Author: Alicja Hiebert
As people start living longer and birth rates decline, society faces a growing challenge: how can fewer and fewer workers support an overexpanding retired population? From immigration to pension changes, we have several options, though hard, difficult choices may soon become unavoidable.
Europe is a museum, Japan is a nursing home, and China is a jail, quipped by prominent economist Larry Summers. What Europe and Japan have in common is a problem of population ageing. Europe now faces a “demographic time bomb”, with a troublesome combination of low fertility rates and rising life expectancy. While in principle longer lives are a good thing, in practice this creates massive strain on traditional public pay-as-you-go systems where current workers support current pensioners.
The average age in Germany will be around 46 years in 2030. To put that in perspective, the average age when my parents were born was approximately 33 years, and 30 years when my grandparents were born. * That increase of 16 years is equivalent to a 50% older society, on average. Europe’s social system was not designed for this; its population is getting grayer and grayer, and its working age population fewer and fewer.
At some point, we must ask ourselves, “What can be done about it?” Three options seem to be available.
The first option is to tinker with existing pay-as-you-go systems by making workers pay more or forcing reductions on pensioners. These are particularly politically expensive, possibly alienating either workers or pensioners – or both. An increased contribution for the working age population, which results in more money going to pensioners, would ultimately end up on higher taxes. Space here is limited: the OECD reports 47.9% total tax wedge in Germany – meaning for every euro earned, almost half is paid in tax. The alternative approach could be to reduce how much pensioners get, surely to the consternation of that cohort of voters.
A second, bolder option would be to strengthen the system by raising the retirement age or expanding the working age population through immigration. This would helpfully raise the number of working age people by delaying their retirement. And a higher working age population could support the growing number of pensioners. Alternatively, this could come from integrating more working-age immigrants into the labor force. However, rather than expanding immigration, curbs are currently being placed against it in many European countries. Let us take Germany for an example. Germany is increasing skilled immigration, but not rapidly enough to compensate with the decrease in the workforce. In 2024, Germany had around 700,000 unfilled jobs, but granted only about 198,000 skilled worker visas, which was enough to cover roughly 28% at best. This challenge is expected to grow further as millions of the post-war generation retire, with estimates suggesting Germany may need around 400,000 immigrants annually just to stabilise it’s workforce.
The third and boldest option would be to overhaul pay-as-you-go systems. That is, replace defined benefit schemes with defined contribution schemes. By encouraging people to actively invest in their retirement instead of leaving money to collect dust in bank accounts, more money would be available to grow businesses and economies. Examples of this are not hard to find – one need only to look at Sweden to see the benefits of such a scheme. A typical future retiree in Germany may receive only about half of their earlier income as a pension, whereas Sweden’s system can replace 70% or more. Through that, Swedish retirees often keep a much larger share of their standard of living.
In conclusion, we must slowly move away from the traditional “pay-as-you-go” system and find alternatives. The solution seems obvious when faced with the facts, but it somehow remains elusive. And as we know, often hard changes only happen when our backs are against the wall.
*The 1943 number is necessarily approximate because wartime Germany’s demographic records were disrupted by World War II and borders/population definitions changed substantially.
Cover image by: Mohamed Hassan from Pixabay
Edited by: Nora Kessler
