Germany’s hypocrisy on pensions will cost money and friends

May 23, 2014, Financial Times

(Op-ed by Klaus F. Zimmermann)

Berlin risks being criticised for applying double standards, writes Klaus Zimmermann

[view FT online version]

The German coalition government’s decision to reduce the pension age to 63 for particular age cohorts is perverse, and not only because it is expected to cost more than €30bn by 2030. Given the ageing population, what is actually needed is a rise in the pension age. Furthermore, the move to cut it runs counter to one of the most significant achievements of Chancellor Angela Merkel’s first term: a pension reforms package approved in 2007, under which the retirement age would have risen from 65 (where it then stood) to 67 by 2029.

The latest move is especially risky for a nation that ranks 11th among the world’s fastest-ageing countries. And it is especially surprising for a nation that otherwise prides itself on its fiscal probity and accountability.

The government – including the centre-left Social Democratic party, which requested the change in the unpopular 2007 measure as its price for joining Ms Merkel in coalition – has created a trap for itself: a set of false expectations that will prove unsustainable before long.

Many Germans believe that the new measure will gradually undo the 2007 reform. The truth is far more illogical.

The earlier change in fact remains in place – but it is waived for people who happen to have been born before 1953. Members of these cohorts can retire at 63, as long as they have paid into the system for 45 years. Starting with the cohort born in 1953, the possible retirement age is gradually increased to 65 for “cohort 1963”. The 2007 reform applies to cohort 1964 and younger.

This boggles the mind. Why should people born before 1964 benefit now in that particular way? This injection of absurdity comes at the pretty price of €34bn.

It is also fanciful to believe voters will not demand a full repeal of the 2007 reforms at the ballot box, once those born after 1963 realise the injustice that has been perpetrated against them.

These inconsistencies aside, the government’s biggest error was its decision to let down young professionals. As in other countries, this group already faces tremendous burdens to maintain the edifice of Germany’s welfare state.

The so-called dependency ratio, which measures inactive pensioners as a percentage of workers, now stands at 31 per cent in Germany –and it is expected to reach 57 per cent by 2050, according to Eurostat.

However, the announcement is especially irresponsible given the European political backdrop. The Germans, in the pursuit of their strategy to right the listing ship of the eurozone, have demanded all sorts of adjustment measures from their partners. All of them are tough, many of them are painful and some of them are deeply unpopular.

In such a highly charged political environment, the government risks being criticised for double standards. It apparently insists on toughness when it comes to the choices that must be made by other nations. But for its own citizens – already comfortably off, in comparison to many in Europe – it sweetens the deal still further, while paying no heed to cost or sustainability.

If the new government, which finds itself in remarkably regular conflict with Washington, were to cast its gaze across the Atlantic even for a moment, it would have seen that emulating the US retirement system is a much better idea.

People there do have the choice to retire relatively early, at 62. If they take up the offer, however, they receive as little as 75 per cent of the retirement benefits they would have been entitled to had they waited. This accords with elementary principles of fairness. It also provides the incentives that are needed if the system is to be affordable.

There should be little room for debate that higher life expectancy in ageing societies increases intergenerational inequities in favour of the ageing.

Instead of reversing course, Germany should increase incentives for individuals to retire later and prohibit employment arrangements that make it mandatory to retire at a certain age. It should also offer financial rewards to those who continue working in order to add to their pensions once they have retired.

Such reforms would set a true example for creating a more equitable society.

The writer is professor of economics at Bonn University and director of the independent Institute for the Study of Labor (IZA)

Reprinted with permission.