NCPA - National Center for Policy Analysis

GENEROUS GERMAN PENSION SYSTEM IN MIDST OF REFORM

July 29, 2004

Germany's generous public pay-as-you-go pension system has undergone significant changes over the last decade and continues to be the target of reform.

The German system is characterized by an early retirement age, which averages less than 60 years. It is also very generous. Germany's replacement rate -- that is, the rate at which pension benefits replace worker earnings -- averages about 70 percent, while the U.S. average is about 53 percent.

Overall, Germany's public pension system has proven quite expensive:

  • Public pension expenditures is the single largest item in the social budget, representing 21 percent of all public spending.
  • Pension spending accounts for 11.8 percent of gross domestic product (GDP), a share more than 2.5 times as great as U.S. Social Security (4.4 percent of GDP).

Economists at the National Bureau of Economic Research say financial pressures mounting from an aging population and negative incentive effects have driven Germany to reform its public pension system:

  • In 1992, pension benefits were anchored to net wages rather than gross wages in order to cut costs; incentives for early retirement were also curtailed.
  • In 2001, a reduction in replacement rates from about 70 percent to 67 percent was to be phased in over 30 years; voluntary individual retirement accounts were also introduced.

The German government finds these measures far from adequate. It has since created a reform commission to examine other ways to stabilize the system. One of the commission's proposals, which has yet to become law, is to increase the normal retirement age from 65 to 67 over three decades.

Source: Axel Borsch-Supan and Christina B. Wilke, "The German Public Pension System: How it Was, How it Will Be," Working Paper No. 10525, May 2004, National Bureau of Economic Research.

For NBER abstract http://papers.nber.org/papers/w10525

 

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