How Ready for Pensioners?

THE WORLD is on the threshold of a stunning demographic transformation brought about by falling fertility and rising life expectancy.Global aging promises to affect every dimension of economic, social, and political life—from the shape of the family to the shape of the world order. Perhaps most fatefully, it could throw into question the ability of many countries to provide a decent standard of living for the old without imposing a crushing burden on the young.

Which countries are most prepared to meet the challenge? And which countries are least prepared? The Global Aging Preparedness (GAP) Index provides a new analytical tool for assessing the progress that countries worldwide are making in preparing for global aging, and particularly the old-age dependency dimension of the challenge as the number of elderly relative to the working-age population continues to grow.

The GAP Index finds that with a few exceptions the countries best prepared to meet the promises they have made to retirees are those that have promised them the least.

We first tabulate the results for individual indicators, ranked from 1 (best) to 20 (worst). We then transform the indicator results into index values, and combine the index values into category scores. Finally, we combine the category scores into overall scores and rankings for each of the two sub-indices.

A crucial lesson

The GAP Index contains some good news and some bad news.

The bad news is that very few countries score well on both dimensions of aging preparedness (see Table 1). Three of the seven highest-ranking countries on the fiscal sustainability index (Mexico, China, Russia) are among the seven lowest-ranking countries on the income adequacy index. Four of the seven highest-ranking countries on the income adequacy index (Netherlands, Brazil, Germany, United Kingdom) are among the seven lowest-ranking countries on the fiscal sustainability index. Not surprisingly, it is the developed countries, with their expansive welfare states, that tend to score better on income adequacy than on fiscal sustainability. In the emerging economies—Brazil being a notable exception—the trade-off is usually the reverse.

Two countries score near the bottom of both sub-indices: France and Italy. To rein in the rising cost of their pay-as-you-go old-age benefit promises, these countries have enacted pension reforms that drastically reduce the generosity of the public “deal” that future retirees can expect to receive.

The good news is that a few countries are successfully meeting the challenge. Australia, which combines means-tested public old-age income support with a large, mandatory, and fully funded private pension system, ranks well into the top half of both sub-indices. So does Chile, which has a similar mix of retirement policies.

Several other countries, moreover, are moving in the right direction. Like France and Italy, Germany and Sweden have scheduled deep reductions in the generosity of future government pension provision. But unlike France and Italy, they are on track to fill in the resulting gap in elderly income by increasing funded pension savings and extending work lives. Although their fiscal burdens remain high, they have been reduced to well beneath what they would have been without undermining the living standard of the elderly.

This contrast points to a crucial lesson. Most developed economies—as well as a few emerging economies, such as Brazil and Korea—must significantly reduce the generosity of their old-age benefit systems to stave off fiscal catastrophe. But unless reforms also provide for other sources of income support to fill in the resulting gap in elderly income, the reductions are unlikely to be socially and politically sustainable. This is especially true in Europe, where the level of elderly dependence on public benefits is very high. In France, Germany, Italy, and Spain, over 70 percent of the income of the typical elderly person comes in the form of a government check.

The GAP Index results also make clear that demography is not necessarily destiny. The aging trend in France, which has one of the highest fertility rates in Europe, is no more severe than in Australia or Canada, yet France ranks near the bottom of both sub-indices. Japan, despite its massive age wave, ranks in the middle of both sub-indices. That’s because it has relatively modest per capita government pension benefits, which helps minimize the fiscal burden on the young, and large percentages of elderly who are still working or who live in multigenerational households, which helps boost the income of the old.

In short, policy matters. The GAP Index includes a reform guide that assesses the urgency and potential payoff of seven key reform strategies in each country, from reducing government pension benefits and health care cost growth to extending work lives, increasing funded retirement savings, strengthening old-age poverty floors, and increasing fertility rates and immigration (see Table 2). Most of the data used to assess the relative importance of the seven strategies are generated by the GAP Index model.