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RETIREMENT CRISIS

Old Age: The New World Threat

July 14, 2002|JOHN J. HAMRE and THOMAS W. JONES | John J. Hamre is president and chief executive of the Center for Strategic and International Studies. Thomas W. Jones is chairman and chief executive of Global Investment Management and Private Banking Group, Citigroup.

WASHINGTON — In a world trying to deal with terrorism, catastrophic illness, starvation, drought and nuclear war prevention, old age doesn't seem terribly threatening.

But during the next three decades, simultaneous aging crises in Europe, Japan and North America have posed a serious threat to global stability, with everything from the investment returns on 401(k) plans to peace and prosperity in the Third World at risk. We can avert this mega-crisis, but the problem is worse than governments acknowledge, and time is fast running out.

A recent study by the Center for Strategic and International Studies (CSIS) and Citigroup found that if developed countries continued to provide benefits to older citizens at current levels, government spending on pensions and health benefits would average 30% of gross domestic product by 2050--twice today's level, and twice the growth projected in official government estimates.

Why the difference between what governments predict and what is actually likely? For most countries, the official projections assume a remarkable turnaround in key demographic and economic trends: more babies, more working women, much slower growth in health-care costs and slower growth in life expectancy. Our projections assume that recent historical trends will continue. If the trend toward longer lives accelerates, if health-care costs do not slow or if growth rates falter, government spending will become even more burdensome than we project.

Nowhere is the challenge more serious--or the official projections more misleading--than in continental Europe, which has the lowest birthrates, the most generous benefit formulas and the earliest retirement ages. For the European Union--excluding Scandinavia, Britain and Ireland--age-related social spending is on track to rise by an average of 15.9% of GDP, 9% higher than the official projections. Spain could see its combined health and pension budgets rise to 37% of GDP by 2050; Greece to 45% of GDP. In France, total government outlays could eventually absorb two-thirds of national output.

Nor does the bad news stop there. Our projections show that, by mid-century, Japan's pension and health budgets could leap by 17.2% of GDP. Canada's health and pension spending is on track to grow by 17.8% of GDP.

The U.S. is better off than most other developed countries, but only by comparison. Social Security spending is likely to rise by 2.8% of GDP by 2050, roughly in line with the official projections. Spending on Medicare and Medicaid is due to rise by 7.4% of GDP.

The least fiscally challenged developed countries are Australia and Britain. Their public pension costs will hardly grow at all, due to reliance on private pensions. Yet, like the rest of the developed world, they too face looming deficits in their health programs.

The truth is that most developed countries cannot hike taxes--even to the levels assumed in the official projections--without harming their economies. Growth rates in Europe and Japan are already sluggish, due in part to stagnant or shrinking numbers of workers and consumers--a trend that is only now gathering force. Almost across the board, their politicians pledge to cut taxes, not raise them. So, it's unclear how they will they cope with the three-decade-long surge of baby boomer retirements that will begin later this decade--particularly when birthrates have dropped dramatically in the developed world, resulting in fewer people paying into the system at the other end.

Under a worst-case scenario, the developed world's retirement crises will combine to deplete global savings and sow upheaval in the capital markets as default risks multiply among the major economies. One potential casualty would be growth in the youthful developing world--where frustrated economic aspirations could produce increased social turmoil. Instability would also threaten the retirement savings of Americans, Australians, Britons and others whose private pensions are a cornerstone of retirement security.

Thankfully, there are signs that governments are beginning to encourage longer work lives, reduce the cost of unfunded public benefits and strengthen privately funded alternatives--the three essential ingredients in a successful strategy. Sweden, Norway, Italy and Germany have taken initial steps toward reform, including such things as creating a second tier of funded pensions to make up for the expected shortfall in contributions, raising retirement ages and instituting contribution-based benefit plans. Spain, Austria, France, and Greece lag badly behind. But even in those countries, leaders are recognizing that government benefit promises will become an economic burden, a threat to prosperity and, ultimately, a source of retirement insecurity.

With the exception of Britain and Australia, however, none of the aging developed countries has taken the bold steps necessary to stabilize pension spending, leaving little room for other goals--including the inevitable rise in health spending.

The challenge of global aging is everyone's concern--and doing something about it is everyone's responsibility. Governments must ensure that today's "generational contracts" are sustainable. Business must invest more in younger workers and learn to value older ones. And both must educate the public, which is reluctant to believe that a system, which worked so well for their parents, can't work for their children.

Overly optimistic projections have masked the magnitude of the coming crisis and provided excuses for inaction. Now that the mask is off, it's time to act, while large postwar boom generations are still in the work force.

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