It's the Years, Not The Mileage: IMF Analysis of Pension Reforms in Advanced Economies

IMF Blog, February 1, 2012

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Pension spending has risen from 5 percent of GDP in 1970 to 8½ percent in 2010.
Pension spending now accounts for about a fifth of government spending.
Pension spending is expected to rise on average by 1 percentage point of GDP, and over 2 percentage point of GDP in over 9 countries.
Gradual increases in retirement ages already legislated in many advanced economies are expected to increase the retirement age by about one year over 1990–2030.
Life expectancy at retirement increased by roughly five years over 1990–2030, outpacing the average legislated increase in retirement ages.
Raising retirement ages by another 2½ years by 2030 —about 1½ months per year— would reduce pension spending in advanced economies by an average of 1 percentage point of GDP.

Aging populations and increases in pensions relative to wages pushed public pension spending from 5 percent of GDP in 1970 to 8½ percent in 2010.
Higher pension spending has helped alleviate old-age poverty in many countries, but has also put pressure on public finances.
The appropriate level of pension spending is ultimately a question of public preference, but many countries need fiscal adjustments that will include big-ticket items such as pensions.
In countries where pension spending will continue to rise under current policies, pensions must be part of fiscal consolidation strategies.

Pensions are vulnerable to demographics: more retirees will consume what fewer workers produce.
There is upside risk to projected spending:
- Life expectancy has consistently outstripped projections, adding fiscal costs.
- Some official projections use optimistic productivity assumptions relative to the recent past.
- Popular resistance could delay or impede reforms already legislated, increasing future spending.
From a fiscal perspective, taming public pension spending will be difficult given population aging.

Main reform options:
- Gradually raising retirement ages.
- Cutting pension benefits.
- Increasing revenues (for example, payroll contributions).
Reasons to favor gradually raising retirement ages in many advanced economies:
- In countries with already high tax burdens, further contribution hikes may jeopardize competitiveness and growth.
- Raising the retirement age can help boost GDP by increasing the number of years the average person spends working rather than in retirement.
- It can avoid larger cuts in benefits than those already legislated, reducing impacts on elderly poverty.
- Raising retirement ages may be easier for the public to understand than cutting pensions or increasing contributions.
- Increasing the number of older workers should not necessarily reduce employment opportunities for younger generations, analogous to the increase in female labor force participation not reducing jobs for men.

Average expected increase in retirement age due to legislated reforms: about one year over 1990–2030.
Incremental policy proposal: raising retirement ages by another 2½ years by 2030 —about 1½ months per year—.
Fiscal effect of that proposal: would reduce pension spending in advanced economies by an average of 1 percentage point of GDP.

Reforms raising retirement ages must be accompanied by adequate disability pensions and social assistance programs to protect those who cannot extend their work lives.
Longevity gains may not be uniform; longevity might not be increasing as fast for lower-income groups as for the rest of the population.
Where benefits are high, some countries could consider reducing pensions, but benefit cuts for those close to the poverty line should be avoided.
Where payroll contribution rates are relatively low, some countries could consider raising contributions; to minimize impacts on low-income workers, measures such as raising the caps on contributions could be considered.
Health care spending is an even bigger challenge than pensions and tackling both should be key components of fiscal adjustment plans.

Advanced countries face difficult choices in fiscal adjustment; pension reforms will need to be part of the picture while preserving pensions’ role in reducing old-age poverty.
Pension issues are also important in emerging economies and will be the topic of future analysis.

Benedict Clements, February 1, 2012