Pension Challenges in an Aging World

• Author: Adair Turner
• Position: Vice Chairman of Merrill Lynch Europe, a Director of United Business Media plc, and a Visiting Professor at the London School of Economics and CASS Business School, City of London. From 2003 to April 2006, he was Chairman of the U.K. Pensions Commission

Except where fertility rates are very low, needed pension system adjustments look manageable

Pensions are high on the policy agenda in many developed countries and, increasingly, in developing countries also. This reflects the challenges that demographic changes are creating for pension systems, whether pay-as-you-go (PAYG) or funded. The broad directions of that demographic change are common, but the precise nature of the pension policy challenge in each country reflects two uncommon factors-the severity of demographic change and the pension systems with which countries start. In some countries, relatively modest adjustments to existing pension systems can ensure their sustainability; in others, more radical change is required.

Two fundamental demographic trends are at work in the world. In countries that are achieving reasonable economic success and are free from the extreme effects of AIDS, life expectancy is increasing, possibly without limit. And in all economically successful economies, irrespective of apparent cultural differences, fertility rates have fallen or are falling to replacement level and, in many cases, well below. The United Nations medium projections suggest that, within 15 years, the total fertility rate will be about 2.0 or fewer children per woman in countries as diverse as Brazil, Iran, and Turkey. (A birth rate of a little more than 2.0 is required to ensure that each generation is at least as large as that of its parents, with the required increment above 2.0 driven by the proportion of children who die before reaching child-bearing age.)

A similar trend is seen in the economically successful states of southern India and in China, whose fertility rate, at 1.74, is well below replacement level. That trend, of course, partly reflects the one-child policy, but low fertility rates in Hong Kong SAR, Singapore, and Taiwan suggest that the Chinese policy has simply brought forward an otherwise naturally occurring phenomenon. Indeed, the East Asian pattern suggests that, as China becomes more prosperous, its fertility rate could fall further.

Longer lives and lower fertility rates are dramatically increasing the proportion of the population above the ages we typically associate with retirement (see table). In the United Kingdom, the ratio of people older than 65 to those between the ages of 20 and 65 will almost double between now and 2050. In Korea, that ratio could increase more than four times.

[ GRAPHICS ARE NOT INCLUDED ]

The implication for countries with PAYG state pension systems (where contributions from current workers fund payments to current beneficiaries) is that some combination of three adjustments will be unavoidable: higher levels of tax or of compulsory contributions to pay for state pensions, lower pensions relative to society-wide average earnings, or higher pensionable ages. But it is important to note that moving to a funded private pension system (where workers save a part of their wages and draw on the accumulated funds after retirement) does not provide a complete and certain escape from this demographic challenge.

All pension systems, PAYG or funded, involve the transfer of resources to pensioners (who consume but do not produce) from workers (who produce more than they...