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Europe is going through an austerity obsession phase as a result of two distinct drives: first, the demand to address the debt crisis and second, the desire to use the crisis for pressing with structural reforms. Pension reform, which is currently high on the agenda of European fiscal accountants, is an illustrative case of the potential pitfalls with this approach.

Pension reform has been with us for almost two decades. It is usually motivated by short- and long-term fiscal pressure associated with rising expenditures for retired persons, who represent a fast-growing population segment. In a nutshell the problem can be described as follows: under the current retirement provisions in terms of age and paybacks, we are likely to be spending twenty to thirty years of our lives not working, thus paying few taxes, yet over-consuming in terms of health care.

There is no doubt that something needs to be done about this. The question is whether the obvious solution to the problem, namely, increasing the retirement age whilst in parallel reducing benefits by putting a cap on annual pension increases, is the right way forward.

This approach saves money in the short-term and promises to do the same in the long-term. In other words, it helps produce polished accounts, which is why I like to refer to it as the accountant’s dream-come-true. But upon closer inspection it fares less good. This is because it is based on a number of assumptions which are not borne out by empirical facts.

For instance: given that the problem with an aging society is that life expectancy increases at a faster rate than healthy life expectancy (i.e. living longer does not necessarily imply we also live longer and healthy lives), increasing the retirement age will, in part, shift the expenditure problem from the pension system to the invalidity system. It is also likely that part of the expenditures will be shifted onto social security through higher unemployment rates among aging employees who, by law, are now required to maintain full-time jobs for longer, yet are costly and not as productive as they used to be, thus end up being fired.

When these and other caveats are taken into account, the projections as to the extent of savings to be made with the help of pension reform must be relativized.

This does not mean that pension reform is unattainable. As shown by research carried out, among else, by the ActivAge project, for pension reform to work, including with regard to its cost containment or ‘austerity’ targets, it must be combined with growth policies in a number of other sectors:

  • investment in education for both young and old;
  • creating incentives for the creation of new jobs;
  • increasing the participation of women in the labor market, which is easier done through parallel investments in child care;
  • improving preventive health care; and
  • facilitating the combination of work and pension, something which is currently practically impossible in most European countries.

A blanket austerity policy never works. Cost containment measures, and especially those targeting structural reforms, are useful only in combination with growth and support measures in other carefully selected domains.