How I learned to stop worrying and love the demographic time bomb

There is a general perception that the ageing population of developed countries will lead to some kind of crisis or demographic “time bomb”. The new IEA monograph Pension Provision: Government Failure Around the World shows the magnitude of the problem, but it is a PAYG time bomb, not a demographic one.

Most Western countries have some form of unfunded or pay-as-you-go (PAYG) pension system. These are effectively pyramid selling schemes, where one generation sells on its pensions commitments to a new generation.

Pyramid selling relies on being able to find a new generation of suckers, which is what the argument for more people proposes - new babies and immigrants being the next generation of suckers. This is no long-term answer – it’s just building a bigger pyramid.

My recent paper, A Bankruptcy Foretold: The UK’s Implicit Pensions Debt, argues that if these systems are not removed the government will face severe financial difficulties. All our pensions – public and private – will be in peril.

Worryingly, Philip Booth argues in the monograph that the political economy of the ageing population makes PAYG reform unlikely. Thus the system may well not be phased out and the public finances will be under enormous strain.

Someone in their 30s or 40s now will hit retirement age at the height of the government’s solvency problems, so their pensions are in serious doubt. To maintain a reasonable standard of living they may have to continue working into their mid-to-late 70s.

A 35-year old today might therefore expect another 40 years of working life. Yet according to research quoted in the monograph, people aspire to retire in their mid 50s – a 20 year difference between expectations and likely experience.

Fortunately, those in their thirties today can expect to be much fitter and healthier than their grandparents. And this longer time frame will completely change the economic decisions made by younger workers.

Firstly, we can expect them to invest much more in education and training, particularly in transferable skills, as they will have 40 years to pay back this investment, rather than 20 or 25 years. Secondly, they will invest more in fitness and preventative health, as they will have to keep themselves active into old age. Finally, they will seek a better work-life balance, as their working life will be greatly extended.

The result should be a boost in productivity due to increased investment in human capital, a lower dependency ratio as people work longer, and reduced healthcare costs due to a healthier, happier workforce. Should we really be worried by this problem?

Simply looking at the ratio of working age adults-to-pensioners is misleading. It’s the ratio of productive workers-to-everybody else that matters. At present, slightly less than half the UK population is a productive worker; the rest are children, students, pensioners, welfare claimants or superfluous public sector workers. Getting people into productive work in private sector and nudging up retirement age by (say) one month every year in perpetuity will sort this out.

Simply looking at the ratio of working age adults-to-pensioners is misleading. It’s the ratio of productive workers-to-everybody else that matters. At present, slightly less than half the UK population is a productive worker; the rest are children, students, pensioners, welfare claimants or superfluous public sector workers. Getting people into productive work in private sector and nudging up retirement age by (say) one month every year in perpetuity will sort this out.

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