First published in the Telegraph on 7 May 2009
When she died six years ago, there was little on the face of it to distinguish Gertrude Janeway from any other elderly American. Bedridden for the best part of a decade, the 93-year-old from Tennessee spent her final days contemplating her life, reflecting sadly on the modern world with its binge drinkers and teenage pregnancies, and saying the odd prayer.
But Mrs Janeway had a secret: she was the very last of the Yankee civil war widows. Every two months until the end of her life, she claimed a $70 government pension that was hers because of a connection with the war fought 140 years earlier between the Union and Confederate armies. At the age of 18, she escaped poverty by marrying an 81-year-old civil war veteran, who had himself joined the fight when he was 18, in 1864.
Mrs Janeway was not merely a precious link with the past; she was also one of the most vivid reminders of a lesson that governments are learning only now: namely, don’t make promises you can’t afford to keep. When the army generals and politicians devised the war pensions system, they envisaged that they might have to carry on paying out until the mid-20th century. Instead, their obligations lasted a good 50 years longer.
Imagine Mrs Janeway’s case writ large: pensions bills lasting longer than anticipated, and not for an army of thousands but for hundreds of millions of people spread across vast continents. This gives some idea of the problem we face.
The crisis is not a new one – we have been facing a pensions black hole for many years – but the current financial and economic situation makes it impossible to avoid for much longer. The dilemma was spelt out by the National Institute for Economic and Social Research (NIESR) this week. The debt being racked up by the Government during this crisis is so gigantic that it must consider raising the official retirement age to 70 in little under a decade, increasing taxes by 15 per cent or cutting spending by 10 per cent. Ideally, the institute added, it should do a bit of everything.
The problem is twofold. First, taxpayers have to contend with a bill of war-time proportions for cleaning up the economy and financial system in the wake of this crisis. Second, in the words of the International Monetary Fund – “in spite of the large fiscal costs of the crisis, the major threat to long-term fiscal solvency is still represented, at least in advanced countries, by unfavourable demographic trends”.
In other words, we have promised both current and soon-to-be pensioners over-generous stipends. And, partly due to myopia in calculating the benefits and partly because the population is ageing, the cost of tending to them will soon become unbearable.
In the past, one could easily shrug off the prospective crisis and make small, far-off tweaks to pensions plans – such as Lord Turner’s plans to raise the retirement age to 68 by the distant future of 2044 and to enrol everyone automatically in a national savings scheme.
Such small, gradual changes may no longer be enough. In the first place, private-pension deficits have entered terrifying territory in the wake of the financial crisis, eroding families’ wealth. More fundamentally, should the Government fail to show it has convincing, long-term plans to sort out its own pensions crisis, it faces the prospect of a buyers’ strike, with investors simply refusing to buy its debt.
Such an eventuality would make the current economic crisis look like a walk in the park. It would involve swingeing tax rises and spending cuts; it would include a trip to the IMF and give rise to social unrest of a kind not witnessed since the 1970s and 1980s.
Appropriately enough, the seeds of the quandary lie in the fall-out from the last epoch-defining financial and economic crisis. For it was in the wake of the Great Depression that governments around the world built the foundations of the modern pensions and benefits system.
In the 1940s and 1950s, Britain went, via the Beveridge Report, from being a warfare state to a welfare state. We may take the current system for granted now, but it was nothing short of a massive economic experiment, one forged in the shadow of terrible suffering. Moreover, it is a system that has been in operation, in its full embodiment, for less than a lifetime.
Unfortunately, it has been an experiment based on unrealistic assumptions about Britons’ longevity and their fecundity. Since the 1940s, life expectancy at birth has climbed from just over 60 years to just under 80. And fertility rates, which peaked at an average of almost three children per family in the baby boom era of the 1960s, have now seen a drop to below two children per family for three decades.
The result is that there will be more pensioners and fewer workers in the future. Had the original architects of state and private-pension schemes realised this, they would presumably have set up finite funds into which workers paid contributions that would then be paid out to them when they retired.
Instead, until relatively recently, most funds were designed either as defined- benefit schemes, with pensioners given a guaranteed payment no matter how much they paid in, or plain unfunded schemes, with pensioners paid from the current account.
Several companies suffer a hangover from large versions of the former – British Airways and British Telecom being prime examples. Many insiders fear that before long we could see a major British company taken down by the burdens of its pension scheme.
But these bills are as nothing compared to the unfunded liabilities of the state. By even conservative estimates, the state and public- sector pensions liabilities could more than double the total national debt, causing far more damage than the current financial crisis. The situation is hardly any better in the US, where the unfunded liabilities for social security and Medicare – health care for the old – are more than $50 trillion.
For all the talk of waste in the public sector, of inefficiency and of profligacy under Gordon Brown, nothing that this Government has done to dent Britain’s public finances can compare with the damage imposed by decades of this demographic disaster. Despite the impression we have of the 1980s as a prolonged public-sector bonfire, the Thatcher government did little to roll back the costs associated with welfare, instead focusing its reforms on industry privatisation and market deregulation. This more significant battle has yet to be waged.
The current economic crisis could mark that turning point. While the Great Depression ushered in a new era in which the state took on responsibility for its citizens’ welfare, the Great Recession of 2009 – or whatever you care to call it – could mark the moment this experiment ended, or was at least replaced with a properly planned, modern version.
Whereas the previous era was defined by careers for life and a pension to match, those currently in their thirties and forties are likely to lead far more nomadic professional lives and to take direct responsibility for their retirement finances as a consequence.
The next 20 years will be about repaying the enormous debts associated with this crisis and extricating ourselves from bankruptcy because of our future liabilities. Solutions exist but they are not pretty.
The first, as the NIESR pointed out, is to work longer or receive lower benefits. The second is for future taxpayers to pay more to fund pensioners, although the consequence of this is weaker economic growth. The third is to reconsider the scale and generosity of both out-of-work benefits and the National Health Service, which together constitute the biggest item of public spending.
The fourth possibility is to throw out the existing pay-as-you-go welfare systems in favour of programmes in which taxpayers have to contribute a certain amount into a fund each month – something the Government has considered for public- sector workers, but shamefully avoided following a confrontation with the unions.
There is, however, a fifth option: to try to set the demographics back in our favour. Given that life expectancy shows little sign of deteriorating, this would mean increasing the fertility rate. And here, at least, there is a glimmer of good news for the UK. For thanks partly to our relatively open immigration policy and partly to a rise in births, Britain’s old age dependency rate is set to increase far less rapidly than that of any other major country between now and 2050, according to UN projections.
In and out of wedlock, babies are being born at a higher rate than for many years, and every new child represents another prospective taxpayer to help reduce that bill.
Teenage pregnancies may bemuse nonagenarians such as Gertrude Janeway, and they may cause hand-wringing among social commentators; but in economic terms, they may be the best hope we have for solving the impending fiscal timebomb.