Ifo Viewpoint No. 4: Funded Pensions

Hans-Werner Sinn
Munich, 3 Nov. 1999

Germany can expect a major demographic upheaval. Even with an additional eleven million immigrants, as the German Statistical Office projects, the number of pensioners in relation to the working population will more than double by the year 2005, and by 2020 it will no longer be possible to finance pensions at the present contribution rates. In addition to growing life expectancy, another cause is the declining birth rate in Germany: currently 10 Germans will have no more than 7 children throughout their lives. With fewer children, there will be fewer social insurance contributors for each pensioner, and the social insurance crisis will worsen.

The solution to this problem can only lie in private supplementary savings, since the declining number of contributors must be offset by personal savings. This must begin immediately while there is still time. It is also not possible to finance these savings by social insurance contributions since the full amount of these contributions is needed for today’s pensioners.

Supplementary savings would also not be an excessive burden, since the money that would otherwise have gone for child-rearing is in principle available for capital investment. In the past, working age people had to support both the old and the young; today they often only support the old. It is not unreasonable to require today's working generation to participate in savings plans in lieu of not having children. The necessary earning power is there.

Supplementary savings cannot be left to individual choice, since in many cases the prospect of social welfare benefits weakens the incentive for private savings. Due to the demographic crises, average benefits from the pay-as-you-go pension system will hardly be greater than welfare benefits. Those who expect a below-average pension, due to a low income or a reduced pension as a childless person, would not benefit fully from their own personal savings since part of these savings would only reduce the welfare payments to which they otherwise would have been entitled. An obligatory savings plan is necessary to compensate for the lack of savings incentives.

Hans-Werner Sinn
President of the Ifo Institute