Pensions

Key points

• The Eurozone countries face a crisis because they have rapidly ageing populations and unfunded public pension liabilities. Britain is better off, both because our demographic position is much stronger, and because our pension savings are more than the savings of Germany, France, Italy and Spain put together.
  
  
• If under the Maastricht criteria borrowing is restricted, then Eurozone governments will have to choose between massive cuts in spending or large tax rises. For example Italy could either cut government purchases by half, or increase income tax by about 28 per cent.
  
  
• If we were locked into an economic union we might be forced to pay for their bankrupt pension systems.
  
  
• The Eurozone countries have made few genuine moves towards pension reform.
  
  
• “Pensions payments could easily turn into a vicious circle. If pension spending were not reformed, but led to higher deficits, some countries would not respect their obligations under the growth and stability pact; which in turn could lead to inflationary pressures; which in turn would result in the ECB having to set higher interest rates with negative impact not only on investment, but also on growth and employment, which are the basis of sustainable pension systems…Clearly the reply to these questions - pay more, work longer, get less, is not an easy message to sell” (Internal Market Commissioner Frits Bolkestein, speech on “defusing Europe’s pensions timebomb” 6 February 2001).

1. Demographic change - Ratio of people over 64 to people of working age

2. Total Pension Assets

Source: William Mercer European Pension Fund Managers Guide 2000

3. The extent of the effect on debt

The UK’s current national debt is equivalent to about £5,000 per person. If one added to that the per capita burden of our unfunded pension liabilities, the total debt burden in the UK would be some £9,000 per person. But if we took on also our share of the total unfunded pension liabilities of the EU, that figure would increase to some £30,000 of debt for every man, woman and child in this country. The adoption of a single currency would entail the adoption of a single ‘balance sheet’, but the extent of unfunded pension liabilities in certain of our European partner countries casts serious doubt upon the long term sustainability of their finances” (House of Commons Social Security Committee, “Unfunded pension liabilities in the European Union” 1996).

4. The adjustment needed

Based on predictions of changing dependency ratios Ferguson and Kotlikoff have calculated the total adjustment needed in Government tax and spending needed to create generational balance. The table shows the change that would be needed if all the adjustment was by that particular method.

Total change needed if one of these types of change were used exclusively

Source: Ferguson & Kotlikoff, Foreign Affairs March/00.

5. The failure of reform

There have been few moves in the Eurozone towards pension reform despite the scale of the problem.

In its review of the Broad Economic Policy Guidelines in March 2002, the European Commission stated, “Further reforms are now strongly required in Belgium, France, Greece, Spain, Italy and Portugal. While dialogue and consensus amongst social partners are needed for reforms to succeed, there is a disturbing trend in these countries for pensions to be repeatedly postponed. With the post war baby boom generation approaching retirement age, delays only increase the cost of reform.”

However, the European Commission has admitted that reform has so far failed: “Progress towards safeguarding the effectiveness and financial sustainability of pension systems, so as to meet their social aims, has been mixed” (Report on the implementation of the 2001 Broad Economic Policy Guidelines, 21 February 2002).

The pensions crisis in Italy is particularly serious. The Government is planning to redirect employees’ pension contributions from company funds to private pension funds. However the Italian government is in danger of replacing one black hole in its public finances for another. The government has not cut pensions pay-outs despite the fact that it has promised employers that, in return for losing an access to pension contributions, they will not have to make high national insurance contributions when they take on new staff (FT, 25 February 2002).

It is unlikely that any movement towards pension reform will take place in France until after the Presidential election. A new report presented to Lionel Jospin in December did not push for any significant reform of the French pay-as-you-go system (FT, 6 December 2001).

6. Why Britain would pay for the Eurozone’s pensions if we joined EMU

The euro lobby have claimed that the “no bail out clause” in the Maastricht treaty would mean that we could join the euro without being affected by the Eurozone pension crisis. In reality, if we joined Economic and Monetary union we would be made to pay for their pensions in several ways. We would either be forced to pay directly to prop up failing economies or pay indirectly via the interest rate.

“As the UK’s outstanding public pension liabilities are substantially below those of other EU members, there would be a risk that if the United Kingdom joined a single currency British taxpayers could be called upon to help finance the pay-as-you-go pension obligations of other EMU members, or suffer the consequences of being tied to interest rates on the single currency that were forced up by the market pressures of financing certain counties’ inherited pension commitments” (House of Commons Social Security Committee “Unfunded pension liabilities in the European Union” 1996).

Another possibility is that a group of the countries with the most severe generational imbalance could pressure the European central bank to pursue a looser monetary policy to “inflate away” the debt. This effectively passes the debt on to the private sector of the whole currency area (seigniorage) by allowing the government to pay for goods and services while reducing the real value of the money.

7. Why the no-bail out clause is worthless

Even if there were a watertight legal ban on bail-outs we would still find ourselves paying. And the so-called “no bail-out clause” may well not be effective.

First there is a separate clause which can be used to bail out member states in trouble. In the treaty of Nice this article was brought under majority voting.

“Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council may, acting by a qualified majority on a proposal from the Commission, grant, under certain conditions, Community financial assistance to the Member State concerned.” [Article 100(2) TEC]

Second, the so called “no bail-out clause” itself contains a bail out loophole.

“1. The Community shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.”

“2. If necessary, the Council, acting in accordance with the procedure referred to in Article 252, may specify definitions for the application of the prohibitions referred to in Article 101 and in this Article.” [Article 103 TEC]

When Part 2 refers to Article 252, this means the Qualified Majority Voting procedure. So how the article is applied depends on part 2, which comes under majority voting. This would allow member states in trouble to outvote member states opposed to paying for other members’ pensions.