Europe's Pension Problem: Too Few Cradles, Too Few Graves

Population trends are forcing drastic reforms in Europe, including reducing people's benefits

Millions of elderly Germans received a notice from the Health & Social Security Ministry earlier this month that struck a damaging blow to the welfare state. The terse statement informed them that their pensions were being cut. The reductions come as a stop-gap measure to control Germany's ballooning pension crisis. Not surprisingly, it was an unwelcome change for senior citizens such as Sabine Wetzel, a 67-year-old retired bank teller in Cologne, who was told her state pension would be cut by $12.30, or 1%, to $1,156.20 a month. "It was a real shock," she says. "My pension had always gone up in the past."

There's more bad news on the way. On Mar. 11, Germany's lower house of Parliament passed a bill gradually cutting state pensions -- which have been rising steadily since World War II -- from 53% of average wages now to 46% by 2020. And Germany is not alone. Governments across Western Europe are racing to curb pension benefits. In Italy, the government plans to raise the minimum retirement age from 57 to 60, while France will require that civil servants put in 40 years rather than 37.5 to qualify for a full pension. The reforms are coming despite tough opposition from unions, leftist politicians, and pensioners' groups.

The explanation is simple: Europeans are living longer and having fewer children. By 2030 there will only be two workers per pensioner, compared with four in 2000. With fewer young workers paying into the system, cuts are being made to cover a growing shortfall. The gap between money coming in and payments going out could top $10 billion this year in Germany alone. "In the future, a state pension alone will no longer be enough to maintain the living standards employees had before they retired," says German Health & Social Security Minister Ulla Schmidt. Says Italian Finance Minister Giulio Tremonti: "The welfare state is producing too few cradles and too few graves."

Of course, those population trends have been forecast for years. Some countries, such as Britain and the Netherlands, have responded by making individuals and their employers assume more of the responsibility for pensions. But many Continental governments dragged their feet. Now, the rapid runup in costs is finally forcing them to act. State-funded pension payments make up around 12% of gross domestic product in Germany and France and 15% in Italy -- two percentage points more than 20 years ago. Pensions account for an average 21% of government spending across the European Union. The U.S. Social Security system, by contrast, consumes just 4.8% of GDP. The rising cost is having serious repercussions on key European nations' commitments to fiscal restraint. "Governments have no choice but to make pension reform a priority," says Antonio Cabral, deputy director of the European Commission's Directorate General for Economic & Financial Affairs.


Just as worrisome is the toll being exacted on the private sector. Corporate contributions to state pension systems -- which make up 19.5% of total gross pay in Germany -- add to Europe's already bloated labor costs. That, in turn, blunts manufacturers' competitiveness and keeps unemployment rates high. According to the Institute of German Economics in Cologne, benefit costs reached a record 41.7% of gross wages in Germany last year, compared with 37.4% a decade before. French cement manufacturer Lafarge says pension costs of $121 million contributed to a 9% fall in operating profits last year.

To cope, Germany and most of its EU partners are using tax breaks to encourage employees to put money into private pensions schemes. But even if private pensions become more popular, European governments will have to increase minimum retirement ages and reduce public pensions. While today's seniors complain about reduced benefits, the next generation of retirees may look back on their parents' pension checks with envy.

By David Fairlamb in Frankfurt

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