Why Pensions Don’t Work: Isn’t it the Demography, Stupid?
While we’re on the subject of pensions, the reason that many people believe that the public sector needs to move away from defined-benefit pension plans to defined contribution type retirement plans (and that the government has to move away from a defined benefit Social Security system) goes beyond the rationale that “it’s the way the private sector does it”. Rather, the argument is basic demography.
In 1955, during the golden age for corporate pensions, the fertility rate in the United States was about 3.6 children per woman. By 1980, the fertility rate had dropped to 1.8 children per woman, and it has hovered around a rate of 2.0 since then. That’s a devastating change if you’re trying to structure a rational, sustainable defined benefit pension plan.
Defined benefit plans have to be supported by succeeding generations, but in 1955, this wasn’t a big problem. In 1955 each couple “contributed” 3.6 new people, on average, to the next generation. Jump forward 25 years, and each of those new couples added 1.8 people to the generation after that. That means, over two generations, there were 6.8 younger people per older citizen (3.6 in the first generation, plus 1.8 times 1.8 in the second generation, [i.e. the fertility rate of 1.8 in 1980 times half of 3.6, because it takes two to make a couple]) available to support a pension system.
However, starting with women of childbearing age in 1980, there were only 1.8 new people per couple in the next generation. There’ll be only 2.0 young’uns in the generation after that. The result is only 3.6 younger people per older citizen (1.8 in the first generation, plus 0.9 times 2.0) available to support defined benefit pension plans for the current generation entering/nearing retirement.
That means — even before accounting for increased life-expectancy — you have to whack people currently in the workforce twice as hard now as you did 25 years ago to pay for public sector pensions, because there are only about half as many people relative to the retiree population. And if the United States follows demographic trends in the developed countries of Europe, this problem will only get worse.