Will the pension time bomb sink the euro?

• Author: Pinera, Jose

The population in Europe is aging and declining. A trend that could have been perfectly manageable with foresight could turn into a catastrophe given the increasing unfunded liabilities arising from pay-as-you-go (PAYGO) public pension programs, now more than 200 percent of GDP in France and Italy, and more than 150 percent of GDP in Germany. This situation is especially difficult in a continent where entitlements are deeply entrenched in a welfare state culture.

The European Commission recently stated, "There is a risk of unsustainable public finances in some half of EU countries. Belgium, Germany, Greece, Spain, France, Italy, Austria and Portugal are on this black list." Furthermore, the monetary affairs commissioner of the European Union warned, "There is only a limited window of opportunity for countries to get their public finances in order before the budgetary impact of aging takes hold as of 2010" (EU-observer. com, May 21, 2003).

So, the PAYGO pension system could turn out to be one of the gravest threats to the single European currency. As Niall Ferguson and Larry Kotlikoff (2000) argue,

The bottom line is that generational imbalances across the eurozone gravely threaten the single currency's medium-term viability [111].... [C]ountries with the most severe generational imbalances may exert pressure on the ECB to loosen monetary policy. For most of the twentieth century, after all, printing money was often the line of least resistance for governments having fiscal difficulties [117].... History therefore suggests that asymmetric fiscal problems--often generated by war--quickly cause monetary unions between fiscally independent states to dissolve. The fiscal problems caused by bloated social security and pension systems could have a similar centrifugal effect on EMU, with welfare substituting for war as the fatal solvent [120]. Parametric Pension Reform Is Not the Solution

Some European countries have begun to recognize the fiscal consequences of these demographic imbalances. But regrettably they seem to believe that changing some key parameters of the PAYGO pension system will solve the crisis. In June 2003, France's Prime Minister Raffarin eloquently spoke to his country's National Assembly of the need for "lucidite demographique" and managed to eliminate some blatant privileges of the public workers pension system. These measures partially correct the abuses of the system but not its flawed roots. The recent German pension reform, basically tax credits for supplementary savings, were a failure because too many people simply cannot save extra money after paying huge payroll taxes. Now...