Some 20 years ago or so I attended the Sony European Executives Seminar, an International Programme in Management at the Institute of Management Development (IMD International) in Lausanne, Switzerland. IMD is renowned for the quality of its executive education and is rated No. 1 outside the US and No 2 worldwide by the Financial Times for its executive education. Forbes rates it No. 1 worldwide and the Economist No. 1 outside the US for its MBA programme. The course consisted largely of case study with plenty of preparation and then analysis and discussion with the professors. But interspersed among the generally routine course work were occasional gems. One lecture on psychology I particularly remember but the outstanding feature was a lecture on demographics by an elderly German professor. His style was matter of fact but his message was dynamite. He brought to our attention something of which most of us were blissfully ignorant, that is that the population of Europe was aging fast, that the baby boomers, those born in the two decades after the second world war were the most numerous cohort in society and that eventually we would retire and expect our pensions to be paid for by later generations coming through. But there would be fewer of them and the model would be hard to sustain. He showed us chart after chart, all based on incontrovertible population data that were almost entirely predictable to high levels of statistical reliability. Actuarial tables could tell us how many would die and when; not who would die but the proportion and the distribution. Only the most catastrophic of events like war or plague would upset these predictions.
And now it’s here. The baby boomers are retiring. Europe’s population has aged. There are fewer of the young in work to pay for the pensions. Just this past decade we reached a milestone where there are more of us aged over 60 than under 16 for the first time ever. One thing has got worse if anything. Contrary to all common sense retirement ages have been moved down when they should have been moved up. There is a late and feeble attempt in some countries to increase retirement ages but this runs into enormous political pressure particularly from trade union leaders who, heads in sand as usual, tend to say, we must stick to what we have got regardless of the ability of the state i.e. the rest of us to pay for it. In France where a small move has been made in the right direction the leading candidate in the current election for President is proposing to move right back and thus condemn future generations to massive unfunded liabilities.
Five of the world’s top 10 oldest populations are in Europe, a result of significantly reduced fertility rates and longer life expectancies. William H. Frey, an analyst for the Brookings Institution think tank predicts the median age in Europe will increase from 37.7 in 2003 to 52.3 by 2050, while the median age in the US will rise to just 35.4.[i]According to the Office for National Statistics, there are now 10,000 centenarians in Britain, compared with only about 100 a century ago. A quarter of all the babies born last year are expected to live longer than 100 years. Over 50 years the Queen sent out 100,000 birthday telegrams and cards to centenarians but it’s doubtful that she will continue to do this much longer as it will be normal for people to reach that age. Although if her own mother’s longevity is a guide she may send herself one on 21 April 2026, the date when she will reach 100. By 2050, a quarter of a million Europeans will be over 100 years old.
The UK’s pension arrangements are particularly chaotic. The vast majority of public sector workers receive occupational pensions paid directly from current taxation. Thus our state pension system is particularly vulnerable to changing demographics, as the number of state retirees whose pensions must be paid out each year after year grows and the number of workers supporting them falls, so reducing the tax base.
The sums of money involved are astonishing. According to HM Treasury total unfunded outstanding public sector pension liabilities are equivalent to 53% of GDP. But this understates the real picture according to independent analysts who question some of the assumptions supporting this assessment, such as, for example, outdated population projections. The CBI believes it to be closer to 70%, the Institute of Economic Affairs puts it at 74% and Towers Watson, a leading firm of actuaries, reckons it is well over 80%, greater than the UK’s official national debt.
It is extraordinary that, in one of the world’s most developed economies, one of the centres of the global asset management industry, years of political short-termism have created public sector pensions that are almost entirely unfunded. Governments of all colours, but especially that of Gordon Brown, have added millions of people to the state pay roll without apparently giving thought to how their promised pension entitlements would be paid. Liam Halligan, chief economist at Prosperity Capital Management describes this as “surely one of the most astonishing instances of ‘kicking the can down the road’ in human history.”[ii]
It would seem that generations of ministers and civil servants have deliberately hidden the financial consequences of our changing demography on public sector schemes. They have clung on to their own generous taxpayer funded retirement benefits while not facing up to tough policy changes. Estimates of future public sector costs have been kept artificially low and in any case are buried off-balance sheet. As someone who has served as a Trustee of a private sector pension scheme if my fellow Trustees I and had run our scheme in such a way we would have been convicted of fraud.
When Herbert Asquith as Chancellor of the Exchequer first introduced a small measure of state funded means-tested pension in 1908 it was restricted to people over age 70. At that time few lived to such an age and if they did for not much longer. Pensioners are now spending decades in retirement, indeed if people retire at age 60 three decades of drawing a state pension will not be uncommon. The cost implications of this for the private sector have been apparent for many years and most companies have withdrawn or at least closed to new entrants final salary schemes. In the private sector it has always been the case that pensions are not transferable so individuals like me who have changed employers a number of times have often left pension reserves behind. In the public sector a teacher might switch schools several times in her desire to seek advancement but her pension rights continue to accrue in a national fund, another example of the quasi-apartheid that now exists between the two sectors. The UK’s public sector pensions have scarcely been adjusted in almost half a century even though life expectancy has risen almost two decades. Liam Halligan says “That’s why there’s a giant Ponzi scheme at the heart of the UK’s public finances, the nature of which is only now starting to be understood beyond a small circle of analysts and commentators, many of us dismissed as cranks, who have been banging on about it for years.”
The demographic time bomb isn’t set to explode at some point in the distant future. It is exploding around us right now as the baby boomers are retiring in droves. Between now and 2016 the number of British citizens aged 65 and over will increase by 1.4 million while numbers aged below 50 in work will fall by 160,000.
But this isn’t just a problem here in the UK and other developed European nations. Japan’s workforce is aging faster than any other society’s. The number of children born per Japanese woman is 1.39, far below the replacement ratio. Many Japanese women put off having children till quite late and many more put it off altogether. The Japanese government has estimated that by 2060, Japan’s population of 128 million will shrink by over 30%, and over 40% of them will be over 65 years old.[iii]This problem is particularly acute because Japanese society is still very homogenous and resists immigration which otherwise could partially alleviate the problem.
But the mother of all demographic time bombs is set to explode in China. While the world watches the Chinese economy gradually overtake all others and apparently defy all the doom mongers that say its political system would not permit such economic advancement there is one unalterable fact it has to deal with. The one-child policy still officially imposed by the communist regime has had two devastating consequences. First it has led to an unhealthy preference for the one child to be a boy with the result that there are some 100 million young Chinese males with no brides in sight. The second is that China’s working population has probably peaked in the past twelve months and now will swiftly decline. Today there are five workers aged 20-59 supporting every citizen over 60. But by 2032, that ratio will have fallen to two, the same as it is in Italy and Germany. Anatole Kaletsky asks the question: “How will China cope with the reduction of labour? The only answer is another question one constantly hears in China: will we get old before we get rich or the other way round? That is the biggest issue of all for China.” [iv]And so, perhaps, for all of us.
One fountain of hope against this bleak scenario is at my alma mater, Oxford University, which has long believed in the power of unified thinking across different academic disciplines. As fertility falls and longevity increases the old will outnumber the young in almost all countries within 50 years. To help the world cope with this fundamental shift in the structure of society, the Oxford Institute of Population Aging is studying all the issues from all the angles. Researchers in anthropology, demography, economics, history, medicine, philosophy, politics, public health, psychology and statistics are working together in a common cause. This is funded by proceeds from a campaign to generate so-called Oxford Thinking which has raised £1.25 billion to date.[v]
It would seem that at the least saving must be made compulsory until we are all firmly in the habit. John Blundell, former Director-General of the Institute of Economic Affairs, argues that all employers should be forced to put 10 per cent of all salaries into individual retirement accounts owned by everyone over 16.[vi]Even casual workers will see a percentage of their earnings go that way. They will also own it, watch it grow and become invested in future prosperity. The Chilean system is like this. In 1980, under the government of Augusto Pinochet, the Secretary of Labour and Pensions, José Piñera changed the conventional state run system to a capital funded system run by private investment funds. About two thirds of the workforce entered the system and had 10% of their income diverted to such funds. There was a safety net for those who did not complete enough service or level of income to qualify for a decent pension. Their system is not without its faults, not least the high administrative charges, and the World Bank has recommended reforms. José Piñera’s brother, Sebastián is now President of Chile and is committed to implementing reforms. While he is of the right his left wing opponents have supported the system while calling for similar reforms. At least we can see one country where politicians are prepared to try a different way.
Copyright David C Pearson 2012 All rights reserved
[i]“Sixty is the new old” Helen Edwards Marketing 9 November 2011
[ii]“The real danger of public sector pensions is finally hitting home” Liam Halligan Daily Telegraph 2 July, 2011
[iii]“Reimagining Japan: The Quest for a Future That Works,” Clay Chandler, Asia editor for McKinsey & Co. 2011
[iv]“There’s one cloud over China’s rosy future” The Times 14 March 2012
[vi]“Beyond Ideology: Towards the Demise of the State and the Coming Era of Consumer Politics” John Blundell Speech to Hitchin & Harpenden Business Club. 2 November 2007