by Andrew Rear, Munich Re

In my last post I described the looming ‘hard landing’ in which incompatible and unsustainable retirement expectations become a political and social battleground. The question is whether we can design, and transition to, a future retirement system that is sustainable, without causing a fracture between generations.

Given a continuously growing (in real terms) economy it would, at least in theory, be possible to maintain continuous relative improvement from generation to generation. If we could design a system that rewards each successive generation only for the improvements in GDP in their working lifetime, we would have a stable system offering continuous improvement so long as the economy was growing generation to generation.

There are many reasons why we cannot achieve this in practice. Like tackling global warming, it suffers from a principal-agent problem. Even despite our ambitions for our children, we over-reward ourselves compared to future generations. Perhaps especially generations beyond our children.

Second, there is our inability to forecast. Forecasts extrapolate trends from a particular start-point without knowing where we are against the long-run central trend. Indeed, the long-run central trend is not necessarily a well-defined concept. Inevitablythose forecasts overshoot or undershoot. For macroeconomics this is an ever-present problem which is mitigated by multiple mid-course corrections. In relation to retirement these corrections need to project forward far into the future, raising the spectre of inter-generational inequity.

And even if possible in theory, such corrections are politically difficult. Changes to retirement systems are highly visible and much better understood by the public than for example decisions about monetary policy. People feel entitled to what the current system offers, and any change risks being seen as a form of government theft. ‘Theft’, which brings little political compensation because any beneficial effects are felt beyond the term of the government.

So it is inevitable that in designing retirement systems we will sometimes, for some generations, overshoot. We will offer a particular generation a settlement that is too generous. We will allow them – or ourselves – to start work too late, to retire too early on too much income, and we will fund the medical advances that help them to survive into very old age. I think the evidence is quite clear that this generation – those who have recently retired and perhaps those who will retire in the next decade or so – is one where we have overshot.

We know that overshooting is not sustainable. We also know from multiple fields, whether economics or population biology, that in unstable systems involving a population’s use of resources, the hard landing is much more common than the soft landing.

A hard landing could hit four big variables of inter-generational equity: retirement age, retirement income, health and education.

First, retirement age. A hard landing means people having no choice but to retire later: deferring retirement through necessity. This risks creating a generation who are working because they have to, without necessarily having the drive or desire to contribute to the best of their abilities.

Second, retirement income. A hard landing means a working generation being forced to pay for the packages of the generation before, whilst not looking forward to the same benefits themselves. At its most acute, paying taxes to support retirement systems from which they will not benefit, and not being able to afford to save to make up the difference.

Third, health spending. In a global, or at least Western world, context, in a hard landing we should expect much lower spending on healthcare and medical research. Longer-term this could lead to a slowdown or even reverse in the rate of longevity improvement. In the short-term spending choices between acute, chronic and geriatric care create an inter-generational political battlefield.

Fourth, education. As we become less able to afford education, and more in need of people in the workforce, we will see governments cutting back on education, particularly higher education, spending. Doing so whilst maintaining spending on older generations creates a further avenue for inter-generational conflict.

A hard landing thus opposes generations, one against the other. Because I am paying for their retirement I cannot afford my own. They made choices with which I have to live, and now I have no choices left. It isn’t fair. Or perhaps, it isn’t fair and now I have the reins of power I am going to change it in my own favour.

The politics here is corrosive. At its worst, policy-making becomes a political calculation between the relative voting power and single-mindedness of each generation. The result is inaction, or at least inadequate action, moving the problem down to the next generation. The more timidly we address the problem, the harder the landing when it comes.

So we really need to help policy-makers find a soft landing. It is inevitable that this will require painful decisions. But they must not be perceived as unfair across generations. As I discussed in my first post, the fact that our expectations are relative gives us the opportunity: I believe people will accept a progressive correction, presented carefully, so long as they feel they are able to make choices in a fair environment.

The key to retirement choice is working choice. Imagine a utopia in which I can retire now with enough (however I choose to define that), or I can choose to work later and be more comfortable. There are options available for me to continue working in a flexible way, which makes use of my skills and does not make me feel inferior. This choice empowers me: asked when I intend to retire, I answer that I haven’t decided yet, but it will be when I choose.

Such a utopia needs both a retirement system and a labour market designed to support this choice. I don’t know what these systems would look like, but there are some good examples of elements that might support a solution, which I’ll look at in a later post. Eventually, the solution lies in remembering that happiness is relative: if I have the freedom to make a choice which I consider to be fair, then I will consider myself satisfied with the outcome.