Germany and the challenge of global aging

Like the rest of the developed world, Germany is being overtaken by an unprecedented demographic revolution called global aging. It’s the result of two forces: falling fertility and rising longevity. This report takes a close look at how this revolution is likely to transform Germany’s economy and society over the next half century. According to the report, global aging will heap vast new costs on public budgets—the equivalent of an additional 25 percent of payroll in pensions and health-care benefits for the elderly. It will usher in an era of widespread labor shortages and slower economic growth. And it may ultimately mean stagnating or declining living standards—unless Germany renegotiates a social contract that, even with recent reforms, is due to channel an ever-rising share of society’s resources from workers to retirees.

In the spring of 2001, Germany passed the Riester reform, a major reform that scales back future public pension benefits while encouraging the development of private funded alternatives. This represents an important symbolic break with the past. The promise that government benefits alone would always be sufficient to maintain workers’ living standards in retirement has been a cornerstone of Germany’s social contract ever since World War II. The Riester reform for the first time acknowledges that workers will have to provide for some of their own old-age security themselves. The fact that the acknowledgment comes from a social democratic government makes it even more significant. In many countries, pension reform - and in particular, the desirability of greater funding - divides left and right. In Germany, both sides now seem to agree on the imperative of scaling back pay-as-you-go promises and boosting funded savings.

In practical terms, however, the Riester reform falls far short of a complete solution. The scheduled reductions in pay-as-you-go benefits are too small to close the long-term deficit in Germany’s public pension system. As for the new private pensions, workers have been slow to sign up, in part because the regulations are too burdensome, and in part because public benefits remain so generous.

Germany’s near-term economic difficulties make the long-term challenge all the more difficult to confront. Germany should be taking advantage of the window of opportunity afforded by the middle-aging of its postwar baby boom to boost savings and growth in advance of the age wave. Instead, at the moment it is becoming the “sick man of Europe.” [adapted from author]