Dienstag, 28. April 2009

German Pensions

In the US and Canada, pension funds have huge exposure to the equity market. As a consequence, pension entitlements are down sharply across the board.

Meanwhile, Germany's labor minister recently announced a 2009 pension hike of 2.7 % for West Germany (3.7 % for East Germany). Pensions are linked to the previous year's sum of all wages. 2008 was a good year for employees (Q4's GDP crash didn't immediately affect the labor market), the sum of wages was up sharply. It also helped that health insurance premiums were lowered.

However, 2009 is a different story: The number of jobs is declining. Millions of people are on temporarily reduced hours (Kurzarbeit). Wages are frozen in many companies, and sometimes cut. In short, it's quite likely that the sum of wages will decline compared to 2008. Not as much as nominal GDP, which will be down 5 % or so based on current projections. But decline it will.

According to today's Sueddeutsche Zeitung, researchers now project a decrease of 2.3 % (assumptions are not provided, but it doesn't sound implausible. Possibly a bit on the pessimistic side, but not by much). Olaf Scholz, the labor minister, disagrees: "The government's calculations" apparently indicate pensions can rise in 2010. Of course he didn't provide a concrete number, and he didn't share those mysterious "government calculations" with the press. And anyway, just to be on the safe side, he wants a law passed that makes it impossible for pensions to be cut. Ever. Other politicians dislike passing a law, but agree that pensions must not be cut.

I also think pensions should not be cut. If we anyway need fiscal stimuli for the economy, subsidising the pension system to avoid a cut probably counts among the most sensible measures with the least potential for "wasteful spending". Still, it's interesting how much such a measure would cost.

According to the Deutsche Rentenversicherung, the sum of contributions paid in 2008 was 179 bn €. The government added another 56 bn €. (Yes, that's right: Nearly 1/4 of all pension payments are not financed by contributions, but out of the government budget, i.e. the taxpayer! I didn't know it either, only learnt it just now. Imagine that: Germany is just starting to feel the effects of an ageing population, but the government already now pays 1/4 of the pension bill to keep pensioners happy! What will happen in 10 years, when the population is much older, and political pressure to keep pensions from eroding keeps going up?)

Let's assume the sum of wages drops by 2 % in 2009. As a consequence, the government would have to add 3.6 bn € in subsidies (on top of what it anyway pays) to keep inflows constant. After throwing in a few billion for extra expenditures in spite of constant individual pensions (the number of pensioners is going up, and health care costs are also rising), we probably end up around 6 bn €. That's 0.25 % of GDP. Hardly noticeable compared to the projected deficits, isn't it? (The fiscal deficit for 2009 will be at least 4 % of GDP = 100 bn €, quite possibly more.)

It doesn't look like much in absolute terms (hey - Deutsche Bank alone already lost more money than that in 2008!), and it is a sensible short-term measure. There's only one problem: Once you increase those subsidies, they will be next to impossible to undo. Ever.

(See also: Previous post on this subject)


  1. Thank you for bringing up the topic of German pensions. A timebomb in my opinion.

    I'm not a fan of raising pensions in Germany. Indeed I think the purchasing power of pensions has to and will come done as it is virtually unpayable. In a aging population the pension system becomes a ponzi scheme.

    Due to the Euro decreasing purchasing power by higher inflation is difficult. The ECB might not like the idea. Thus, two other options remain: Cutting pensions and a default of Germany. Assuming that a default is in no ones intrested, cutting pensions remains the only option. However, the ECB might allow high inflation in case its threatend by a Germen default that likely will also cause the end of ECB itself.

    From my perspective, cutting pensions is the most sensible solution. Therefore, any raise (or defered cut) in pensions is harmful.

    Your calculation assumes the goverment will only defer cutting pensions for one year. However, any defered cut will likely also increase the future pensions by roughly the same amount. Calculating the NPV of the defered cut leads to costs up to 3.6 bn € divided by 4% interest rate equals 90 bn €. And here we did not account for the growing number of pensioners. The total cost might still be well above 90 bn.

    Germany risks of entering a self sustaining vortex of population in working age leaving the country to avoid being taxed for the pensions of the older. This was one of the reasons for me to start blogging.

    I like your blog a lot. Keep up the good work.


  2. I'll put up a follow-up post to discuss the matter a bit further.

    Regarding the cost of not cutting pensions next year: I agree, it's only correct to do a one-year calculation if the economy bounces back in 2010 to completely make up for its drop in 2009. Hardly a realistic assumption, it seems.

  3. Quote Ketzerisch: "In a aging population the pension system becomes a ponzi scheme."

    A pay-as-you-go pension system such as the German one is by definition a ponzi scheme, no matter if the population is ageing or not:

    Many economists define "ponzi scheme" as a scheme where the newcomers (= young generation) pay to those that joined earlier (= old generation).

    That's exactly how the German pension system works (except that the government also puts in some additional funding).

  4. Thomas, I agree. While a system with constant (or rising) population density across time would be stable, it nevertheless would be a ponzi scheme.

  5. And I certainly agree that a ponzi scheme is more attractive for the participants if the number of participants is increasing or at least stable...