The Economic Policy Committees of both the EU and the OECD have launched studies to examine the impact of ageing on the finances of public pension schemes and thus on public finances as a whole on the basis of internationally comparable projections. The Ifo Institute was commissioned by the Federal Ministry of Finance to conduct the long-term simulations required for the Statutory Pension Scheme (gesetzliche Rentenversicherung) – the most important branch within the German public pension system – as well as spending on the Civil Servants’ Scheme (Beamtenver-sorgung). Calculations are based on internationally harmonised and standardised assumptions regarding population, labour force participation and employment, productivity growth, interest rates and other general government revenues and expenditure. Taking the “standardised” scenario as a baseline, a number of sensitivity analyses and policy simulations had to be carried out.
Projections were prepared using the CESifo pension model, which was developed for the Advisory Board of the Federal Ministry of Economics (1998) and has been employed in numerous studies of the Center for Economic Studies (CES) and Ifo. The model is based on a partial equilibrium approach for forecasting the pension budget and incorporates the essential regulations for financing and granting statutory pensions in Germany. A similar approach is used for calculating retirement benefits for civil servants. In order to assess the impact of demographic ageing on public finances in general, the methodology of calculating “General government fiscal balances” was adopted from earlier work done by the OECD.
In order to extrapolate historical data from the system of National Accounts and from time series provided by the German social security administration (Verband Deutscher Rentenversicherungsträger) standardised assumptions were used as suggested by EU and OECD. Population projections were provided by EUROSTAT.
The main results of the study consist of a projection of total public pension expenditure as a percentage of current GDP up to 2050. Currently, spending in the public pension schemes – both for normal employees and for civil servants – has already reached a considerable level (11.8%). Until 2015, some relief will occur in the area of the Statutory Pension Scheme, which can be attributed to the effects of the 1999 Pension Reform Act and several minor reforms of recent years. Without additional changes in the law, the financial burdens of pension financing in the years after 2020 will increase to higher levels than before and will remain high throughout the rest of the projection period (2050: 16.9%). Assuming that this increase in the proportion of public pension expenditure to GDP will be financed through higher public deficits, the ratio of public debt over GDP will go up from a current 61% to 126% over the next fifty years. Taking into account automatic adjustments in social security tax rates that are built into the current legal framework, the debt ratio will climb up to 68%. Additional calculations show that these unfavourable results obtained for the 1999 legal framework – as indicated by both EU and OECD – are largely robust with respect to the pension reform that was finally adopted in Germany in 2001. Given the new set of rules, the share of public pension expenditure in GDP is projected to reach 16.7% by the year of 2050, and the increase in the debt ratio will be unaffected.
For the sensitivity analyses, standard assumptions on population trends, labour force participation, unemployment, productivity and interest rates are altered in turn. The alternative scenarios reveal, on the whole, that the projected developments of public pension expenditure as a percentage of current GDP are relatively stable. Via cumulated effects and compound interest, larger deviations from the results of the standardised scenario are obtained in some of these variants regarding the effects on public finances. In terms of policy responses, the most promising paths appear to be further reductions in benefit levels and increases in the effective age of retirement. The strongest effects can be achieved through switching from current net-wage indexation to CPI indexation (of pensions after award) or through making actuarial adjustments in the benefits level with regard to projected increases in life-expectancy.
If compared on an international level, the increase in pension expenditure projected for Germany using the assumptions made for the standardised scenario is ranging above the average. It appears that the following institutional features of the German public pension schemes contribute to this outcome: the dominant role of unfunded benefits within the overall system providing retirement income in Germany, less-than-actu-arially-fair reductions in pension benefits in the case of early retirement, a relatively generous approach to indexing pensions based on wage growth, and a comparatively high level of pension benefits in general. Consequently, these are aspects that should be addressed in good time when drafting further reforms needed to mitigate the sharp increase in pension expenditure which is projected to happen following 2030.
Economic Policy Committee of the EU (2000), Budgetary challenges posed by ageing populations: the impact on public spending on pensions, health and long-term care for the elderly and possible indicators for the long-term sustainability of public finances, EPC/ECFIN/655/01-EN final (24 October 2001), Brussels.
OECD (2001), OECD Economic Outlook No. 69, Chapter 4: “Fiscal Implications of Ageing: Projections of Age-Related Spending”, pp. 145-167.
M. Werding and H. Blau (2000), Auswirkungen des demographischen Wandels auf die öffentlichen Finanzen: Modellrechnungen für die staatlichen Alterssicherungssysteme (Final report), Munich: Ifo Institute.
M. Werding (2001), Auswirkungen des demographischen Wandels auf die öffentlichen Finanzen: Modellrechnungen für die staatlichen Alterssicherungssysteme (Final report for a follow-up study), Munich: Ifo Institute.
M. Werding and H. Blau (2002), Auswirkungen des demographischen Wandels auf die staatlichen Alterssicherungssysteme (Modellberechnungen bis 2050, ifo Beiträge zur Wirtschaftsforschung Bd. 8, Munich: Ifo Institute.
RSS