Retirement Income Provision and Household Income: Between- and Within-Cohort Inequalities in Germany and the United States since the 1980s
Jan Paul Heisig
Pension reform has featured high on the agenda of OECD countries in recent decades. As a result of growing life expectancy and low fertility rates, most member countries are already experiencing declines in the size of the working-age population relative to the older population, and this trend is set to continue into the future. One of the more serious implications of this development is the threat posed to the solvency of public pay-as-you-go pension schemes. Labour shortages are another scenario troubling policy-makers and employers alike.
This demographic challenge, along with more general budgetary pressures, has triggered far-reaching reforms of pension systems, other welfare state programmes and labour market policy (see Schwander in this volume).
Parts of this chapter are based on Chaps. 3 and 6 in J. P. Heisig, Late-career Risks in Changing Welfare States: Comparing Germany and the United States since the 1980s, Amsterdam: Amsterdam University Press, 2015.
J.P. Heisig (*)
© The Author(s) 2016 131
M. Wulfgramm et al. (eds.), Welfare State Transformations and Inequality in OECD Countries, Transformations of the State,
Up until the 1990s, many countries, particularly in Continental Europe, actively promoted early retirement to reduce labour supply in the face of persistent unemployment (Ebbinghaus 2006). Since then, however, encouraging later retirement and elevating employment rates of people in their 50s and 60s have become top policy priorities. Cutbacks in public (early) retirement benefits are a crucial element of this new agenda. Not only do such cuts directly reduce pension outlays but they also induce individuals to postpone retirement, thereby increasing labour supply, tax revenue and contributions to public insurance schemes. In a survey of pension reforms between 1990 and the mid-2000s, the OECD (2007, Table II.1.1) identified 14 member countries where reforms since 1990 ‘adjusted retirement incentives’. In most cases this involved introduction of or increases in financial penalties for early take-up of public old-age benefits. These reforms are prime examples of the growing supply orientation in mature welfare states (see Starke, Wulfgramm and Obinger in this volume).
Efforts to raise older workers’ employment levels have not been confined to public pension schemes alone. Other welfare state programmes, such as unemployment insurance and disability benefits, also underwent major reforms in recent decades, with the ‘activation’ of older workers and other groups such as the long-term unemployed being a top priority. This goal was pursued through a combination of ‘enabling’ measures (for example, training and counselling measures) and ‘demanding’ measures (for example, tightening suitability or medical criteria, or cutting benefit levels) (Eichhorst et al. 2008). While often not targeted specifically at older workers, these reforms were an integral part of the broader policy package for promoting later retirement. Programmes such as unemployment or disability insurance often function as auxiliary transfers that help early retirees bridge the gap between leaving work and starting to draw regular retirement benefits.
Many OECD countries also saw far-reaching changes in the sphere of complementary pensions, that is, in occupational/employer-based and individual private pensions. While all advanced economies have some public programmes for providing income in old age, the overall size of these schemes and the replacement rates received by different types of workers differ widely (Ebbinghaus 2011; OECD 2007). In countries such as Germany or Belgium, where a strong public earnings-related tier guarantees high replacement rates even to higher-earning workers, complementary pensions have traditionally played a supplementary role. This practice is changing, as public pension replacement rates are declining and even countries with a strong reliance on public pensions are moving towards a multi-pillar model. For the time being, however, there remain clear differences to those countries where the public pension pillar has effectively focused on basic income security, either by providing a low basic pension (for example, the Netherlands) or by offering earnings-related, but highly progressive benefits, as is the case in the United States. In these ‘mature multipillar pension systems’ (Ebbinghaus 2011, 14), complementary pensions have long been crucial for retirement income provision.
The face of the complementary pension landscape, however, has changed quite dramatically in many of these countries over the past decades. Particularly in the Anglo-Saxon countries, employer-sponsored occupational pensions are increasingly designed as defined-contribution rather than defined-benefit plans (Broadbent et al. 2006). Under a defined- benefit design, employers guarantee a certain level of retirement benefits based on an employee’s work and earnings history. Defined-contribution plans, by contrast, can be thought of as special (tax-privileged and employer-subsidized) savings accounts whose eventual balance is contingent on an employee’s individual investment choices and susceptible to market fluctuations. Growing emphasis on defined-contribution pensions thus fits into the broader trend towards supply side-oriented policies, which ‘shift the responsibility for welfare outcomes from the public into the individual sphere’ (see Starke et al. in this volume). Indeed, many (for example, Hacker 2006) argue that defined-contribution plans render retirement incomes much more uncertain.
Against this background, this chapter reviews recent changes in the systems of retirement income provision in Germany and the US and uses household panel data to better understand implications of these changes for the economic well-being of and inequalities among older people. Throughout the chapter, the focus is on men’s retirement because cohort differences in labour force participation complicate the interpretation of results for women. I find evidence for substantial inter-generational inequality (recent retirement cohorts fared worse than those who left the labour market in the 1980s) and for growing intra-generational inequality
(vulnerable groups such as involuntary early retirees or less-educated workers seem to have been hit hardest by recent reforms).
Germany and the US are interesting cases for studying changes in retirement income provision because they exemplify the broader institutional trends noted above. During the 1970s and 1980s Germany actively (and successfully) promoted early retirement, but quite rapidly moved away from this paradigm starting in the 1990s. The Netherlands is another country that has followed a similar trajectory. Other early-exit countries, especially those in southern Europe, have been slower to institute reforms, but most seem to be moving in the same direction, especially after budgetary pressures were reinforced by recent financial crises (for an overview, see Ebbinghaus and Hofacker 2013).
The United States is a useful case for studying the consequences of the shift towards defined-contribution plans and, more generally, towards strengthening individual responsibility in retirement preparation. Not only have employer pensions in the US become increasingly dominated by defined-contribution plans, in which the individual worker bears the investment risk, but employer plans are also entirely voluntary in that employers do not have to offer coverage and employees do not have to participate. In other countries such as Australia and more recently also the United Kingdom, defined-contribution plans have diffused primarily as mandatory employer pensions (that is to say, coverage and participation are not voluntary). The fact remains, however, that workers carry all or most of the investment risk (for further information on complementary pensions across the OECD, see Broadbent et al. 2006; OECD 2014).