Postponing retirement: the political push of aging

Conventional economic wisdom indicates that the aging process will cause large financial unbalances to the PAYG social security systems, unless contribution rates increase drastically. A commonly advocated reform measure – at least by economists and international institutions – that may help to cope with this financial sustainability is to postpone retirement. According to the political economy approach, however, decisions on pension policy go beyond economic theory into the realm of politics. The crucial insight of this literature is that pension systems need not be welfare enhancing, but rather politically feasible. In democratic countries, this amounts to obtaining the support of a majority of the Parliament or, more directly, of the electorate. This intuition carries an additional, powerful, consequence: normative analysis and policy recommendations may not be useful, unless they lead to the design of politically sustainable reform packages. This paper analyzes the impact of the aging process on the political sustainability of current PAYG pension systems. How do political constraints shape the social security system in six OECD countries under population aging? Aging increases the dependency ratio, thereby reducing the average profitability of an unfunded pension system, but it leads also to an older electorate, thereby increasing the relevance of pension spending on the policy-makers’ agenda. The simulations presented in the paper suggest that the political aspect dominates, as the contribution rates are set to increase. These simulations deliver a strong policy implication: an increase in the effective retirement age always decreases the size of the system chosen by the voters, while often increasing its generosity. Yet, will this policy measure be feasible in OECD countries? Simulations of the political feasibility of postponing retirement under aging in France, Italy, the UK, and the US for the year 2050 suggest that retirement age will be postponed in all countries, although social security contribution rates will still rise in all countries, but Italy. The political push to increase the retirement age is mainly due to a negative income effect induced by aging, which reduces the profitability of the existing social security system, and thus the individuals net social security wealth.