The Bigger Picture
Published on May 20th 2010 in Metro Éireann By Charles Laffiteau
Last week in my discussion about why the developed countries of the world actually need more immigrants, even if our current levels of unemployment are uncomfortably high, I mentioned that one reason was because all of these nation’s pension systems were designed based on the assumption that their working age populations would increase at the same rate as their retiree population.
But there are some other assumptions that are also built into the design of those pension systems that are going to have to be dealt with sooner rather than later.
When the American and European pension systems were originally set up more than sixty years ago, the average life expectancy in the world’s developed countries was around 68 years of age. So deductions from worker’s wages to fund these pension schemes were based on the assumption that pension payments to workers would last for an average of 3 to 6 years if they retired between the ages of 62 and 65.
But as of 2010, advances in healthcare and medical treatments have now extended the average life expectancy in those same developed countries to an average age of 80. So that means the government funded pension schemes are now providing pension payments for an average of twelve more years than their pension schemes were designed to. Assuming a reduction in current and future pension payments is not an option, there are only three prudent courses of action under these circumstances:
1) A 250%-300% increase in deductions from every worker’s wages to fund an average of 12 additional years of pension payments.
2) Increase the retirement age for workers by the same number of years that their life expectancy has risen so they can’t retire until they are 74 to 77.
3) A combination of increased wage deductions and retirement ages.
But politicians in America and Europe are usually not too keen about telling their constituents “Oh, by the way, you’re going to have to work a few more years before you can retire and or we are going to have to double or triple the amount we take from your wages to fund your pension scheme.” So rather than tell voters the truth about their pension schemes, they look for a way to avoid dealing with the issue.
They can get away with putting off facing the problem and taking potentially risky political actions to fix it, so long as the working age population is increasing at a rate that is commensurate with the number of workers who are retiring, Of course this also means that when the day finally arrives when they have to make unpleasant adjustments like cutting benefits, raising wage deductions and retirement ages, these are much more painful and difficult for those constituents to accept. Think Greece!
The German political option means politicians have to be more honest with their constituents and start making smaller adjustments much earlier in the process. Nonetheless, the demographic pressures of a declining working age population and increasing numbers of pensioners will result in significant pension scheme changes. These include reducing future pension benefits by an average of 7-10% and increasing workers’ contributions by a similar amount as well as raising the retirement age to 67.
On the other hand, the American social security system has already increased workers’ contributions by 5% and begun to raise the retirement age to 67 (and will continue to gradually increase it to at least 70, 72 or maybe 75). But because America has a higher fertility rate, thanks to its legal and illegal immigrants, it doesn’t have to use reductions in current or future benefits to address its funding problem because its working age population continues to keep pace with increases in its retirement rolls.
Make no mistake, I am not suggesting that throwing open your doors to legal and illegal immigrants is the solution to the developed world’s underfunded pension schemes. The core of the problem, after all, is the combination of fewer native citizen workers paying taxes due to low fertility rates, and the fact that more pensioners are being paid more in benefits from those taxes because they are also living longer.
What I am suggesting is that if developed countries allow more immigration from less developed countries; they can avoid cutting benefits to future retirees and mitigate some of the pain associated with increasing workers’ contributions to their pension schemes, and reducing their take home pay in the process, as well as increases in the age when workers can retire with full benefits. Even though America has higher levels of both legal and illegal immigration than its European and Asian (Australia, Japan, Korea, Taiwan and Singapore) counterparts, it has still not been able to avoid raising workers’ contributions as well as their future retirement age.
Nor is the issue of underfunded pension schemes exclusively the province of the world’s more developed countries. Why? Because we live in an increasingly interconnected globalized world where no country or region is immune to the problems experienced in other parts of the world. One of the lessons learned from the recent ‘Great Recession’ is that although it was caused by the financial excesses of the developed countries, developing countries like Brazil and China also suffered during the downturn because they rely on the developed world to buy most of their exports.
Granted, the emerging economies in the developing world did not suffer as deep or as long of a recession as America and Europe have, but they still need the developed countries as customers for much of their output. If the developed countries don’t fix their pension scheme problems soon, then the inevitable cuts in benefits to pensioners and higher taxes for workers will translate into less money for both groups of citizens to spend on consumer products imported from the developing world.
So if immigration helps America address its pension problems, why are some Americans so upset about illegal immigration? I will discuss the most common myths about immigration next week.
To keep the global economy on track, people in the United States and the rest of the developed world need to work longer before retiring, pay higher taxes and expect less from government. And the cheap imports lining the shelves of mega-chains such as Wal-Mart and Target? They need to be more expensive.