Launched by Bismarck over a century ago, German ”public retirement insurance” was not only the first but one of the most successful pension systems in the world over the past 100 years, providing generous retirement incomes at reasonable tax rates. But times have changed and according to recent polls, most young Germans do not believe that they will receive a pension that covers their old-age consumption; and the number of employees using the few existing loopholes to escape the otherwise mandatory retirement insurance system has increased dramatically.
In a paper published in the latest Economic Journal, Professor Axel Borsch-Supan examines the reasons behind the increasing perceived and real difficulties of the German pension system. He argues that the system may be able to limp through the coming decades in its present form but it will cease to be the exemplary Bismarckian machine. Current policy proposals are insufficient; instead, a few but incisive design changes and some degree of ”prefunding” would rescue the present system”s many positive aspects:
- A decisive step towards prefunding could exploit the large differences in rates of return between ”pay-as-you-go” (PAYG) and a fully funded system. Since the German system has much less redistributive features than other systems, a relatively large share of the PAYG system is actual insurance, albeit at fairly low rates of return and can thus be privatised.
- Of course, there are reasons to be conservative in the degree of prefunding. PAYG systems have a built-in insurance against inflation and secular capital market failures. Since Germany has experienced the disastrous effects of hyperinflation and stock market crashes in a rather dramatic way, Germans are probably willing to pay a high price for this insurance.
- The transition costs to a degree of prefunding that is palatable to the German public, say 50%, are relatively modest, even if the burden lands on a single generation.
- Germany is in a situation that makes such a transition particularly attractive. The extent of population ageing – stronger than in almost all other industrialised countries – makes the difference in returns between PAYG and funded schemes very large, reducing relative transition costs.
Moreover, Borsch-Supan concluded, problems such as the ”mis-selling” of private pension plans in the UK are now better understood and could be avoided if the currently emerging market for pension funds in Germany were properly regulated. Germans can also learn from the Dutch and Swedish experiences. It is rather helpful to have a few good neighbours who have ironed out many of the problems of funded pensions – rather than being the country that faces the first real big problem with a besieged PAYG system.
”A Model Under Siege: A Case Study of the German Retirement Insurance System” by Axel Borsch-Supan is published in the February 2000 issue of the Economic Journal. Borsch-Supan is Professor of Macroeconomics and Public Policy and Director of the Institute for Economics and Statistics at the University of Mannheim.
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