How should EU countries confront the nagging problem of pensions facing its member economies? The projected costs of paying for pensions already promised are alarming. Given Europe’s aging population and ever-longer life expectancies, the share of GDP devoted to pensions will double by 2030. Three solutions (which may or may not be combined with each other) are available. EU countries can make those with jobs pay for the rising costs of pensions through increased taxes or social security contributions; they can allow the relative purchasing power of mandatory pensions to decline; or they can increase the ratio of workers to non-workers by extending the retirement age and/or allowing for more immigration. None of these measures is sufficient in itself; all raise their own problems. Encouraging more immigration, for example, would incite serious political tumult and raise moral questions. Is it right, say, to allow foreigners to enter the EU only so that their taxes can be used to help finance the pensions of EU citizens? So Europe faces an inexorable choice: who is to bear the brunt of the demographic turnaround needed to prevent pension costs from derailing economic growth, the working or non-working part of the population? Some background information on the relative positions of both groups may help here. In 1950, the average retirement age was 67 for men and 66 for women. In 1995, men retired, on average, at 61 and women at 58. During the same period, life expectancy grew by 11 years. Despite longer retirements living standards among those on pensions improved enormously. Is it likely that an equal increase in living standards could occur between now and 2040 (when there will be two working people – as opposed to four today – for each person in retirement)? No, because social solidarity is not what it was. After WWII, pensions were very low and the costs they imposed on workers were modest. Because economies were growing, workers voluntarily accepted continuous increases in the taxes paid to finance the pension system. Today, in all EU countries, the average income provided by pensions is much higher and, in some cases, such as in France, higher than many incomes received by the working population. Rising pension pay-outs, when combined with continuous increases in taxes and social security contributions, have made those with jobs unwilling to contribute more to the retired. This resistance has brought forward the issue of allowing capital markets to play a role in financing Europe’s pension systems. In years to come, the development of a system of supplementary capitalized pensions in Europe is inevitable because private retirement savings can provide individuals with a defense against declining levels within mandatory pension schemes. The rising popularity of personal retirement savings may also help enhance the efficiency of Europe’s financial markets, the lack of which is partly responsible for Europe’s slower growth and higher unemployment. For countries where private pension funds are the most developed (the US, and Britain and the Netherlands) have the highest stock market capitalization. Nevertheless in order to avoid private pensions threatening mandatory pensions and thus erode social solidarity, three conditions need to be present: • avoid ideological prejudgments. Retirement savings should be encouraged, not this or that particular investment vehicle. Apart from pension funds, there are also life insurance products and salary-reduction savings; • the costs of reforms that provide the most support for the most modest types of savings should be divided among all citizens; • workers must participate in establishing a pension system to complement state pensions. A proposed European Commission directive about professional pensions is now on the table. In attempting to harmonize among EU members the prudential rules governing institutions involved managing retirement savings, this proposal has many favorable aspects, particularly if it facilitates cross-border mobility among workers (i.e., the ability of a worker to carry a pension program with him when changing jobs, even if he or she takes a job in a different country). Europe should be more ambitious. The EU should put in place a common fiscal framework applicable to all capitalized forms of pension savings: pension funds, life insurance, or salary-reduction savings. Wage earners opening a plan under a form and framework of their choice (say, a pension fund) should be able to deduct their contributions (up to a fixed ceiling) from income tax or, if they have no taxable income, should receive tax credits. Further, up to prescribed limits, employee contributions should be, up to prescribed limits, matched by employers. These savings should be constructed in such a way as to favor their being taken out in the form of annuities, without excluding (with an appropriate penalty) the possibility of a one-time withdrawal of the principal. If pension reform is to work, attitudes toward savings must change. Europeans should stop complaining that they save too much and consume too little. In fact, Europe needs to invest more, and so must save more. The economic policies of EU countries also need to be resolutely adjusted to promote investment, productivity, and growth. If increased savings are used to finance public deficits or are invested overseas not least in the United States (too often the case nowadays), encouraging such savings may not be worth the effort. Every now and then, Europe must act decisively to accomplish important political objectives. Such was true with the euro’s establishment. An equally bold vision is required to assure Europe’s future pensioners.