Retirement Finance Reform Issues Facing the European Union

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Changing demographics are forcing countriesaround the world to reexamine their publicpension systems. The member states of theEuropean Union are no exception. Indeed, theEU nations are among those facing the greatestsocial, budgetary, and economic challenges as aresult of their aging populations. Therefore, EUmembers will be forced to rethink their publicpension programs and move away from traditionalpay‐​as‐​you‐​go (PAYGO) pension modelsto new systems based on savings and investment.

The need for pension reform has engenderedheated political debate in Europe. In many waysthat debate mirrors the debate over SocialSecurity reform in the United States. This paperexamines many of the issues involved inreforming European pensions and reaches thefollowing conclusions:

  • Long‐​run data from many countries showthat the yield on market assets is sufficientto provide adequate retirement income at areasonable cost. Indeed, such income islikely to be significantly higher thanincome that can be provided throughPAYGO systems.
  • A market‐​based system would not necessarilyreduce the redistribution that someEuropeans consider an important characteristicof EU pension programs. Moreover,those programs may be far less redistributivethan commonly believed.
  • Moving to a market‐​based pension systemcan help promote labor market flexibilityby more closely linking contributions andbenefits. In addition, a market‐​based systemwould eliminate incentives for older workersto leave labor markets prematurely.
  • Although transition financing would be acomplex issue, it is cheaper to move tomarket‐​based systems than to continue currentPAYGO systems. It is possible todesign a transition scenario that is a winwinsituation for all generations.
  • Administrative costs in a market‐​basedsystem can be kept low.
  • Market‐​based systems would increaseasset ownership and give workers greatercontrol of the wealth‐​producing assets ofsociety.

Given those conclusions, EU member statesshould begin the transition to a market‐​basedsystem of pensions as soon as possible.

Download the Social Security Choice Paper


William G. Shipman

William G. Shipman is chairman of CarriageOaks Partners LLC and co‐​chair of the Cato Institute Project on Social Security Choice. An earlier version of this paper was prepared for the European Commission in 2001.