Only Canada and the Unite d States have labor force participation rates that are higher today than they were in 1950. In the United Kingdom, the labor force participation rate has remained nearly steady over the last 40 years, while in the four other countries, the rate has fallen .
In all countries, the labor force participation rates of men have fallen. Young men are delaying their entry into the labor force, spending more time in formal education, while older men are exiting the workforce earlier , either by taking early retirement or by simply not working past age 65.
| Only Canada and the U.S. have labor force participation rates that are higher today than they were in 1950. |
Young and older women's labor force participation rates have fallen in accordance with men's, but these declines have been dwarfed by the rise in the labor force participation rates of prime-age women. Only in Canada and the United States, however, have women's labor force participation rates grown fast enough to offset the declining rates of men.
Most of the seven countries are taking steps to reverse the declines in their labor force participation rates, either by increasing the normal retirement age or by increasing the work requirement for full pension benefit s.
Long phase-in periods for these changes - in some cases up to 30 years - won't do much to affect the near-term health of public pension systems, however. Furthermore, these changes may have little effect on early retirem ent, which at present is taken by a majority of individuals in all seven countries.
Another troubling factor for the viability of public pension systems has been the rise in unemployment rates since the 1950s. One has to be working in order to contribute to the coffers of the public pension system (alth ough Germany requires individuals receiving unemployment payments to contribute). Thus, the higher the unemployment rate, the greater the deviation between potential and actual social security revenues.
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Will Real Wages Grow Fast Enough?
The amount of revenue an individual worker generates for the public pension system in a given year depends on the worker's wages and the rate at which these wages are taxed. Holding tax rates fixed, an increase in the wa ge results in higher revenues for the public pension system. A rise in wages that is linked to inflation, however, doesn't help much. Public pension benefits are also linked to inflation, so retiree benefits are rising at the same rate. Thus, the only way to generate an increase in public pension revenues without a simultaneous rise in expenditures is through a rise in real wages. (Even this is not possible in Germany since pension benefits are indexed to wages.)
Growth in real wages is driven primarily by increases in productivity - how much output each worker produces. When the output of a worker rises, the real earnings of that worker also rise.
In all seven countries, productivity growth in the past two decades has dropped sharply below that of previous decades. In Japan, for example, manufacturing output per hour grew by an average of 7.9 percent a year from 1 955 to 1973; since then, it has fallen to 3.9 percent a year. In the United States, labor productivity in nonfarm businesses grew at an average of 2.8 percent a year from 1960 to 1973, but declined to 1.1 percent a year since. While many economists do exp ect productivity growth to improve, few expect improvements large enough to restore the health of public pension systems.
[ How It Works ] [ Keeping It Going ] [ What We Can Do ] [ Conclusion ]
[ The U.S. Advisory Council on Social Security: A Group Divided ] [ More Information ]