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A Tale of Two Pensions Reforms: a Sraffian View
*
Sergio Cesaratto
Department of Political Economy
University of Siena
Cesaratto@unisi.it
(forthcoming in B.Grave (ed.), The Future of the European Welfare States, Ashgate)
In most countries Pay-as-you-go (PAYG) is the dominant pension scheme. The conventional view is that the secular
demographic developments (lower fertility rates and increasing longevity) and, in the short period, the retirement of the
baby-boom generation, threaten the sustainability of PAYG since an increasing number of long-surviving elderly
persons will weigh upon a falling number of young workers. We shall critically examine here two main pension
reforms. The first is a re-engineering of PAYG according to the principles of the Notional Defined Contribution (NDC)
plans. The partial or complete substitution of PAYG with Fully-Funded (FF) pension schemes is seen as a second
solution. Section 1 will examine the NDC reforms. Section 2 will expound some criticism of the adoption of an FF
schemes. Section 3 will present our view of the sustainability of PAYG as an economic and not as a demographic issue.
1. THE NDC REFORMS
1
The NDC reforms, tried out in the 1990s in Italy, Sweden and elsewhere, are said:
(i) to assure the financial sustainability of PAYG in view of the ageing process.
(ii) to introduce greater fairness in the calculation of pensions in favour of flat career workers,
(iii) to avoid more radical reform aimed at creating FF schemes, reforms that meet formidable problems (see section 2
below).
Financial stability
We may single out three archetypal organising principles of PAYG (Musgrave 1981): (a) Defined Contribution
scheme (DC); (b) Defined Benefit scheme (DB); and (c) Ad Hoc Provision.
Let us take two generations of ‘young’ workers and ‘old’ retirees, N tw and N tr , respectively; the subscript t
indicating time. Let us call wt the given wage rate (or, more in general, the per-capita labour income) and  t the
contribution rate. At the end of a selected financial period PAYG is financially balanced if the individual pension
benefits b t and/or the contribution rate have been such that:
bt N tr   t wt N tw
(1)
If the wage bill ( wt N tw ) grows at a rate  t , we get the expression:
t
 (1  t )
t
*
1
This paper is heavily based on Chapter 9 of Cesaratto (forthcoming a).
Cf. also Cesaratto 2002; forthcoming a, Chapter 2; and forthcoming c).
(2)
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where  t 
bt
is the ‘replacement rate’. This suggests that for a given  , there is a policy choice in combining
wt 1
 and  while maintaining PAYG in financial equilibrium. If  changes, either  or  or both must also vary.
(i) according to the DC criterion, contributions are fixed as a percentage of wages and, in each period, benefits are
determined in order to guarantee the financial balance of the system. In this scheme the level of current benefits relative
to wages (i.e. the replacement rate) is adjusted to take into account the rate of change of the wage bill so as
automatically to assure the financial equilibrium of the scheme. As a result, premiums are certain but benefits
2
uncertain. Referring to equation (2), any change in the rate of growth of the wage bill  , given  , is reflected in a
change in the replacement rate:
t
 (1   t ) .
t
The DC scheme is the closest to the principles of private old-age insurance.
(ii) with the DB criterion, the independent variable is the replacement rate. From equation (2) we get:  t 

(1  t )
.
The rationale of this principle can be found in the continuity of income between the pre-retirement years of activity
and retirement. In this case the variable that is adjusted in order to assure the financial equilibrium, whenever the rate of
growth of the contribution base changes, is the contribution rate. Musgrave’s criticism is that the adverse circumstances
hit only contributors.
(iii) finally, the ad hoc provision is defined by Musgrave (1981, p.99) as the ‘provision for the aged as a
redistribution scheme between the working population and the aged, to be decided on a continuing and ad hoc basis’.
The supporters of this view - among them great Keynesians like Abba Lerner (1959) and Robert Eisner (1998) actually recognise the existence of social conventions, such as the ‘insurance fiction’, that give legitimacy to the quid
pro quo pact around which the consensus for PAYG has more or less openly been built, but they are suspicious of
actuarial solutions to the pension problem.
The labour movement has in various countries often been ambivalent about the methods of financing PAYG: on the
one hand it has seen (progressive) general taxation as the most socially equitable financial source (conversely, the DC
schemes are based, for instance in Italy and Sweden, on proportional taxation up to a cap after which contributions are
zero), but in periods of Welfare State retrenchment like the current one, labour has resorted to the contributory principle
to defend pension rights. Also the ruling class often changed its mind. For instance, Bismarck rejected the contributory
principle as he wanted workers to regard pensions as a gracious gift from the State, whereas the liberal bourgeoisie
preferred the (subsequently adopted) contributory principle which it felt was closer to private insurance and related
market moral principles (cf. Cesaratto 2002 and forthcoming a, Chapter 1). Currently, progressive economists are still
divided on this matter. The danger they feel is that pensions paid out of general taxation would tend to be basic
‘welfare’ pensions, whereas contribution pensions are expected to be higher since they are related to wages. But in
practice this might be less true in the future with the NDC reforms (which apply the DC principles in a very strict way).
Fairness in NDC schemes
As said, a DC scheme would bring about, in the long run, the financial stability of the system, although at a price that
is entirely paid by the retirees. The NDC reforms, however, are said to bring about greater fairness. It can indeed be
recognised that pensions in the DB schemes exacerbate market income inequalities while the DC principle merely
reflects them (the scheme is said to be actuarially neutral).
Let assume that there are two kinds of workers, flats and steeps, that both work for two periods, but the former for
the same wage w F (they have a flat career), while the latter receive a higher wage in the second period (they have a
steep career with wages w S1 and w S 2  hwS1 , respectively, in the two periods, with h  1 ). Both groups retire only for
2
We note that Musgrave’s neoclassical background leads him – as most of the participants in the pension debate - to equate
demographic and employment risks, a view that we have repeatedly rejected in this book.
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one period and the contribution rate is the same. Supporters of a DB scheme typically emphasise that it defends the
principle of continuity of income from the activity period into retirement. Supporters of the DC system reply that the
DB scheme conceals an inequity between the two social groups. This is usually seen as the flats having an implicit rate
of return on contributions lower than the steeps (e.g. Gronchi et al., 2003, pp.11-12). I prefer to regard the question as
the class of flats paying an amount of aggregate contributions that only partially goes to the retired members of the
same group.
To focus on the effect of the different wage careers only, let us assume without loss of generality that the economy is
made up of just four workers (two from each class) and two retirees (one from each class), that wages are constant (in
this stationary economy the time index t can then be omitted to save notation space), and that w F  w S1 . The financial
equilibrium of PAYG in the period considered is given by:
[w F  w F ]  [w S1  wS 2 ]   F w F   S wS 2 .
If, according to the DC principles, the benefits of each group’s benefit reflected the respective contributions, the two
F
respective replacement rates (considering the simplifications suggested above) should be, respectively:  DC
 2 and
S
 DC

 (1  h)
F
S
F
S
, with  DC
. According to the DB principle the uniform replacement rate  DB
  DB
  DB
  DC
h
consistent with the financial equilibrium would instead be:
 DB 
 (3  h)
(1  h)
.
F
S
Since  DC
, it is clear that in a DB scheme the retired flats are receiving less of the contribution flow
  DB   DC
from the active flats than under a DC regime (and viceversa for the steeps). As said, the same concept can be expressed
by saying that, given the equilibrium rate of return on contributions  (which is zero in the example), in a DB scheme
each individual in the flats group is receiving less than it, while each steep individual is receiving more than it. For
instance, it is easily verified that with   0 (for simplicity), the rate of return for the flats, calculated as
 w F  2w F
benefits  contributi ons
, or DB
, is negative, and that the analogous rate for the steeps is positive.
contributi ons
2w F
Supporters of a DB scheme typically emphasise that it defends the principle of continuity of income from the
activity period into retirement. Supporters of the DC system reply that the DB scheme conceals an inequity between the
social groups. This is usually seen as workers with flat careers having an implicit rate of return on contributions lower
than those with steep careers (e.g. Gronchi et al., 2003, pp.11-12). We regard the question as the class of flats paying an
amount of aggregate contributions that only partially goes to the retired members of the same social group.
Summing up, the advocates of the DC schemes see it as a system capable of maintaining PAYG in financial
equilibrium, that is of avoiding changes in contribution rate or the recourse to general taxation in the case of a fall in the
contribution base, with the fall in average replacement rate compensated by a greater social equity compared to the DB
scheme, so that this fall would mainly hit the steeper careers. In Italy for instance, where this reform was adopted in
1995, it was said that the replacement rate for blue collars did not change (only that of white collars did). This is not
certain in the future, especially if the parameters on which the calculation of pensions is based are revised to take into
account the expected lengthening of life and if the careers become more discontinuous after the introduction of labour
3
market flexibility policies.
Another alleged advantage of an NDC scheme is indeed the automatic adjustment of benefits to increased longevity
so as to assure the financial stability of PAYG. Workers are said to be able to compensate the lower benefits by working
3
In Italy the effect of the NDC reform on the retirement decisions will not be felt before two decades or so, since most retirees in the
near future will withdraw with the old system, or at least with a mixture of the two. In the meantime, however, various measures have
been undertaken to encourage later retirement.
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longer, a particularly beneficial response in times of expected labour shortages. (Later retirement also helps PAYG’s
financial balance in the short period, although not in the long run).
The neoclassical economists tend to regard later retirement as a rise in the labour supply and of employment, since in
their view employment depends on the labour supply, given wage flexibility. In a Keynesian view, according to which
employment is independent of labour supply, however, an increase in the age of retirement requirements may:
(i) if successful in delaying the average retirement age, displace the job opportunities for the younger; or
(ii) increase the unemployment among the older workers if firms are successful in dismissing them before the statutory
retirement age is reached in favour of more skilful, motivated and less costly young workers.
In the longer run the demographic developments (see below section 3) may render these negative results less likely
insofar as the shrinking supply of younger workers will make mature workers more competitive.
To conclude, NDC reforms in Italy, Sweden and other countries stemmed from concerns about a rise in the ratio
between PAYG costs and GDP due, in the near future, to the retirement of the baby-boom generation and, in the long
run, to the secular process of ageing. Making virtue out of necessity, the NDC scheme, by correcting the inequities of
the preceding DB schemes favouring the pensions of the more professional workers with steep wage careers, obtains a
substantial share of the desired cuts by hitting this last group, safeguarding the greater part of the replacement rate of the
less professional workers characterised by flat wage careers. Moreover, both groups of workers are said to be able to
preserve a decent replacement rate by retiring later. Again making virtue out of necessity, the forthcoming drop in the
labour supply from the younger generations, on the one hand, will reduce the fear of a displacement effect of later
retirement on the job opportunities for the young workers and, on the other hand, will render the labour supply from
mature workers more precious than it is now. The Italian experience suggests that the NDC reform in the long run,
when fully operational and once the retirees belonging to the baby-boom generations begin to fade away, will be able to
restore PAYG costs on GDP to the present level. The open question is the increasing gap between the pension benefits
and per-capita income, a gap that may be exacerbated by the more discontinuous ‘flexible’ careers and by an income
distribution that is less favourable to wages. The reliance on a second FF pillar to compensate the lower retirement
income is examined in the next section.
2. FULLY OR POORLY-FUNDED REFORMS?4
Mainstream economists and institutions propose FF schemes as a radical alternative – partial or total – to PAYG.
According to the conventional view, these schemes are the best equipped to cope with the pending demographic shock.
Suppose a baby boom followed by once-for-all decline of the working population – which after the shock recovers its
previous secular rate of growth. If the old have accumulated real reserves, ‘crystallised’ in the capital stock, these will
be absorbed: (i) partially by an increasing capital-labour ratio that, according to the conventional theory, is induced by
change in the relative scarcity of capital and labour supplies; and for the remaining part (ii) by the disinvestment of
savings that, taking advantage of the amortisation funds, recover their original liquid form. In this way the old realise
their target consumption without bearing too heavily on the less numerous young, as would have happened with the
unfunded PAYG system. It may be observed that the first part of the adjustment process is a natural victim of the capital
theory critique (see below), while the practical possibility of the second is a source of preoccupation even among the FF
reform sponsors. Enhanced life expectancy may be coped with by a reduction in the annuities that the old receive from
the pension funds. This would follow a policy adopted by the funds of spreading the sale of the equities owned by the
old over longer time spans so as to distribute the proceeds over the entire lifetime of the pensioners. This will diminish
the per-capita pension level. However, it may be shownd that the postponement of part of the old’ consumption leads to
a higher per-capita capital intensity that partially offsets the fall in the annuity. For all these reasons, according to
neoclassical economists, a pension reform that raises the marginal propensity to save for the ’foresight’ motive, by
leading to more investment and, ceteris paribus, to a higher capital-labour coefficient, will better equip individuals to
cope with the impending demographic shocks (while raising the current per capita and aggregate income). In addition,
according to the prevailing view, FF schemes also show higher average return rates than other pension schemes. In this
case, however, the argument has not been fully established either analytically or empirically.
4
Cf. also Cesaratto 2002; forthcoming a, Chapters 3 and 4; and forthcoming b.
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Obstacles to an FF Reform
The creation of an FF mandatory scheme encounters two obstacles: (i) the difficulties of inducing a rise in the
marginal propensity to save; and, even if this succeeds, (ii) the saving paradox. It should be appreciated that the first
obstacle is independent of the Classical-Keynesian criticism, while the second relies on it. Let us reconsider them in
turn.
It is generally recognised that if the State mandates workers to increase their old-age saving, the reaction might be a
cut in voluntary foresight saving. If workers reduce their voluntary old-age savings by putting them in pension funds
(PFs), although a system of PFs is created, in the first approximation the reform is only a façade, since the only real
change that occurs is in the management of the same amount of ‘foresight’ saving. Even worse, by introducing a
mandatory old-age risk sharing, the FF scheme may require a lower level of saving supply to provide the same amount
of annuities. A positive impact is expected: (a) for those workers who did not save before that must, however, be
wealthy enough to a mandatory saving scheme; and, perhaps, (b) for those workers that saved for the purpose of making
a bequest and not for their old age, and have enough income to contribute to mandatory savings without cutting their
bequest-motivated saving. If they cut their bequest-saving, workers would just be diverting existing savings to the FF
scheme, perhaps leaving the income received in old age out of these savings as a bequest in any case. Bequestmotivated saving may indeed have a hidden old-age risk motivation in exchange for the offspring’s support in old age.
Finally, workers may cut precautionary saving for other purposes and increase their foresight saving. However, while
aggregate saving has not changed, it can hardly be said that the general safety of the population against future
unforeseen events – of which old age is just one – has increased.
The difficulties encountered in raising the marginal propensity to consume are of course greater if workers already
contribute to a PAYG scheme. In this case it very likely that they will reduce their private ‘foresight’ saving if
mandatory saving schemes are introduced. Moreover, in many countries PAYG contributions represent quite a large
proportion of gross wages, so that it appears politically unfeasible even to ask workers to pay in more.
In order to by-pass these difficulties, many pension reformers (in particular, the World Bank) has proposed diverting
PAYG contributions to the PFs. The government, in the meantime, could issue new public debt to finance the current
pension transfers. It is thus clear that, prima facie, the PFs will use their funds to buy the above-mentioned public debt.
From the aggregate point of view, the higher workers’ mandatory saving supply is matched exactly by the lower
government saving, so that old age saving has not increased. True, PFs have been created, but in the first approximation
they only possess Treasury bonds issued ad hoc to finance the current pension transfers. Some economists have defined
this scheme a ‘privatised PAYG’. It is clearly an unfunded scheme based on a notional fund.
Nonetheless, this sort of reform has been defended on a number of grounds: let us briefly re-examine them:
(i) The scheme is said to be safer that the traditional PAYG since workers’ contributions to the PFs now enjoy the
guarantee of the Treasury bonds bought by the funds. This argument is particularly weak since any government that
finds itself in financial difficulties might default on its promises irrespective of whether they have a legislative dressing,
as in the traditional PAYG, or consist of Treasury bonds held by the notional scheme. The recent example of Argentina
is particularly appropriate in this case.
(ii) Those schemes in which contributions are accumulated in individual financial accounts would have a positive
effect on labour supply since workers will not see their taxes used for income redistribution to other individuals.
However, it has been objected that the same result can be obtained by adopting NDC schemes within the traditional
PAYG with the advantage of avoiding the huge management costs of PFs.
(iii) It is said that Treasury bonds would have a higher rate of return on contributions than that obtained from PAYG.
However, some authors have shown that the higher rate of return may imply higher taxation which, if it were levied on
the same beneficiaries as those of the presumed advantage, would cancel it out exactly. In any case, the same higher
return could be adopted in a traditional PAYG without incurring the high management costs of unfunded PFs.
(iv) A major argument to defend the privatisation of PAYG is implicit in the idea that PF schemes can diversify into
private (and foreign) financial assets and be transformed into what we defined as diversified funds. The frequently
heard thesis in this regard is that the diversification of the assets held by the notional scheme, in which Treasury bonds
would be sold and private assets purchased, would make the financial market denser and, due to the larger scale of the
operation, better organised. Diamond, Stiglitz and other American economists regard this kind of diversification as a
device to paternalistically force risk-adverse families to take a stake in the capital market. More efficient financial
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markets would in turn foster capital accumulation. This argument seems rather weak. Although efficient financial
markets might be favourable to capital accumulation, they are not the main force, or even one of the main forces, behind
it. In Italy, for instance, where this argument is often heard, the financial sector inefficiencies were no obstacle to capital
accumulation when this was at its height.
(v) Finally, the privatisation of PAYG would reveal the true pension debt implicit in a PAYG scheme. This partially
hidden motive behind privatising PAYG aims to increase the alarm of the public opinion concerning the costs of the
public pension system and prepare it for more radical reforms. After Caffè (1972), we labeled this strategy as a ‘strategy
of economic alarmism’.
The often cited Chilean case is not a good example of privatisation of PAYG, since in this instance, the existence of
an ‘on-budget’ government surplus, obtained independently of the pension reform, masked the real cost of the
transition. Chile is also cited as an example of a positive association between the creation of an FF plan and investment
growth. This view may be challenged by referring to some authoritative studies that explain the relatively good
performance of the Chilean economy over the final two decades of last century on the basis of a different set of
circumstances regarding, for instance, the export performance and the control over de-stabilising financial capital
inflows (e.g. Agosin 2001).
In those cases in which the pension reform does not just change the management of existing old-age saving, the
dominant view is that the higher marginal propensity to save will lead to higher investment and, for a given labour
supply, to a higher capital-labour ratio. This argument rests on the existence of a downward sloping demand schedule
for capital (investment) that is negatively elastic to the rate of interest. In this case the additional saving supply, by
determining a fall in financial market interest rates, will induce the entrepreneurs to adopt more capital-intensive
production methods. This view was criticised from different angles by Keynes and later by Sraffa.
The Role of the Capital Critique
Keynes based his criticism on the rigidity of the nominal rate of interest when a fall in the natural rate was necessary
to adjust investment to an increased saving supply. Neoclassical economists, however, took advantage of the short-term
nature of this rigidity to re-establish the validity of the traditional theory, at least in the long run. The results of the
capital theory controversy, however, validate the Keynesian principle of the independence of investment from saving
by showing that, generally speaking, there is no demand function for investment which is negatively elastic with
respect to the rate of interest (Garegnani 1983).
The criticism of the neoclassical view of the saving-investment relation, that is valid both in closed and open
economies, is the ultimate challenge to the conventional view of capitalisation reform. Not only is it difficult for policy
makers to raise the propensity to save, as pointed out earlier, but even if successful, the effects on investment may be nil
and the reform results abortive. True, in the new situation, a lower number of more thrifty savers is required to finance
the initial level of investment, so that PFs may be created for those lucky enough to have maintained their jobs. But this
is a poor result. If we also consider that the level of investment is likely also to be negatively affected by the fall of
effective demand, even this meagre outcome is in doubt. Ironically, the only certain outcome would be a weakening of
the wage (or tax) base of PAYG. If pension transfers are cut to balance PAYG, this might further negatively affect
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effective demand.
The critique of neoclassical capital theory also disposes of the conventional view that a higher saving supply from
the northern countries will find a natural débouche in the capital-poor southern countries. Keynes’ saving paradox can
indeed be extended to an open economy: an increased amount of foreign saving is obtained at the cost of a lower
national output (cf. Dalziel and Harcourt 1997).
Finally, the Keynesian and capital critique led us also to reject the utility of a social security ‘Trust Fund’. In this
case the surplus from current workers’ contributions – which is a regressive tax - are not used to finance current
pensions, but either to finance additional on-budget spending or tax cuts for the upper classes or, if they are not used in
this way, they have a deflationary effect. In all cases, no real accumulation of assets is taking place. In the case of future
financial disequilibria of PAYG the Trust Fund is useless, and they will have to be solved by increasing taxes, cutting
5
Adding irony to paradox, after a suggestion by Steindl (1990), Cesaratto (forthcoming a, Chapter 4 and forthcoming b)
shows that the PAYG deficit that results from the fall of national income will be, prima facie, financed by the newly
created PFs that, however, are in this respect unfunded
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other expenses, or by issuing public debt. So the only result of an SS surplus now is a cut in real wages (and possibly of
6
national income) without protecting future pensions.
To sum up, by firmly rejecting the marginal theory, both on an analytical and on an empirical basis, can we avoid the
neoclassical trap in which some wet defenders of PAYG, such as Aaron, fall when they argue that: ‘when the
government high-employment deficit falls – from additions to Social Security reserves or from any other change of
policy’ and the monetary authorities reduce interest rates, ‘investment tends to rise …the capital stock grows’, … so
that ‘additions to Social Security reserves or in any other way, can help the nation prepare for the costs of increased
transfers to retirees’ (Aaron, 1990-91, p.171. This position - which Aaron expressed against the more Keynesianoriented opinions of Wray (1990-91) – would be fully endorsed by Martin Feldstein.
3. AGEING, LABOUR MARKET AND THE SUSTAINABILITY OF PAYG7
Let us finally dwell on the potential impacts of the ageing process on the economies of the developed countries,
focusing upon two effects: on the labour market, employment and output, on the one hand, and on the trends of PAYG
Pensions
spending, on the other. Considering the ratio
, in one sense the former aspect has to do with the denominator,
GDP
while the second with the numerator.
The Secular Demographic Developments
Ageing is the result of a process of so-called ‘demographic transition’ from high-fertility growing populations
towards low-fertility and high-longevity non growing populations. Historically this is the result first of a fall in child
mortality, which in the developed countries has taken place since the 19th century or so, which later caused a fall of
fertility when it was realised that a target number of surviving progeny could be obtained with fewer births. The fall was
affected by better female education and labour market opportunities. As aptly summarised by Bloom & Canning (2004,
p.6): ‘The historical patterns of the fertility transition …has been repeated in many countries, with the declines in death
occurring first, followed at a later stage by declines in the birth rate’. In the long run, the main cause of ageing is the
long trend decline in fertility. Increases in longevity (due to the progress in medicine, nutrition etc.) are an additional
factor (supposing a fertility rate at the replacement level, longevity would become the only long-term cause of ageing).
A first result that must be stressed is that ageing is the outcome of a process of stabilisation of the world population. Its
main cause, the fall in fertility, might have gone too far in some developed regions, and it is still too slow in other poor
regions, but a more stable world population is necessarily associated with a relatively older population. A second result
is that the demographic developments are associated with a variety of local situations. With regard to the developed
countries, a broad subdivision is between settlements and non-settlement countries and, among the latter, between North
and South Europe plus Japan. Settlement countries tend more to welcome future migrants and to have fertility rates
close to the replacement rate. Northern non-settlement countries tend to be below the replacement rate, but closer to it
than South Europe and Japan. A mere consideration of demographic trends, however, says little about the economic
sustainability of public pension systems.
The Economic Impact of the Demographic Developments: Labour market, Employment and Output
Focusing upon the relation between ageing, labour supply, labour demand and output we may envisage two
approaches. According to the Neoclassical approach, the demo-economic alarm regards the possible negative
consequences on employment and output of a shrinking supply of population in working age. According to the Classical
approach the evolution of the labour-age population is relevant insofar as it affects the industrial reserve army.
Potential labour supply has three main dimensions:
(a) migration,
(b) participation rates,
(c) productivity growth, which includes the number of hours worked and labour-saving technical progress.
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7
Cf. Cesaratto 2002 and forthcoming a, Chapter 5.
Cf. Cesaratto, forthcoming a, Chapter 8; Cesaratto, forthcoming d).
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Let us review them in turn.
(a) The role of immigration in preserving potential labour supply is controversial. In general it is considered as part
of the solution, but not as the solution. The point is that on the one hand the endogenous demographic trends are so
momentous that the number of migrants needed to moderate them is very high. In addition migrants come with
dependants (who increase population but not the labour supply) and rapidly acquire the fertility habits of the local
population). The role played by current population density in host countries in the determination of potential
immigration must be explored by future resarch. In the first approximation traditional settlement countries may
welcome more immigrants, although they need fewer of them because of the higher fertility rates. The controversy
regards also the social acceptance of immigration. It is not only the populist right wing that protests against
immigration. Also some liberal pundits point to the possible role of immigration in reducing social cohesion and the
consensus around the welfare state.
(b) A higher female participation rate is a first potential source of additional labour supply for the next two decades
or so, at least for those countries where female activity rates are still particularly low, as in South Europe. They have
been low for cultural reasons, but more importantly, also for the lack of job opportunities. An increasing participation of
non-prime age workers is a second source. What are considered as the ‘normal life course’ and working age (say ‘1564’, ‘over 15’ and so on) are cultural expressions that emerge from history as a second nature (a Classical economists’
expression), and that may change according to the circumstances. The average effective retirement age and the activity
rates among mature and older workers have dramatically fallen in capitalist countries in the last century. The slower
economic growth and structural change of the last two decades of the century have accentuated this trend, particularly in
Europe. Recent pension reforms attempted in various countries have begun to reverse this phenomenon. It must be
stressed, however, that the low activity rate among mature workers is not only the result of the opportunity offered by
public pensions, but also an outcome of their labour market difficulties – as witnessed by the difficulties experienced by
older workers in re-entering the labour market once they have been expelled. Private firms generally resist policies
aimed at holding or hiring older workers or at affording them smooth exits from activity, for instance through part-time
contracts, etc. In the short-medium run, on the one hand, labour market flexibility measures, in particular those
concerning young workers, disadvantage older workers to the point of having being indicated as a form of agediscrimination. On the other hand, a successful policy to increase effective retirement age may have the effect of
displacing the turnover of generations and create youth unemployment. In the medium-long term, it is possible that any
labour scarcity will make firms less reluctant to retain or hire older workers (Hamermesh, 2001). An increased
retirement age also encounters stubborn opposition by public opinion.
Assuming the continuation of and, in settlement countries, even an increase in, the present levels of employment,
with productivity growth sustaining output growth, the question seems therefore not to be whether there will be enough
future labour supply or not, but whether a thin industrial reserve army is consistent with capitalism (Kalecki 1943).
High participation rates have so far characterised North European countries endowed with strong social pacts, as well as
the US, in which the threat of immigration and a low level of labour rights have functioned as a deterrent to labour
behaviour. To live with high participation rates, the rest of Europe will have to choose between the consensus model
and that based on an intimidated labour force. The impression is that, unfortunately, the European Union is pursuing the
second route. This started with the aim of weakening the traditional strong European Trade Unions. In the near future
this policy may reveal itself to be increasingly useful in managing a tighter labour market.
(c) In the past the reduction of working hours has contributed to absorbing productivity growth and to avoiding
technological unemployment. This process might be brought to a stop and even reversed in future. Increased working
hours should not, however, be envisaged as a measure to reduce labour costs in order to compete with low-wage
countries, as is currently being proposed, but encouraged on a voluntary basis by increasing pay. The future pace of
labour-saving technical change is difficult to predict. The labour market developments described above might
encourage it, especially if the dominant classes, in order to moderate labour demand and wages, do not opt for low
levels of growth.
Ageing and Old-Age Spending
9
13/02/16
Av.Benefit
Av. Pr oductivity
The second aspect we touch upon is the evolution of the pension burden over gross output,
the equation
Av.Benefit
Re cipients
PENS
POP 55 POP 2064
, in which

2064 Employment Av. Pr oductivity
GDP
POP
POP 55
dependency ratio.
PENS
. Let us consider
GDP
POP 55
POP 2064
is the old-age
POP 2064
is the inverse of the employment rate. This ratio measures the aforementioned expected
Employment
rise in the share of working-age population in employment given, on the one side, the fall in the potential labour-supply
and, on the other, the increasing female labour market participation and the measures to reduce early retirement.
Observe that a fall of this ratio, say due to a fall of POP 2064 for a given employment level, indicates that a decreasing
number of inactive adults is dependent on the active adults, and this may compensate the ageing burden. The term
Av.Benefit
is the ratio of the average pension benefit on per capita productivity, measuring the effects of pension
Av. Pr oductivity
reforms – such as the abolition of the real indexation of pensions to wages or, in Italy and Sweden, the effects of the
Re cipients
NDC reforms. Finally, the terms
is the eligibility rate, which also reflects the introduction of more
POP  55
PENS
GDP
ratio will increase in most of the countries. The old-age dependency ratio, however, is likely to rise even more. The
divergence between the two ratios is mainly due to: (i) cuts in pension benefits, e.g. through the abolition of real
indexation of pensions to real wages, the NDC reforms and stricter eligibility rules; and (ii) to the fall in the ratio of
labour age population over employment that partially compensate for the rising ratio of older population over
employment. Both factors will lead to greater homogeneity among countries with regard to PAYG’s burden over GDP.
The role of productivity growth in alleviating the rise of the ratio of pension spending to output needs also to be
carefully examined. Productivity growth is not a panacea, as is often envisaged. In a nutshell, if productivity growth is
used to offset ageing (the rise in the number of retirees over employment), than it cannot be used to increase pensions in
line with increased productivity. It might therefore be necessary to redistribute income from wages and profits towards
the retirees if we want to keep pensions in line with the growth of incomes in the active population. Nonetheless,
productivity gains, which have been spectacular over the last two centuries, will lead to a substantial increase in the
level of net real income of active workers in spite of a possible higher contribution rate (Palley, 2002). The burden of
PAYG can also be transferred to non-wage earners either by increasing real wages in proportion with contributions, or
restrictive rules of access to retirement and pensions. According to most scenarios (e.g. Dang et al. 2001), the
8
by using general taxation. As Wray (1999, p.1 et passim) has pointed out, most economists fail to distinguish between
the financial imbalances of PAYG, that may well increase into the future, given the current parameters that govern the
schemes, and the ‘real problems involved in producing a sufficient quantity of resources to care for future retirees’, that
cannot realistically be considered as an insurmountable burden. The viability of PAYG is, to a large extent, a question of
distribution of the social product between generations and social classes, and this has no mechanical negative impact on
economic growth and welfare. One big question, which we shall defer to future research, concerns the difficulty of
raising taxes, especially over financial capital, in this era of financial liberalisation and tax competition. In this regard,
at least one point must be noted here, namely that financial liberalisation has been a deliberate political choice pursued,
inter alia, in order to create problems for the financing of the Welfare State.
Considering the impact of the demographic developments on transfers from the employed population to the
dependent population, our attention should be focused on two other elements, one that aggravates the picture, and one
that improves it: (a) the increase in health spending related, in particular, to extreme old age; (b) the consideration of the
so-called total dependency ratio, that is the ratio between the total dependent population (which includes youth, inactive
8
General taxation might be mainly directed to financing a basic component of pensions, which derives its rationale from social
solidarity, while pay-roll taxes will finance the additional ‘contributory’ part, thus leaving the principle of pensions as ‘acquired
rights’ unaffected.
13/02/16
10
adults and retirees) over the employed population (Concialdi 1999). One consequence of the demographic
developments is not so much an increase in this ratio, but rather a different composition of the dependent population,
with a fall in the first two components and a rise in the latter. Clearly, the change in the composition involves a change
in the channels through which support is given to the dependants: the old must be supported through public channels,
whereas children and dependent spouses are mostly supported through the family. Moreover, as we know, the old tend
to be more costly than the young because of health spending.
To sum up, although the demographic developments do not pose any real threat to the reproduction and growth of
our economies, the possibility of a draining of the industrial reserve army accompanied by the necessity to finance
increasing public transfers to the old may encounter fierce opposition from the dominant classes. The preoccupation,
already expressed, is that, especially in the European countries, the apprehension of a possible increasing bargaining
power of labour and of an increasing tax burden of the elderly, aggravated by the threat of increasing competition from
the low labour-cost economy, might enhance the choice of diminishing workers’ rights in the labour market – which is
known as labour market flexibility. This ‘neo-Malthusian option’ of keeping the economy on a non-growth path in
order to unnerve labour demand, so as to keep the direct and indirect labour costs under control, may prove a
counterproductive route for European capitalism itself. An impoverished and stationary European economy is in fact
likely to lose the competitive challenge from the US and Asia. Conversely, changing income distribution in order to
maintain the relative standard of living of the elderly will sustain effective demand and growth and maintain social
cohesion. At the moment, Europe seems to be pursuing the first (declining) path. Pension rights are currently still
embedded in the socially dominant expectations about the life course. True, the media have instilled into the young
generations that their future will be different from that of their parents. Whether in the long run the European population
will accept this gloomy prospect is an open question.
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