Why it is possible that wages and pensions can increase simultaneously in an ageing and stagnating % A theoretical investigation and a simulation of the German case

Abstract

This article investigates the possibilities and restrictions of inter-generational income development for ageing and stagnating economies. In a first step, the basic logic of ageing will be investigated in a simple dynamic model. In particular, the investigation points out the existence of the demographic distribution mass and its meaning for inter-generational income development. It proves that the demographic distribution mass makes it possible for wages and pensions to grow simultaneously in an ageing and stagnating economy. In a second step, the development of wages and pensions is simulated for the German case through to the year 2050. It is demonstrated that (under normal circumstances) it can be expected that the burden from ageing can almost always be over-compensated by the economic growth of the respective year. Against this background, ageing appears to be rather a problem of acceptance and income distribution than that of real income reductions.

Acknowledgements

I am grateful to Inga Schroeder, Stefanie Thiel, Rolf Johannes, the audience of the HHL-colloquium and the anonymous reviewers of this Journal for useful comments that have helped me to improve the quality of the article significantly. However, the responsibility for any errors or omissions rests with the author.

Notes

¹ Financial Times Germany, 19 November 2002.

² According to Hans Werner Sinn, President of the IFO Institute in an interview on 15 June 2005, available at http://www.finanznachrichten.de/nachrichten-2005-06/artikel-4945149.asp.

³ For instance, the internet pages of the German Social Democratic Party, SPD, read: ‘The ageing structure of the population in the Federal Republic is going through a dramatic process of change: There are increasingly more old and increasingly less young people … In the face of such changes, the pension system must be re-adjusted to maintain its effectiveness.’

⁴ One step in this direction, which has already been realized, is the so-called ‘Riester Rente’ based on the Gesetz über die zusätzliche private Altersvorsorge, which became effective on 1 January 2002.

⁵ For the German discussion see, for example, the article in the Frankfurter Allgemeine Zeitung, 28 April 2003.

⁶ This insight has already been recognized by Mackenroth (1952). Of course, this does not mean that we can neglect the fact that the institutional arrangement of pensions has various effects – not only on income distribution, but also on economic growth and, thus, the size of the cake to distribute. For the discussion of the Mackenroth hypothesis see also Feldstein (1977), Schmähl (1981) and Homburg (1988).

⁷ This implies that all other income groups, in particular unemployed and children, do not exist in our model world. As explained above, this simplification serves the purpose to focus the investigation on the development of the two remaining income groups – workers and pensioners – in the ageing process. However, it should be mentioned that the Statistisches Bundesamt forecasts a decrease in the number of young people – a development, which, of course, only causes the entire process of ageing. This development, again, has a relieving effect on the financial burden of the active population.

⁸ Note that technical progress is a pre-condition for the stagnation of an ageing economy. Without technical progress, any ageing economy would be contracting. I will address this point later.

⁹ This assumption might appear a little heroic for Germany and many other OECD countries and requires some justification. Primarily it is just another simplification, which spares the necessity of an independent explanation for the development of the economy's gross product (beyond the neoclassical equilibrium framework). However, most of all, this assumption can be justified because it isolates the income effect of ageing from effects that result from a change of unemployment in the economy.

¹⁰ However, |ÿ_t | (ceteris paribus) decreases in the course of time.

¹¹ For instance, an article in the Frankfurter Allgemeinen Zeitung from 6 November 2002 reads: ‘The President of the Confederation of German Employer's Association (BDA), Dieter Hundt characterized the plans of the governing coalition to increase pension duties as an additional blow against growth and employment policy. “These plans are a fatal consequences of a misguided economic and social policy and of insufficient reforms of the pension system.“…” (own translation).

¹² We still assume that the ‘contribution ratio’ represents all transfers from the active to the inactive generation.

¹³ To isolate the inter-generational income development and that of the demographic distribution mass, we will exclude all people below the age of 20 from the simulation: as in the theoretical part, the total population consists only of those people aged 20 or over. However, all changes in this ‘total population’ through to 2050 will be completely taken into account, i.e. the above assumption of a constant population will be dropped.

¹⁴ Due to the higher level of income, the demographic distribution mass is larger in this scenario than in the case of an assumed productivity growth of 1%: it is now about [euro]6.6 billion per year, on average.

¹⁵ For instance, in a speech before the LVU-Unternehmertag on 3 June 2004, BDA-President, Dieter Hundt comes to the conclusion: ‘Due to the demographic development, we have no choice but to extend working life.’ Source: http://www.lvu.de/04/0603_8.html (own translation). In their coalition talks, SPD and CDU both explicitly expressed the extension of working life as being one of their political targets. See Frankfurter Allgemeine Zeitung, 28 October 2005.