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World: The Pros And Cons Of Private Pension Systems

By Anthony Wesolowsky

In a three-part series, RFE/RL correspondent Anthony Wesolowsky examines the need for reform of state-run pension systems in Eastern and Central Europe and the former Soviet Union. In Part One, Wesolowsky examines current aging trends, explains the differences between pension systems in the East and West, and looks at why private pension funds are seen by many as a viable alternative to current "pay-as-you-go" methods.

Prague, 9 September 1999 (RFE/RL) -- A slowly graying population and declining birthrates threaten the viability of state-run pension systems worldwide.

In the countries of the Organization for Economic Cooperation and Development (OECD), the percentage of people over the age of 60 is expected to rise by about half over the next 50 years. In the year 2050, about 30 percent of the population in those countries will be over the age of 60.

Propelling the trend will be the impending retirement of the generation known as "baby boomers," those born in the years immediately after World War II. The problem is aggravated by alarmingly low birth rates in much of Europe. In 1997, Italy became the first nation in history with more people over the age of 60 than under the age of 20. Last year, Germany, Spain and Greece joined Italy among the ranks of prematurely aging societies.

Combined, these two trends spell trouble for state-run pension systems. Many experts on the topic predict that the current system will collapse if immediate reforms are not undertaken. The system currently common in much of the world is known as "pay-as-you-go." Workers pay the government part of their earnings, and that money is used to pay pensions to support people who have already retired.

Mike Tanner is the an expert on pension privatization with the conservative U.S. think tank the Cato Institute. He recently told RFE/RL why he feels the pay-as-you-go system is doomed.

"Well, countries all over the world are realizing the traditional pay-as-you-go model of social security is no longer viable. Under the old pay-as-you-go system, what would happen is individuals would pay a payroll tax, but that tax would not be saved or invested for their retirement in any way. Rather, it would be used to pay for the retirement benefits for current retirees. Those new retirees would have to hope that another generation of workers would pay for their benefits."

In some Western countries -- such as Germany, Austria, Portugal and Spain -- retired workers collect large pensions from the state's pay-as-you-go program, sometimes as much as 80 percent of their past salaries. But in most of the West, including the United States and Canada, state-run pensions are meager, just enough to keep the elderly out of poverty. In those countries, many workers supplement their retirement income with private pension funds.

Under a private pension plan, workers pay into a fund that invests in stocks and bonds and accumulates interest. If the fund performs well in the market, the workers' gains will be higher when they retire.

It is those private pension funds that many experts now advocate for governments. They say moving away from the state pay-as-you-go model toward a private system will mean not only more money for pensioners, but also lower costs for government.

In Europe, Great Britain has been the most keen to embrace the private model. The British pension is largely based on the retiree's past salary. The more you earned when you worked, the more you get when you retire.

But under the conservative leadership of Prime Minister Margaret Thatcher in the 1980s, the government offered tax breaks to people who opted to invest some of their payroll taxes in private pension funds. London hopes the changes will add up to a lower pension bill for the government.

But the approach has its share of detractors. Among them is Mike Reddin, an authority on pension policy at the London School of Economics. As he explained to RFE/RL recently, many working people were lured into the private schemes, sometimes with disastrous results. Reddin says:

"More and more people have been tempted to do that; it seemed to them quite financially attractive at the time. The pension companies promised them a great deal in benefits but has consistently and systematically let them down and failed them. And the government has had to keep returning to bail out those schemes and reinventing schemes and new rules and new regulations to give the people a fair deal in the pension market."

British pension regulators says the cost of bailing out investors tied up in failed pension schemes could top $15 billion.

Still, according to government projections, by 2030 -- when most of the post-war generation will have retired -- the cost to the British government of providing pensions is projected to be 6.2 percent of gross domestic product. That compares with 6.8 percent projected in the United States, 14.2 percent in Germany, and 17.2 percent in France.

Because of these encouraging figures, the private pension approach has grabbed attention around the globe. The World Bank says some 30 industrialized countries will implement something similar to the British plan within the next 30 years.

(In Part Two, Wesolowsky looks at how some former East Bloc countries are coping with pension reform.)