Who will pay for 100 million boomer pensions?

0:00 When baby boomers started working,

0:01 about five of them had to work to provide for every pensioner.

0:05 Today, this number has gone down to around

0:08 three workers per pensioner in rich countries.

0:10 And this will only get worse.

0:12 Based on OECD projections, 30 years from now,

0:15 there will be less than two workers per

0:18 single pensioner when the baby boomers all retire.

0:22 This does not look good.

0:24 So, of course, this raises the question.

0:26 Can Gen Z and millennials actually afford to pay for all boomer pensions?

0:30 In France, this question is not a theoretical math problem.

0:34 It is already leading to a neverending political crisis.

0:38 In the capital, thousands of people taking

0:40 to the streets after French President Emanuel Macron

0:44 forced through an unpopular bill that raises

0:47 the retirement age from 62 to 64 years old.

0:50 And given that France is actually a relatively young

0:54 rich world country and that on top of pensions,

0:58 medical costs will of course also skyrocket as the boomers turn in 75,

1:03 economists like professor Charles Goodheart from the law school of economics

1:07 have said that unless AI gives us a miracle far bigger than

1:12 anything we're seeing so far economically speaking the next 40 years are

1:16 not going to be anything like as wonderful as the last 40.

1:21 So what can we expect?

1:22 Political crisis in France, the UK,

1:24 and Germany make it clear that the current pension system,

1:27 where Gen Z and millennials pay boomers can only

1:30 be sustainable if we drastically increase the retirement age,

1:33 cut pensions, or if young people accept sky high taxes.

1:38 But there's hope.

1:40 Small North European countries like Denmark, the Netherlands,

1:43 and Iceland have systems where every pensioner saves for their own retirement.

1:47 All of these savings are then pumped

1:50 into the stock markets which have historically only gone up.

1:55 Right?

1:56 Right.

1:56 Hm, it makes you wonder, have these countries really found a magical pension

2:02 solution or are they blowing yet another financial bubble?

2:06 To answer these questions, our team has spent weeks interviewing experts,

2:10 diving into the various pension systems and population

2:13 data of all rich countries around the world.

2:15 And what we found was quite interesting.

2:18 Denmark and the Netherlands may be right, just not in the way they think.

2:24 But before we get into how we can save

2:27 boomer pensions and young people's incomes at the same time,

2:30 we first need to confront reality.

2:32 What happens if we do nothing?

2:35 Here's chapter one, the unsustainable reality of our pension systems.

2:39 Broadly speaking, there are two ways countries finance their pension systems.

2:43 There are funded systems where workers save

2:46 for their own pension and the so-called

2:49 pay as you go system where current workers pay for current retirees.

2:54 In practice, most countries use a mix of both systems,

2:58 but the balance varies widely.

3:00 Countries like Germany, Spain, and Italy rely almost entirely on pay as you

3:05 go pensions where benefits are financed by today's workforce.

3:08 By contrast, countries like Denmark and the Netherlands

3:11 depend much more heavily on funded systems where people

3:15 save for their own retirement using public or private

3:18 pension funds that invest in bond and stock markets.

3:22 They use these returns earned there to minimize contributions.

3:27 Right now, countries like Italy, Germany, and France that rely on pay as you

3:31 go systems are facing severe pension crisis because

3:34 it is very clear that their pension system

3:37 was not built for a rapidly aging population.

3:39 Fewer workers that pay the same contribution to support

3:43 more retirees that want a stable pension income.

3:47 The math simply does not work.

3:49 Therefore, countries have tried four controversial

3:52 ways to make the system sustainable.

3:54 The first option is to raise the retirement age.

3:56 Germany, the UK, and the Netherlands are all moving towards 67.

4:01 Meanwhile, Italy will go even further.

4:03 They have tied the retirement age to rising life expectancy,

4:06 meaning that it will rise to 70.

4:09 However, as you can imagine,

4:10 many people who are close to retirement are not exactly thrilled about this.

4:15 Why should they pay the price for the unsustainable pension system?

4:20 This applies especially to workers in physically demanding jobs.

4:23 Therefore, Italy's Prime Minister Maloney is now facing strong pressure

4:27 from labor unions to freeze the retirement age at 67.

4:31 Luckily for Maloney, there are three more options.

4:34 The second option is to reduce pension payments.

4:37 So far, this has only happened in case of massive political crisis

4:42 such as when Greek pension payments were cut during the Greek debt crisis.

4:47 What some governments have done though is pretty smart.

4:50 They pledged to cut pension payments in the future, not today.

4:54 After all, people are less likely to protest getting

4:57 a lower income if they don't feel it yet.

5:00 For example, in Germany,

5:02 the average pension was set to fall from 48% of the average wage to 45% by 2040.

5:07 Still, here are a threepoint drop seemed actually

5:10 a bit too far for older workers especially,

5:13 and they have revolted causing politicians to raise this back to 46%.

5:17 This then brings us to the third option, raising worker pension payments.

5:22 For example, between 2018 and 2023,

5:25 Canada has been gradually increasing the contribution rate from 5 to 6%.

5:30 And similarly, Mexico and South Korea have

5:32 announced worker contributions will have to increase.

5:35 But again, this is politically super tricky.

5:38 When it comes to pension reforms, there are just no good options.

5:42 It seems.

5:43 more retirees and fewer workers.

5:45 Of course, someone will have to take a hit.

5:47 This is why pay as you go

5:49 pensions reforms almost always trigger massive public backlash.

5:53 You still have 2/3 of the French opposed to the pension reform.

5:58 Although there is of course a simpler option, for example,

6:02 the most rapidly aging country in the world has so far

6:06 avoided politically very hard pension

6:08 choices by simply increasing government borrowing.

6:10 And honestly, while people like to think about government

6:14 inefficiencies and bureaucracies that are behind ever rising government debt,

6:18 the cold hard reality is that for most of the rich world,

6:23 it has mostly been about increasing social security payments to pensioners

6:27 and ever increasing healthcare costs that also mostly go to pensioners.

6:32 Sadly, today it seems like more and more governments are hitting

6:35 the limits of what they can borrow without facing massive consequences.

6:38 Both the UK and France recently flirted with a government debt crisis.

6:43 And not coincidentally,

6:44 these are the two countries with some of the most generous pension payments.

6:50 So, it seems like governments now have to make

6:53 a really hard choice between three bad options.

6:56 Number one, increase the pension age.

6:58 This will piss off Gen X and young boomers who are close to the pension age.

7:04 Option number two, cut pension benefits.

7:06 Again, this will piss off boomer pensioners or again

7:10 Gen Xers who are close to the pension age.

7:14 So, there's also option three, increasing taxes massively,

7:18 ticking off Gen Z and millennial workers.

7:22 Or do they?

7:23 Could it be that countries like Denmark

7:26 and Netherlands have discovered a magical fifth option?

7:29 An option that seems to make the system both more fair and more sustainable.

7:34 What if workers saved for their own retirement instead

7:38 of relying on future generations to pay the bill?

7:41 This is exactly the promise of fully funded systems.

7:45 Heavily funded pension systems like those in Denmark,

7:48 the Netherlands, and Iceland,

7:50 by the way, are consistently ranked as being the most sustainable on the planet.

7:55 And on the surface, it's easy to see why.

7:58 In these systems, rather than paying for an older,

8:01 potentially much larger generation,

8:02 Danish and Dutch workers mostly save for their own

8:06 pensions via either private or collective pension funds.

8:09 These funds then invest savings in financial markets.

8:12 Rather than being funded by current workers,

8:15 these pension funds pay out a pension based on what the workers saved,

8:19 plus the returns the pension funds

8:21 made on these investments in financial markets.

8:24 This clearly looks more sustainable than a pay as you go system.

8:28 Instead of relying on a shrinking workforce to pay current pensions,

8:31 retirement is financed by what each

8:34 generation saved plus financial market returns.

8:36 And while financial markets may go down from time to time,

8:40 in the long run, financial markets can only go up, right?

8:44 So, it seems like in these countries, Gen Z, millennials,

8:47 Gen X, and boomers, they just pay for their own pensions.

8:51 Gen Z is not supporting a much larger boomer generation.

8:55 But is that actually true?

8:57 Because this story got me really suspicious.

9:00 You see, as macroeconomist, I was trained to distinguish between what happens

9:04 in the financial system and what happens in the real economy.

9:08 The economy of goods and services,

9:10 the total amount of output, doctors, food, and care.

9:14 Financial markets often act very differently than the underlying economy.

9:19 Yet in the long run, financial assets like stocks in companies are

9:23 merely claims on future goods and services.

9:26 So if the economy suffers because of aging,

9:28 then of course these companies will start to suffer as well.

9:32 In theory, stock market prices should reflect company prospects.

9:36 However, in the short run, meaning decades, pretty long,

9:39 this does not have to be the case.

9:42 You see what also matters for financial markets is how much

9:45 money people invest in them compared to spending on other things.

9:49 In fully funded systems, the government has essentially forced people

9:54 to invest more in financial markets.

9:56 So what happens when a large generation

9:58 like the baby boomers enters the workforce?

10:01 Millions of people start saving at the same time.

10:04 Pension funds are suddenly flooded with cash and rush to buy financial assets.

10:08 As a consequence, prices of assets go up and up and forever up.

10:13 That is until the demographic situation flips.

10:16 If the boomers start retiring,

10:18 then all of the sudden people are taking out more money

10:22 from their pension funds than the smaller

10:24 new younger generations are putting in.

10:26 So if forced saving raised all asset prices at the same time,

10:30 then of course mass retirement should

10:33 in theory cause a sustained asset meltdown.

10:36 This simple logic is behind the asset meltdown

10:39 hypothesis which state that once the boomer generation retires,

10:43 this flow will reverse crashing assets.

10:46 Pension funds now need to sell more and more assets to pay out pensions.

10:51 But this time the new generation who is

10:53 supposed to buy all of these assets is smaller.

10:56 Already in 1994, based on US demographics,

10:59 Sylvester Sheber and Professor John Schovin predicted that private pension

11:02 funds in the US would start emptying out around 2024.

11:06 That's right.

11:06 This problem will not just hit countries

11:09 with fully funded systems like Denmark and the Netherlands.

11:12 It will affect private pension funds all around the world,

11:16 which boomers and Gen Xers have used to supplement their pay as you go pensions.

11:21 In the past 40 years, many boomers have already saved for their own pensions.

11:25 This created massive demand for stocks and bonds,

11:28 contributing to the massively impressive stock market

11:31 gains that we have seen since the 1980s,

11:34 despite Western economies growing far more slowly than in the years before.

11:38 When they start selling off assets,

11:41 optimistic pension sustainability calculations in countries like

11:44 Denmark and the Netherlands could become meaningless.

11:48 For example, the Dutch have saved very, very conservatively.

11:52 So conservatively that a 2% average profit on asset markets would

11:56 be enough to cover most pension payments for the foreseeable future.

12:00 But what if the asset meltdown hypothesis is correct?

12:04 What if so many people retiring

12:06 in the coming decades means that financial markets

12:08 will stop rising forever and rather start falling for a very very long time?

12:14 In that case, countries with fully funded systems will again face

12:18 the same difficult choice that pay as you go countries like the UK,

12:21 Germany, and France face today.

12:23 But is that indeed what will happen?

12:26 Are fully funded systems just a financial trick that will

12:31 not solve the fundamental demographic problem of fewer workers per retiree?

12:35 The answer is yes.

12:37 And it won't work.

12:38 It doesn't matter whether you try and fund it

12:42 because the cost of funding it will become increasingly severe.

12:45 Now I have to say luckily economists have found that so

12:49 far many pensioners actually do not perfectly spend down their pension savings.

12:53 Typically they die with substantial saved up assets still

12:57 in their name which are then passed on to the next generation.

13:02 So this could soften the blow but still

13:05 the underlying demographics are hard to escape.

13:07 Whether you are a pay as you go or a fully funded country,

13:10 the cold hard demographic reality is that if

13:13 more people retire compared to those who work,

13:16 less stuff is made while demand by pensioners remains high.

13:20 Therefore, economists like Goodheart and his co-author

13:23 Pradhan predict that what they call the great demographic reversal will lead

13:29 to decades of number one lower asset prices.

13:32 Number two, higher inflation because all these pensioners do keep spending.

13:38 Number three, higher taxes, and number four surprisingly lower inequality

13:43 which perhaps the only positive takeaway.

13:45 After all, if there are not enough workers,

13:48 especially in the low paid care sector,

13:50 then these workers can demand higher wages.

13:53 Yet, even these workers will face higher inflation.

13:55 So, overall, the reality will remain.

13:57 Aging will lead to three tough political choices.

14:01 Number one, retire later, number two,

14:05 lower pension payments, or number three, increase taxes.

14:08 Or will it?

14:09 Because actually when doing the research for this video,

14:13 a strange thought popped into my head.

14:16 Could the fully funded system be superior after all?

14:19 At least for small aging countries like Denmark and the Netherlands.

14:23 You see, a pay as you go system is national.

14:27 German Gen Z workers pay for German boomer pensioners.

14:30 German demographics determine the sustainability

14:32 of the German pension system right now.

14:35 But Dutch and Danish pension funds, they have invested the majority of Danish

14:39 and Dutch boomer pension savings abroad,

14:41 especially in the US, which has quite a bit better demographic profile.

14:48 So could it be that while fully funded pension systems are essentially

14:52 a trick that may cause a big asset meltdown when most boomers retire,

14:57 smaller older countries may avoid this scenario for a long

15:01 time if they invest in sufficiently young economies.

15:04 We will have to see.

15:07 In fact, that is the conclusion for this entire video.

15:11 We will have to see.

15:13 You see, the world has simply never

15:16 gone through this massive demographic transition before.

15:19 So the asset meltdown hypothesis and Goodheart

15:22 predictions of increased inflation, higher taxes,

15:24 and lower inequality, these have never been scientifically tested,

15:28 at least not in the West.

15:31 Because interestingly, the asset meltdown hypothesis may have

15:34 accidentally been tested in Chile during COVID-19.

15:38 You see, to alleviate the financial

15:41 stress many households felt during the pandemic,

15:43 the government allowed them to access their pension savings early.

15:47 Guess what happened?

15:49 Number one, the local stock market crashed.

15:52 Number two, there was a massive inflation spike.

15:56 Number three, and this is new,

15:59 the government stepped in, essentially nationalizing the pension system,

16:03 making it from relatively fully funded to pay as you go.

16:07 That's right.

16:08 Two of Goodart's main predictions immediately came

16:10 true when Chile's expension systems were drawn down.

16:13 So sadly, I suspect there is a real

16:16 chance Professor Goodhart will soon be proven right

16:20 that the next 40 years are not going

16:23 to be anything like as wonderful as the last 40.

16:26 That is unless we do actually see a miracle

16:29 from AI where honestly there are some pretty incredible developments.

16:33 But if you want to know more about those, I have to refer

16:37 you to the following three follow-up

16:40 analysis from our advertising sponsor, The Economist.

16:44 Specifically, I recommend you check out this detailed

16:47 analysis about how AI is disrupting shopping.

16:50 Then follow up with this analysis on how

16:53 AI is transforming the pharma industry for the better.

16:56 And finally, this analysis on how big the threat to entry-level jobs already is.

17:01 As these analysis show,

17:02 The Economist delivers insight that truly helps you to see the bigger picture.

17:07 This is why I highly recommend you subscribe to The Economist,

17:11 which now offers an exclusive 35% discount for money macro viewers.

17:16 Whether you prefer their daily journalism in the Economist app or you are

17:20 like me and prefer to catch up on the global economy during the weekend,

17:24 sitting down with a nice cup of coffee and the paper edition.

17:28 You'll always stay on top of the latest

17:30 global developments no matter where you are.

17:32 So don't miss out.

17:33 Click the link in the description or top comment below

17:35 or head over to economist.com/moneymackro to claim your exclusive 35% discount