Auguste Comte (1798-1857), a French philosopher and social theorist of the 19th century, made a prophetic observation that “demography is destiny.” Also, Alfred Sauvy (1898-1990), a French demographer, said that the 21st century will be “the century of the aging of mankind.” In fact, unprecedented demographic transition of population aging is already underway in most developed countries with profound and pervasive long-run macroeconomic implications.
“The challenges of global aging, like a massive iceberg, looms ahead in the future of the largest and most affluent economies of the world,” observed Peter G. Peterson, the Founding Chairman of the Peterson Institute for International Economics, in his book Gray Down: How Coming Aging Wave Will Transform America and the World (2000).
A broad consensus is emerging that the future economic growth potential would be seriously hampered in the OECD countries. For example, the average incomes of the Canadians could be lower by nearly 20 per cent in the next two decades due to population aging, according to the Bank of Canada's calculations.
We can no longer ignore the unambiguous demographic realities. Daunting fiscal challenges lie ahead. In the absence of anticipatory comprehensive fiscal reforms and other appropriate policy responses to ward off the crisis of population aging, it would be a Herculean task for the fiscal policy makers at all levels to ensure the sustainability of the trajectory of government expenditures and tax revenues growth
In particular, given the ballooning deficits, debt and bleak economic growth potential, the affordability, security and sustainability of the public sector pension plans in aging economies is a matter of grave concern.
“The next 40 years of the world’s economic life will be dominated by one underlying theme: how we deal with the retirement income security of a growing, aging, and longer-lived global population,” says Richard A. Martin, author of Global Pension Crisis: Unfunded Liabilities and How We Can Fill the Gap (2013).
Most national and sub-national governments around the world are under mounting pressure to revisit their defined benefit pension systems, which are facing increasing funding deficits. Of course, the roots of the problems of financial sustainability of unfunded pension plans are mostly due to the increasing ratio of retirees to contributing members to the pension plans, very low and volatile returns on investment, and a longer life expectancy.
As elsewhere, P.E.I. is also facing a looming public sector pension crisis. In fact, the pension system is currently facing a hefty funding deficits totalling over $400 million. There has been a sharp drop in the ratio of contributing employees to the retirees receiving pensions. For example, at present, there are only two contributing members to the pension plan for every retiree, compared to eight contributing members for every retiree in 1970.
To tackle the financial unsustainability of the pension system, the government has announced major plans to reform the public sector pensions during the fall session of the legislature. The proposed reform will affect about 14,000 government employees and retirees representing five unions.
The government plans to eliminate guaranteed annual cost-of-living increases in the pensions for the retirees, what is known as indexation. Instead, starting in 2017, it will be contingent on the pension fund’s ability to pay. To provide a sound footing to the fund, the government has pledged a special annual contribution of 25 million to the pension fund for the next 20 years.
After 2014, pension will be calculated based on career average salary, rather than their best three to five years, according to the proposed pension reform.
Also, beginning in 2019, the public sector employees will have to work until they are 62, to get an unreduced pension benefit, or between the ages of 55 and 62 if the employee has 32 years of pensionable service. At present, only 30 years of pensionable service is required.
On the whole, without any question, the proposed public sector pension reform is far-reaching. It is a move in the right direction. But it is a bitter medicine to swallow. Given the demographic crisis, unsustainable public finances, gloomy economic growth potential, increasing unemployment and income inequity, will this bitter medicine solve the looming pension crisis? Will it make the pension system financially secure, sustainable and affordable?
All things considered, it is doubtful without a concurrent major fiscal reform to tackle the issues concerning the sustainability of public finances and sustainable development of the island economy.
The impact of demographic shift on the provincial public finance has to be assessed very carefully. The efficiency aspect of public expenditure must receive greater focus in the public policy forum.
Above all, the potential role of redistributive income policy should not be overlooked in promoting social harmony and sustainable development.
By Dr. Palanisamy Nagarajan
Dr. Palanisamy Nagarajan is Emeritus Professor of Economics & Research Associate of the Institute of Island Studies at UPEI