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Defusing the demographic time bomb

As people live longer, healthier lives it is natural for them to want to work longer and so mitigate the costs of pensions argues John Grieve Smith.

Economics is known as the ‘Dismal Science’; but even so, it is strange that the encouraging fact that people are living longer is now regarded as a potential economic disaster - the so called ‘Ageing Time Bomb’. Pension policy, in particular, is being dangerously distorted by exaggerated fears of the cost of supporting increasing numbers of older people. Indeed, demographic projections are being widely used as a pretext for cutting back state pension provision. Both openly under the Tories, and implicitly under New Labour, the projected growth in the population over 65 has been used as an argument for whittling away both the basic pension, by abolishing the earnings link, and earnings related pensions by running down SERPS.

What these projections fail to take into account is the fact that being 65 today is not the same as it was 30 years ago, or will be 30 years hence. As people live longer and healthier lives it is natural for them to want to work longer. But at the moment, large numbers of older people, both under and over 65, who would like to work are denied the opportunity to do so. One of the dangerous current myths about retirement is that early retirement goes hand in hand with growing prosperity - you draw your pension as soon as you can and then enjoy yourself! But on the contrary, most early retirement is involuntary, particularly in the older industrial areas. A far higher proportion of older people are at work in the more prosperous areas of the country, where the demand for labour is stronger and there are more jobs available. This is illustrated by the fact that in the Spring of 2000, the proportion of men aged 50 to 64 and women aged 50 to 59 who were economically active was only 61 per cent in Wales, as against 77 per cent in the South East.

Even in the more prosperous areas, early retirement is frequently a consequence of firms ‘downsizing’ their staff. This may be the least painful way to cut staff from a firm's point of view, but for the economy as a whole it merely aggravates the problem of increasing the total number of older people at work.

We need to provide better job opportunities, both for those over and under the standard retirement age. The economy is still a long way from full employment. In addition to the 1.5 million unemployed and actively seeking work, there are many more who would be looking for jobs , if they thought they had any chance of getting one - the so-called ‘hidden unemployed’. The seemingly unrelated need for more active regional policies to attract industry to the older industrial areas is likely to be a key factor in easing the potential pension burden. The other major element is to adopt pension and employment policies which would make it easier for older men and women to stay in work longer if they wish to do so. This would involve the abolition of compulsory retirement ages in firms and institutions. These are illegal in the United States and likely to become so here as the Government implements a recent EU Directive. People should also be permitted to draw their occupational pensions while continuing to work part time for the same employer - something the Government envisage in any new pension legislation.

The real economic burden of pensioners on the economy depends on the proportion of the total population in work; because the consumption of pensioners (and others not in the labour force) must come from the output of those at work. While the official projections (on very conservative assumptions) suggest that this proportion will fall from 47.8 per cent in 1999 to 44.5 per cent in 2030. But more active employment policies could bring as many as 2 million extra people into work to keep the proportion steady. This may seem ambitious, but we certainly should not base our pensions policy on the assumption that we can do nothing to bring more people into work.

As the number of older people increases, the need to provide adequate pensions becomes more, not less, vital. It is amazing that in its recent Long Term Public Finance Report (published with the Green Paper on Pensions) the Government should take pride in the fact that expenditure on state pensions in the UK as a proportion of national income is actually expected to fall over the next 50 years; whereas in other major European countries, where it is already much higher, the proportion is expected to continue rising, so that by 2050 it would be at least three times as high in Germany and France as in the UK. This, of course, reflects the fact that official policy here is to limit pension increase to increases in the cost of living, so that they will get lower and lower in comparison with average incomes.

Although the Government is afraid to say so, this policy would inevitably end up with a purely means tested system; the growing number eligible for the Minimum Income Guarantee is but a foretaste of what is to come if there is no change in policy. The state would only be a pension provider of last resort - hardly an attractive policy when private and occupational schemes have never looked so dodgy; and what incentive will lower earners have to save, if to do so reduces their means tested state pension entitlement? The only way to ensure a decent state pension system is to agree that the basic pension should be indexed to earnings and remain an adequate proportion of the average wage.

The private sector is now in a state of turmoil sparked off by the fall in share prices. Many companies are closing their occupational schemes to new entrants. But the present panic is largely overdone. Falls in share prices do not necessarily imply the need for higher employer contributions to these schemes; that depends on an actuarial assessment of the pension fund's probable future income as against its forecast future expenditure on pensions. Firms who happily took a "holiday" from pension contributions when their schemes were in surplus, are now unwilling to contribute when things are more difficult. Although much of the present ‘crisis’ in private occupational schemes is misconceived, the fact that firms seem to be taking every pretext to reduce their financial commitment merely reinforces the view that employees can no longer rely on them over the whole of their working lives.

The current problems with occupational and private schemes suggest that instead of the state withdrawing from the provision of earnings related pensions, it has an important role to play. Only two other countries in the EU (the Netherlands and the Irish Republic do not have state earnings related pension schemes). Instead of pursuing its weird State Second Pension Scheme, which will eventually give people a second flat rate pension which they can contract out of, we need an updated SERPS.

We must have a stable state pension scheme, with both an adequate basic pension paid as of right, and provision for earnings related supplements. A long term settlement is needed to remove the present uncertainty and give people as reliable an idea as possible of where they stand. It is only realistic to accept that there will be changes from time to time, but the public need to be assured that these will be kept to the minimum dictated by circumstances and will so far as possible improve, not worsen, their pension prospects.

This might be done by setting up a statutory Pensions Commission that would be responsible for adjusting pension levels and contribution rates on agreed principles. One way or another it is vital to inject more stability into the system.

This article is based on The Challenge of Longer Life; Economic Burden or Social Opportunity, a Report of a Working Group chaired by the author and published by Catalyst (catalyst@catalystforum.org.uk)