Three things to remember when comparing European pension systems

15.6.2022 Väänänen Niko

Citizens, journalists and experts enjoy making comparisons which put their national pension systems into a wider context. It is common to compare retirement ages between countries. Although such an exercise can be informative, a simple comparison can result in misunderstandings. Here are three tips to avoid common mistakes.

Understandably, demographic ageing has led to a rising interest in pension systems. The number of retired citizens has risen, and the costs of pensions have climbed. These two factors have increased our need for information on retirement ages, contribution rates and the size of pension assets.

Pension experts know that getting sensible comparative information is tricky. Pension systems are embedded in their past and reflect their societies. Comparisons can easily result in a classic ‘Apples to Oranges’ -type of problem. A report prepared for the European Parliament stated that the historical development of pension systems has led to complexity across the continent, making it difficult to classify them consistently and evaluate them in a comparative way.

1. Retirement age is only one parameter

The Finnish Centre for Pensions’ web page on retirement ages in Europe is very popular. People want to know whether they must work longer than elsewhere. In 2022, the retirement ages for men ranges from 62 to 67 years. Does it mean that you must work for five years longer in Denmark than in Sweden?

One must be careful before jumping to such conclusions. Besides meeting the criterion of retirement age, other exit routes, such as early retirement schemes or full career pensions, grant access to old-age pension benefits. Therefore, the legal retirement age does not systematically reflect the actual age when people retire, also known as the effective retirement age.

As an example, public pensions can be taken up at the age of 62 in Sweden, yet the age of 65 is seen as the norm for retirement. On the other hand, in France a key parameter is the length of the working career. A full pension is received after a working career of 41 years and 9 months, and it can be granted from the age of 62. This age, not 67, is perceived as the legal retirement age.

2. Contribution rate – what does it tell?

A fraction of our salary is withdrawn in the form of a pension contribution to finance public pensions. These contribution rates are presented and compared as if they described the costs or generosity of public pensions. Contribution rates range from approximately 2 per cent in Denmark to 33 per cent in Italy. Such comparisons are problematic, especially considering that in Germany federal civil servants don’t make any contributions towards their pension.

First, in many countries, public pensions are supplemented by occupational or private pensions that also need to be financed. If we were to have a more holistic picture, we would need to include both these parts. Yet, such data hardly exists. Currently we at the Finnish Centre for Pensions are updating our previous study comparing the costs of pension systems in different countries. It will be published in late autumn.

Second, in addition to contributions, general and earmarked tax revenues play a role. For example, in Denmark public pensions are paid mostly out of taxes. The pension adequacy report of the EU predicts that the share of tax financing will grow in the future. The financing of European pensions will become more diversified, and the nominal contribution rate will tell us less about the full costs.

3. Funded pensions – beware of pub-discussion-level analysis

The third way to jump to quick conclusions is what Nicholas Barr refers to as ‘pub economics’. According to Barr, pub economists are people who think that funded pensions are insulated from demographic ageing. Whilst it is true that a balance between pay-as-you-go and funding is a sensible way to finance pension benefits, especially when fertility fluctuates, and generations differ in size. Yet, looking solely at the size of pension funds gives a misleading picture. In Europe, pension funds range from 200 per cent in relation to GDP, as in the Netherlands, to less than 10 per cent.

Pensions are about dividing total output between those who produce and those who do not. What is needed for future pensions is future production. If everybody stopped working, there would be no services and no production. Nobody could be paid pensions anymore. Funds do play a valuable role, but different countries have adopted different approaches. In the end, what is most important is a growing economy providing jobs and generating revenue. Such an economy will be able to pay adequate pensions.

References

Barr, N., 2021. Pension Design and the Failed Economics of Squirrels. LSE Public Policy Review, 2(1), p.5.

European Commission, Directorate-General for Employment, Social Affairs and Inclusion, 2021 Pension Adequacy Report: Current and future income adequacy in old age in the EU. Volume 1, Publications Office, 2021.