Pension: is there hope for the German pension system?

Demographic changes are the nail in the coffin for the German pension system. It seems to have been characterized for years, decades, when the future of pensions has been publicly debated in Germany. A kind of mathematical inevitability is assumed for this thesis, which is based on simple assumptions: the relationship between employees and pensioners is changing increasingly to the detriment of the pension system. As a result, expenses increase in relation to income.

Countermeasures are unpopular

As countermeasures such as a longer working life, higher pension contributions or a lower pension level are unpopular, politicians prefer to leave these parameters untouched for fear of not being re-elected. The result: By 2025 at the latest, when the baby boomers with their high incomes – and equally high pension rights – retire, the whole system will topple. The Damocles sword of social aging will then become a guillotine for German pensions.

Germany has been aging for a long time

The logic of this argument would be convincing if the German pension system were rigid and e.g. depending on a fixed number of employees. In fact, however, we are dealing with a breathing system: the pension always develops in relation to the labor market, which has its own dynamics and thus its own set screws. That explains why the pension system didn’t collapse long ago. Because it is often forgotten that demographic changes do not just begin with the baby boomers, but are already taking place now – and have been for many decades.

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Let’s look at the relationship between pensioners and employees over a longer period of 100 years. In 2020, there were 34.9 pensioners for every 100 employed between the ages of 20 and the normal retirement age. The so-called pensioner quotient is 34.9. In 2060, the ratio between wage earners and pensioners is expected to be 50.2 – an increase of almost 44 percent in 40 years. In light of the fact that the federal government already has to inject well over €100 billion, or a third of total pension spending, from taxpayers’ money, it looks devastating.

Contribution rates have been almost constant for decades

But this overlooks the fact that the pensioner quotient has already undergone a similar development: Between 1985 and 2020 it increased even more in an even shorter time, namely by just over 45 percent (from 24.0 to 34.9) in 35 years. In the previous 25 years, between 1960 and 1985, it increased by a third (from 18.0 to 24.0). Demographic changes have hit us as hard in recent decades as they will in decades to come. But so far the pension system has not collapsed.

One can object that it may have something to do with increasing contribution rates or tax subsidies. But that is not the case. It is true that the employee pension insurance contribution rate rose from 14.0 to 19.2 percent between 1960 and 1985. But then it fell again to 18.6 percent today. In fact, over the past 50 years the contribution rate has fluctuated in a narrow corridor between a low of 17.5 percent and a high of 20.3 percent – ​​most of the time it was around 19 percent.

The German pension system has been under pressure since the 1960s due to the aging population.

Have federal tax subsidies really increased?

The federal subsidy, on the other hand, has increased continuously since the start of the German pension insurance in 1957. If the federal government added 2.73 billion euros in 1960, it was 17.16 billion euros in 1985 and about 106.64 billion euros in 2021. But if if you put these amounts in relation to DRV’s total income, the situation is different: in 1960, 10.73 billion euros were taken in, of which 25.4 percent came from federal funds. In 1985, it was 19.0 percent with a turnover of 90.17 billion euros. And according to the latest figures from 2021, the share of federal funds was around 30.7 percent, with an income of 347.66 billion euros. If you compare all the figures for the past 70 years, a similarly inconsistent picture emerges.

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The reason: the total federal funds in the pension balance consist not only of pure federal grants, but also of injections from other agencies, which are often tied to specific purposes. These include, for example, payments from the Federal Employment Service for pension contributions from the unemployed or federal grants for the recognition of child-rearing periods. Here, the parameters change over the decades depending on the political orientation of the respective federal government. In general, however, it can be said that the more that is done for the citizens, the higher the percentage of the tax subsidy.

Wages are not decoupled from pensions

Pure federal funds currently account for about 22.7 percent of retirement income. This figure has been almost constant since the turn of the millennium, but was already well below the 20 percent mark between 1965 and 1990, with a low of 14.2 percent in 1975. Due to reunification and high unemployment in the 1990s and early The 2000s. the need for tax subsidies for the pension system increased massively.

A third possible reason for the surprising stability of the pension system would be a decoupling of pensions from wages or inflation: if wages increase with inflation, but pensions do not keep up, then the pension level falls – this would mean that the income of the pension fund would increase through contributions increase more than their expenses. But that is not the case either. Since 1960, there has only been a ten-year period, namely from 2000 to 2010, when pension increases have not more than compensated for inflation, otherwise pension increases have always been well above inflation. At the same time, pensions have mostly increased in sync with wages – so there was no decoupling here.

In the past, pension increases have usually more than offset inflation.

How is it that the demographic change has already hit hard, but the pension system’s vital data still speak for a flourishing life? The answer is simple: From the point of view of the pension balance, the labor market has developed extremely positively over the past 30 years. According to the Federal Statistical Office, the number of people in employment in Germany increased by 5.9 million or 15.2 percent between 1991 and 2021.

The air is slowly getting thinner for retirement

At the same time, however, the number of inhabitants in the Federal Republic increased by almost 3 million or 3.7 percent. The number of unemployed remained the same at 2.6 million each. This means that over the past 30 years, employment has not only increased nominally, but also as a percentage of the total population. Together with wage increases, this led to higher total income in the pension fund, which could compensate for the higher expenses due to an increasing number of pensioners.

But now comes the problem: Demographic changes have so far revealed no natural limit – for example, due to a biologically determined maximum age. But there is not much room for improvement when it comes to employment participation. Why? Because enormous progress has been made in the past 30 years, especially with regard to the integration of women and the elderly in the labor market, it is becoming increasingly difficult to exploit the potential. According to a study published in August by Cologne’s Institute for Economic Research (IW), only Sweden and the Netherlands have an even higher employment rate for women in a European comparison. Germany is also in the top group in Europe when it comes to labor market participation for people between the ages of 50 and 64.

The labor market has reached its peak today

In the medium term, the only way to prevent the working-age population from falling is through migration. According to IW, 1.5 million people would have to immigrate gross each year. In other words: The war and crisis years of 2015 and 2022 were to repeat themselves. And year after year. “After more than 15 good years, Germany’s labor market has reached a peak,” sums up IW expert Holger Schäfer. “A decline in the labor force by 2030 will probably be inevitable.”

Overall, this means that the German pension system has proven to be robust despite all the challenges of recent decades, but now the air is getting thinner. Whether the pension can be saved does not only depend on fundamental reforms in the system itself. The pension is linked to the labor market, which in turn depends on the success of the German economic model. And how this will develop in an increasingly fragmented world is uncertain.

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