The Political Future of Social Security in Aging Societies, by Vincenzo Galasso, Cambridge, Mass., London: MIT Press, 2006, 257 pp., ISBN-13: 978-0-262072-73-1, ISBN-10: 0-262072-73-4

While most authors focus on the financial sustainability of pensions, Galasso emphasizes the importance of political sustainability of pension reforms because of the greater political weight of older people. They have different preferences – compared to younger workers/voters – regarding the acceptable or desirable parameters related to retirement, namely the retirement age, the level of contributions and the level of income provided by the pensions (e.g., their replacement rate). He notes that older voters pressure policy-makers to maintain or even increase pensions’ generosity despite the adverse economic effects. He tries to assess how such political pressures change the pension schemes in response to population ageing. As such pressures magnify the impact of ageing on pension spending, he suggests that postponing retirement not only mitigates this effect but also enables more generous pensions and it is therefore the only viable solution to ensure their sustainability.

Restoring the financial sustainability of public unfunded pay-as-you-go (PAYG) pensions, argues Galasso, will either require the scaling down of pension benefits or increasing the tax burden on workers. This concern over financial sustainability led governments across Europe to introduce incremental “parametric” reforms during the past two decades, which did not modify the underlying unfunded nature or defined benefit nature of the schemes, though they did tend to delay effective retirement age and somewhat reduced the generosity of the schemes. However, as implementation is extended over a lengthy transition period, the author warns of the risk that changing government majorities may be tempted to yield to pressures from the more politically active lobbies representing the elderly against retrenching benefits. It is therefore crucial not so much that pension reform policies maximize economic welfare but that they are supported by a broad political consensus on the reforms’ components (e.g., retirement age, contributions rates, eligibility criteria and benefit calculation rules).

The reforms impose large burdens on specific groups of voters while creating only dispersed and uncertain gains. Individuals’ position and preferences related to the different components of the reforms are influenced by various factors such as age (different age cohorts have different contribution histories and benefits expectations), educational attainment, career paths and the related incomes, and therefore have a different outlook on the proposed policies. They also respond differently to incentives and disincentives of existing legislation, taxation and welfare systems. Hence the need to enable policymakers to show the expected outcome of different policy alternatives. To this end, Galasso made simulations that go rather far in showing the long-term impact of each reform alternative. His quantitative analysis of future political sustainability of pension systems in 2050 covers six ageing societies – France, Germany, Italy, Spain, the United Kingdom and the United States – where the impact of ageing differs in magnitude, as do the current level and design of the existing pension systems and the political dynamics.

The simulations draw a bleak picture of drastic growth by 2050 in pension spending in all six countries, with overwhelming increases in contribution rates and a decline in replacement rates in all countries except France and the UK, compared to the prevailing rates and effective retirement age in 2000. (The largest rise in contribution rates is expected in Spain, the fastest ageing country, where an unchanged effective retirement age of 62 will require contributions to rise from 21.3% in 2000 to 45.5 % of the wage bill in 2050, while (wage) replacement rate will decline from 67.9% to 64.6%. Raising effective retirement age to 65 will mildly reduce the rise in contribution rate to 40.7%, though it will enable a significant increase in the replacement rate to 77.3%.)

But, warns Galasso, the expected substantial increases in contribution rates may result in labour market distortions inducing younger workers to withdraw their labour since it is so heavily taxed. As saving patterns of older workers lead to an increase in the stock of capital, he suggests that this makes it possible to increase real wages, thus mitigating the pain of higher contribution rates. Such pay increases could also stem from his assumption of a global improvement of the population’s educational attainment, a visible recent trend. These two converging trends may however be questioned. Indeed, while globally educational attainment of the population has increased over past decades, the presence of many low-skilled, low-paid, poorly-educated precarious workers and the persistence of high levels of long term unemployment and social exclusion across Europe seem to run counter such optimistic conclusion. Furthermore, technological change, globalization and off-shoring also tend to reduce labour demand of skilled workers and graduates in Europe, the US and even Japan.

Beyond the effect of intergenerational redistribution by the PAYG pension schemes on social security expenditures (e.g., transfer from the younger generation to the older), Galasso suggests attention should be given to other redistributive intra-generational flows that are taking place and need not be influenced by demographic ageing (e.g., from rich to poor and from two-earner to one-earner families), as these can largely affect individuals’ preferences related to pension schemes. Such transfers create an opportunity for shaping a coalition of voters in favour of the system, as has been the case of flat rate pension schemes, which target low-income individuals at low cost in terms of contribution rates. In the UK the introduction of such a system was supported by a voting coalition of rich and poor: low-income individuals supported it because of its highly redistributive feature, while high income individuals supported it because the low contribution rates, which allow them to save and invest in the private market for their old age.

The book will interest policymakers, the social partners, economists and political scientists concerned with the future of pensions systems in an ageing society from a political economy perspective.