Thursday, July 5, 2012

Failing Pension Plans, Deferred Retirement, and Unemployment

Developed countries clearly face an issue that cannot be dodged. Promises have been made to their elderly citizens about retirement and about income in their nonworking years. These promises were made by national governments, local governments, and by private companies. Benefits to be available in retirement were determined at a time when economies were growing and earnings on investments were reliably high. 

A number of factors have combined to put this system at risk. One is the increase in life expectancy. People are living longer and placing greater fiscal demands on the existing pension systems. A second is the decreased potential for earnings on investments. Secure interest-earning investments are delivering much lower revenue now than in decades past. This is not likely to change in the near future. Limited-risk capital investments are also performing poorly relative to earlier times. The only path to high earnings involves higher risk strategies, not a desirable option in an arena where everyone has to be a winner. A third factor is the aging of societies coupled with declining birth rates. This causes the number of people taking money out of the pension system to increase relative to the number of workers contributing cash flow into the system.

An article in The Economist discusses these issues: Promise now, bill your children. The author of the article points out that private companies have recognized this problem and are rapidly shedding themselves of any responsibility for their workers. They are moving from a system where workers’ benefits were guaranteed, to one in which company contributions are "defined." Defined contributions are not guaranteed contributions. They are often so small as to be negligible, and are changeable as needed. The responsibility for making contributions and investing wisely, falls mainly on the worker. This system is a disaster in the making, placing the responsibility for providing sufficient income in retirement on government programs.

The article provides this graphic to illustrate the difficult investment environment that has set in over the past decade.

Most OECD countries are doing poorly with an average real return near zero. The US is actually well below zero. To put this in perspective, the pension plans in the US with the best benefits are based on expected earnings of about 8% per year.

Clearly, the status quo is not acceptable. The article’s author arrives at the easiest conclusion: people must work longer and retire later; put more money into the system and take less out.

People in the US have a weak national pension system (Social Security), and diminishing other options. They have been coming to the conclusion that they must work longer. An article in the New York Times by Catherine Rampell provides some illuminating data.

Labor force participation rates are even more relevant to the current discussion.

Instead of retiring, many more people are staying on in the workforce. This may be a trend that bodes well for the fiscal health of a pension plan, but what does it mean for the health of an economy? or a society?

Economists seem to believe that if a person’s life expectancy increases by five years then that person should be expected to work an additional five years before retiring. Does this make sense? It is absurd for those involved in manual labor. For those in more contemplative occupations, it is being assumed that no matter how old a worker is he/she can be just as productive as a twenty-something who usually comes to the job better educated and trained than did the senior citizen. It can be taken as a given that age brings with it experience and wisdom, but wisdom and experience are sometimes things; things that can be purchased as needed. That is what consultants are for. Energy, ingenuity, and the ability to think outside the box are hallmarks of the young mind; those are needed daily.

It is being argued that economies would be healthier if the aged were financially able to retire when they believed it was time to move on rather than having to hold on to their job as long as possible. It is not a coincidence that increased labor force participation by the elderly is accompanied by diminished employment opportunities for the young.

The economic argument is made that such a notion is unaffordable. This claim is always made based on assumptions that need not be valid. It is reasonable to assume that just about every worker who retires opens up an employment opportunity for another person. While the person who works to an advanced age saves his pension plan funds, it forces society to deal with an unemployed person over the same interval. The question of declining productivity with age is never raised as an economic burden. (Full disclosure: I am 68 years old and realize I am not the man I once was. Some would argue that I never was the man I think I once was.) The growth in income inequality is never mentioned as a contributing factor. If wealth and productivity gains were more broadly shared, then employee contributions to pension plans would be higher and the need for pension income would be lower. How and when people retire is a social decision. The economics will have to adjust to that decision, not the converse.

Economists would have us believe that the only healthy society is one in which the ratio of workers to non workers exceeds some given value. The value normally chosen can only be met with an ever increasing population. We know how those work out in the end. In Population Management, Aging societies, Total Dependencies, and Fertilities we discussed the notion of a society whose growth had stopped and its population had settled into an equilibrium condition. Equilibrium suggests a ratio of the nonworking aged to workers that is much higher than exists today in counties like the US. Much-maligned Japan might better be described as approaching economic and social equilibrium rather than senescence in both categories.

Societies must learn how to deal with this aging issue because it is going to become ever more important. A broad societal approach is required rather than a myopic economic study of one budget line.

Increasing productivity and sharing the benefits would be a good place to start.

1 comment:

  1. As usual, an insightful analysis. Did enjoy the sentence finishing with "-the man I think I once was." We tend to think a bit better of ourselves than the bloke down the street, even if a bit of prudent humility is added for good measure. I'm 71 and fortunate to have retired with a good defined -pension plan (so far) in a physically demanding field and still have a part-time job to enhance my options. My Swedish cousins were productive in their working life, in a country which places a strong value on people per se. Thanks Rich, David Karlson


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