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José Luis Álvarez Arce, Professor of Economics and Business Administration, University of Navarra, Spain School

Are pensions in danger?

Sat, 20 Feb 2010 09:58:23 +0000 Published in Navarra Newspaper

In the ceremony of confusion that the government's economic policy announcements have become, few issues could have caused as much public impact as that of the government's proposal to delay the retirement age and modify the rules for calculating pensions. The publication of the proposal - grotesque in form, unclear in content and in flagrant contradiction with the criticisms launched by the government a few months ago against an almost identical proposal by the Bank of Spain - has had the opposite effect to the one desired. Instead of calming the markets and generating confidence among citizens, it has caused great uncertainty, even arousing the fear of Spaniards of losing their pensions.

Are these fears justified? I do not think so. Spaniards want to maintain their Welfare State, whose backbone is the public pension system. Moreover, according to surveys, they would be willing to pay more taxes if these were dedicated to their pensions. Political parties and the so-called social partners also believe in maintaining the system, as shown by the Toledo Pacts. Under these conditions, there is no reason to believe in the brutal blow to the welfare state that the disappearance or drastic cut in benefits would entail.

However, Spaniards should be aware that, in the absence of reforms, the public pension system will face enormous financial difficulties in the not too distant future, which will make it more expensive to maintain and will cause macroeconomic problems. As you know, we have a pay-as-you-go system which functions as an instrument of redistribution or transfer of income: workers pay for the benefits received by the passive population with their contributions. Some phenomena have increased, apart from discretionary policy decisions on subject, the generosity of this mechanism. On the one hand, the age of entry into the labor market has been postponed, thus reducing the length of the active contribution life. On the other hand, life expectancy has increased, prolonging the period of life over which pensions are received. While the dedication of more years to training and the enjoyment of a longer life are excellent news, both add pressure on the financial health of pensions.

This pressure has been withstood in the recent past thanks to economic and demographic factors. Specifically, immigration has led to an injection of young people which, together with the incorporation of women into the labor market at work, has boosted the active population. This has been accompanied by a long period of economic growth and intense creation of employment and, therefore, an increase in issue of contributors and Social Security revenues. Unfortunately, however, the crisis is now generating unemployment by leaps and bounds and the projections for recovery are not optimistic. Moreover, demographic forecasts indicate that, within four decades, the aging of the Spanish population will have increased the ratio between the population over 64 and the working-age population from the current 20% to 60%. The pressure will be excessive and the system, at its current design, will not be able to sustain itself. Can this status be avoided? Of course it can, provided that action is taken now in the right direction. I believe that the first thing that should be demanded of our rulers is a communication and pedagogical effort to make citizens aware of status and the options for change. Based on this and the consequent discussion, an in-depth reform of the pension system is needed, and not small patches such as delaying the retirement age. But, above all, what is needed is a battery of structural reforms to boost economic activity, job creation work and productivity growth. Of course, all of this requires a firm hand and a clear mind from the person at the helm of economic policy. International markets do not seem very convinced that we have such a helmsman.