Germany's vagaries when it comes to retirement
The coalition contract between the two main German parties (Chancellor Angela Merkel’s CDU/CSU and the Social Democrats of the SPD) heralded change a couple of months ago, and now we have the confirmation: Germany intends to reverse some of the reforms that have made it successful in recent years. This doesn’t bode well for Germany’s medium-term economic prospects, but paradoxically might help to mitigate the lingering euro crisis.
Introduction of a minimum wage and a turn toward greener energy are two of the cost challenges the German economy will face in the near future. The biggest challenge, however, will be the reform of the retirement system, which will enable people who have contributed for 45 years into the pension system to retire at age 63. This is a U-turn from the previous reform, which took place just seven years ago, and lifted the retirement age from 65 to 67.
This reform is odd for several reasons in my view. First, it shows once again the almost caricature shortsightedness of some politicians. As the fine print in all our research publications states: “Past performance is not a guarantee of future performance.” It is not because the German economy has managed to grow well and even outperform its European peers in recent years that it could continue to do so. It is not because Germany has transformed itself from the “sick man of Europe” to an “export juggernaut” over the last decade that will enable it to retain this status. Quite the contrary, it is far more likely that reversing some of the reforms that made it such a success story will also reverse its success.
Second, Germany’s public finances and debt situation do look much better than those of most other industrialized countries. With a debt-to-GDP ratio of roughly 80%, it is indeed the “best in class” of the G7. But then again, 80% is 20 percentage points higher than the former Maastricht Treaty (remember it?) cutoff level for countries that wanted to be included in the Eurozone. Moreover, this 80% figure doesn’t take into account the unfunded liabilities of the government, i.e. all the promises embedded in the law whose financing is not secured.
The government pension schemes of countries with dismal demographics fall most especially into this category. And in this respect Germany is very dismal. It already has the second-oldest population in the world (behind only Japan) with a median age of 46.3 years. According to UN projections, this median age will rise to 50 in the next two decades while the German population will shrink by roughly five million.
Therefore, the old-age dependency ratio (the number of people over 65 in percentage terms versus the number of people between 20 and 64) will increase from 35.3% today to 60.2% by then. It doesn’t take a PhD in economics to understand that, with this reform, the unfunded liabilities of the German government will skyrocket.
Finally, there is an issue related to German leadership in the context of the current euro crisis. Almost all management texts tell you that “leading by example” is one of the best ways to rally your troops. Conversely, preaching water while drinking wine tends to result in serious issues and dysfunctional teams. How can Germany preach austerity to the rest of Europe while failing to live by its own precepts?
Yet there remains at least one positive twist to this story. A root cause of the euro crisis lies in the heterogeneous nature of the countries that make up the Eurozone when it comes to social and labor laws. It is a class with one top pupil and a lot of underachievers. To achieve the necessary homogeneity, either the bad pupils would have to strive for excellence or the best pupil could slide into mediocrity. It’s clear what’s happening here.