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What are the economic consequences of people living longer?

Till a century or two ago, people could be reasonably sure of dying early and in harness, so they did not have to worry about how they would get through old age. The rise in living standards and reduction in sickness have created the problem of a second childhood: people are at risk of living beyond the age when they can support and look after themselves, and of becoming dependent Luckily, there is a correlation between standards of living and longevity; societies that bear higher burdens of caducity also have greater resources to bear them.

The rich countries created a number of mechanisms- public pensions, forced savings for the private sector, old age insurance, etc - to look after the aged. But two old systems-defined-benefit systems, which give an assured pension irrespective of what a retiring man contributed, and defined-contribution systems, where he earns a return on what he himself has contributed still dominate. Longevity does not only create financial problems. Old people also require more help in day-to-day living.

Rich countries have the resources to afford that. But they are also more short of workers, whose
help many old people need to get through life. Longevity-related problems have engaged the attention of governments of richer countries; an essential component of their solution is pensions. The Organization for Economic Cooperation and Development, a club of rich countries, has done much work on them.

I t finds that countries have tried to cope with the rising burden of pensions in three ways. Some have raised the age at which people qualify for pension. That is not a perfect solution, for people may live even longer; so some countries have explicitly linked retirement age to national longevity. Still, contributory pension schemes reward old people irrespective of their age and need. So some countries redistribute incomes between pensioners on the basis of equity, just as with income tax. Finally, some countries have tried to induce or force people to save more for their old age than they voluntarily would, so that they would cost the state less.

Universal pensions paid by the state were the ideal amongst industrial, especially European countries. But they provide only about three-fifths of the pensions. The rest of old people's income comes more or less equally from private pensions and working beyond the pensionable age. Governments define pensionable age in two ways. One is a fixed age, such as 62 for men and 60 for women; at  that age, the elderly get a fixed pension. Another is a minimum number of years at work, say 35 or 40. Some governments have now developed a hybrid: they give a minimum pension based on minimum years of work, and a bonus for every extra year of work.

However, the earnings during that year would be taxed, so net, there would be a subsidy or tax - in effect, an incentive or disincentive to work beyond retirement age. Japan's implicit tax is the lowest amongst industrial countries, so it has 75 per cent of old people working; Belgium's tax is the highest, so only 20 per cent of its old people work. In Greece, the net life· time income of a person would be reduced by 85 per cent if he worked a year beyond retirement age; no wonder that Greeks retire early and begin to live on state pensions. The loss in Luxemburg is 75 per cent; but then, few Luxemburgers work there.

They can go and work in Belgium or France, which are just an hour's drive away; many of them can live on rent of property given out to companies that have settled in Luxemburg because of low taxes. Governments apply progressivity not just to taxes but also to pensions and to tax incentives for pension savings. As a result, richer people save a smaller multiple of their incomes in pension funds than the poor in most countries. Only in a few countries - mostly those in southern Europe, such as Spain,  France and Italy-do the rich and  the poor save about the same multiple. In other countries, the poor get larger pensions in proportion to their income; in other words, income inequalities are lower amongst old people than amongst people of working age.  It would be in the interest of governments to encourage old people to work; they would prove less of a burden as pensioners. But other factors militate against their working. 

Salaries generally go up with the number of years of work. So old people cost more, and employers have an incentive to replace them with younger people. Old people’s skills may also become outdated and they may be less capable of learning and adapting. Some governments have legislated to prevent age discrimination, but have not  been very effective. Antidiscrimination laws often increase discrimination against old people. 

However, old people do not cost more everywhere. It is only in some West European countries that earnings increase with age all the way in most countries, they peak in the 40s and then decline. In general there is little correlation between old people's wages and their likely hood of being employed; but if they look for new jobs, they are much less likely to be hired than young people. Employment of old people depends much less on laws than on the general employment situation:  countries with high employment levels amongst the young are also  those with high employment  amongst the old. 

The money collected for pensions must be invested. Pension funds are torn between the need to maximize returns and to keep money safe; governments seek to make them even safer by imposing  rules on asset allocation. As a result, pension funds' returns are modest. In the five years to 2012, Danish pension funds got a real average annual return of 6.1 per cent, while those of Estonia lost 5.2 per cent of their value. Of the 31 countries OECD covered, pension funds of 18 lost money: The poor returns are not surprising since over much of the money goes into government bonds and bills.

But a few countries have invested heavily in shares in  search of return, notably Australia,  the US, Canada, Finland and  Poland. Some also invested in property,  loans, insurance contracts,  hedge funds, private equity and  structured products.  Most pension funds invest in domestic assets, out of government pressure or to avoid exchange risk, but European funds form an exception:  the euro has removed ex·  change risk on intra-EU investments.  The smaller East European countries in particular invest in  West European assets. 

That is the current situation; the future will be different. As populations age, current pension arrangements will become impossible. Till now, advanced countries have tended to reduce retirement benefits as demand outruns pension funds' income.  OECD suggests a different path: that the retirement age should rise as people live longer. But it does not dare ask the ultimate question:  why should people retire? They would become incapable of work at some age; then they can be taken  care of just like children. But there is virtually no hard physical labor  left in rich countries; almost all  work can be done by old people. So the time has come for them to abolish retirement. 


Article Courtesy:
The Telegraph, India Edition, Nov12, 2013

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