From Bismarck to Bankruptcy?

PRINCETON – Democracies find it hard to deal with inter-generational social transfers, and with pensions in particular. Like all such transfers, the demand for more security in old age produces a fierce clash of opposing interests. In favorable circumstances, those clashes are resolved by the promise and reality of economic growth. When times are bad, it is hard to provide a solution that is not based on deceit and lies.

The modern welfare state has a peculiar patron: Germany’s “Iron Chancellor,” Otto von Bismarck, who pushed through the big reforms of the 1880’s on sickness, accident, and old-age insurance against liberal parliamentary opponents. The motivation behind the reforms was avowedly cynical – to buy off labor protest, or, as he put it, to give the working class an interest in the state.

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The reforms were the product of a state that was only partly democratic – and in large measure still authoritarian. Only someone in Bismarck’s position could shift social entitlements so decisively. For more accountable politicians, large-scale reform of social insurance – as the US has found in the case of healthcare reform – is immensely divisive.

Bismarckian old-age and invalidity insurance involved payment of a pension that was based on the beneficiary’s wage level and period of contributions. But, since it was payable at the age of 70 – an age that few workers reached – provision of it remained rather theoretical. The number of pensioners in the German scheme actually fell continuously until World War I. In a practice that anticipated the recent development of many European welfare states – most spectacularly in the Netherlands and Scandinavia – invalidity at a much lower age became a substitute for old-age pensions.

The greatest push for more generous pensions came during economic booms. A new German model again set a precedent for other countries – and again reflected a fundamentally political calculation. A few weeks before the 1957 general election, Chancellor Konrad Adenauer set out a reform that provided for a “dynamic” pension, which would increase not only with cost-of-living adjustments, but also with economic productivity. German voters rewarded Adenauer’s  Christian Democrats massively: for the first and only time in the history of the Federal Republic, one party gained an absolute majority of the popular vote.

As with Bismarck’s plan, free-market liberals, including Adenauer’s own economics minister, Ludwig Erhard, bitterly resisted the “dynamic” pension scheme. Erhard, who was widely credited with creating the institutional setting for Germany’s post-war economic miracle, believed that the new measures would undercut prosperity.

In the short run, Adenauer was right and Erhard wrong. German productivity continued to rise, and the German model became an inspiration for other European countries (including, after 1989, formerly communist countries). German employees were, as Bismarck had calculated, securely tethered to the political system. But, just as Bismarck found, the reforms did not produce long-term electoral gratitude.

In the longer run, the basis for the European pension model became deeply problematic. It would have been hard in 1957 to predict the massive rise in life expectancy as a result of medical advances and the decline of physically ruinous occupations in all the advanced economies. In Bismarck’s time, people were literally worn out before they could claim a pension. By the late twentieth century, they looked forward to an idealized retirement in the sun.

Moreover, the model was undone by the use of pensions in the 1960’s and 1970’s as a mechanism for controlling the labor market. Lowering the retirement age – even at a time when people were on the whole healthier and living longer – looked like an ideal way to free up jobs as the better-educated products of the post-war baby boom came of age. But lower retirement ages, higher education levels (and university programs that in some European countries went on and on without visible results), and declining birthrates – which seem inevitably to accompany increased prosperity – soon meant that fewer people and a smaller proportion of the population were contributing to compulsory pensions plans.

Logically, there were two ways to respond to the resulting pension crisis. The first was to move away from the Bismarckian principle of universal pensions paying a benefit determined by the size of contributions and the length of the contribution period, rather than by the ability of the economy, or society as a whole, to pay.

Middle-income countries, notably Chile, pioneered this new reform, which at first seemed like a good way to restore advanced industrial countries’ competitiveness. But, while it worked at a time when stock markets looked as if they produced continual gains, reversals, like the collapse of the dot-com bubble in 2000-2001, and then the Great Recession of 2007-2009, undermined optimism that individuals could really secure themselves against future shocks.

The second way to rescue the Bismarckian principle is more straightforward and attractive, at least on an arithmetical basis. Every existing pension scheme can be rescued relatively simply by an adjustment of the pensionable age. Since many people are healthier and active for longer – since 80 is the new 60 – this type of reform is intrinsically appealing.

Objections to raising the retirement age reprise the arguments against Bismarck’s original plan. Critics point out that not everyone is really that wonderfully healthy at 60 or 70: people who have physically undemanding jobs and healthy diets are in a different position from manual workers with poor nutrition. A favorite example is roof tilers, who really are still exhausted by work.

So, as in the Bismarckian system, there is a fundamental element of unfairness. While those affected by it are far fewer than in the 1950’s, the unfairness argument still ultimately mobilizes political pressure against any sort of reform. And we can expect that it will be dealt with in impeccably Bismarckian fashion: expansion of invalidity benefits.