Fix the super roof while the sun is still shining

Published in Insights, The New Zealand Initiative’s newsletter, 15 June 2012

Far, far from the troubles at the home front, Prime Minister John Key was visibly enjoying the military honours and his joint press conference with Chancellor Angela Merkel on his visit to Berlin last week. A better use of his time would have been studying the effects of delaying superannuation reforms.

Although last month’s budget once again confirmed the rising costs of superannuation, the Prime Minister ruled out reneging on his 2008 campaign promise not to increase the age of eligibility. It was not needed, as the system was working well, Mr Key told journalists on Tuesday.

If that sounded so familiar to me, it is because I am German. Germany still provides the best case study for a country that forgot to fix the pension roof while the sun was shining. Now it is trying to weather a demographic storm with a leaky roof.

Demographers have been warning since the 1970s that the country’s pension system was financially unsustainable. When it was introduced under Iron Chancellor Otto von Bismarck in 1889, life expectancy was barely 40 years, and you had to wait until 70 to be eligible for a small pension. Over time, German life expectancy almost doubled while the pension age was actually lowered to 65; pensions became more generous too.

You did not need to be Einstein, Rutherford or an actuary to see what was wrong with this scheme. Regardless, German governments pretended everything was fine. A pensions minister of the 1980s famously ran a big advertising campaign under the slogan, ‘One thing is safe: Pensions’.

As it turns out, the only thing that was safe was the hole it burnt into public finances. Pensions were originally designed to be an entirely contributions funded scheme. Today, more than 17 per cent of Germany’s federal budget is diverted to the pensions system to prevent it from collapsing under its obligations. Only in 2006 was the pension age adjusted to 67. Even this won’t come into effect until 2029.

New Zealand should study the German case study carefully. The Prime Minister is right when he says superannuation costs are affordable in the short term. But that’s missing the point. Germany could also afford its pensions in the 1980s – but it should have fixed the system before costs started spiralling out of control.

Once you realise the need to reform eligibility, the earlier you start the better. No election promise is worth keeping if it jeopardises the country’s fiscal future.

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