The False Promise of Later Retirement

EU Economics Commissioner Pedro Solbes warns that Europe's shrinking population will soon hit the Continent's economies hard. Reforms to defuse the crisis are needed. Alain Jousten examines one alluring but false reform that is often discussed.

Social welfare systems are shaking as never before. Not only in Europe, but in parts of North and South America, and Asia as well. A collapse in fertility rates, coupled with longer life expectancy, is driving a rapid and pronounced aging of populations. Worse still, the demographic threat is being heightened by the way most countries finance their public pension schemes.

Many retirement systems rely heavily on a pay-as-you-go (PAYG) philosophy. Rather than forcing each generation to pay for its own retirement, benefits paid to today's pensioners are financed by contributions from the young.

Inter-generational solidarity, however, is only as strong as the number of entrants into the labor force. When this number falls as a result of lower fertility rates, and when higher life expectancy swells the ranks of pensioners, the only way to sustain PAYG systems is to decrease the level of benefits relative to contributions.