Underfunded Pensions: A French Formula To Bridge The Global Demographic Gap

-Analysis-

PARIS — While the sustainability of France’s public debt is back in the news, the financing of pensions could soon become an urgent and vital concern once again.

Let’s not forget that France’s current debt of over 3 trillion euros does not include the nearly 1.7 trillion euros in off-balance sheet commitments for the future pensions of civil servants. But contrary to popular belief, this major imbalance is not only a French problem.

The economic consequences of an aging population and falling birth rate in Western countries are now well understood, but their economic impact on pension systems is still underestimated. In his latest annual letter, BlackRock CEO Larry Fink sounded the alarm, reminding us that the latest estimates from the U.S. Social Security Administration confirm that American basic pensions will no longer be able to be paid at full rate from 2034!

Given the proximity of these deadlines and the scale of the problem, Fink underlines the imperative need to consider not only raising the retirement age, but also increasing savings over longer periods. He points out that BlackRock now devotes more than half of its assets under management to pensions.

Global underfunding

So this is not only an issue for France; it is one that correlates with the level of development and wealth achieved by most OECD countries.

Demographics are relentless; the fact that people are living longer in retirement, combined with a collapse in fertility rates, is making the balance unsustainable. This is despite the capitalization models implemented by many Anglo-Saxon countries, including Australia, which is considered a model in this field.

Anticipating the risk of a “grey tsunami,” in the 1980s the Australian government created a system known as “superannuation,” the principle of which was to force workers to save from an early age, in order to accumulate and capitalize over the longest possible period in anticipation of future demographic trends.

Although this pension system is considered to be the best-financed in the world, many voices have recently been raised about the likely future decline in pension levels. Overall, some estimates put the global underfunding of pensions at nearly 0 trillion, or around four times world GDP.

The greatest force

So where does this leave France, the only major developed economy to continue to rely on a pure pay-as-you-go system? In other words, the contributions deducted each year (some 350 billion euros) are never invested, and therefore never earn interest, because they are paid out in full to current retirees. With an initial ratio of four contributors to one retiree in the 1970s, the system is now at the end of its tether, with just 1.5 contributors today.

Fertility is unlikely to rise again in the coming years, as it is a function of the aspirations of new generations. Nor is life expectancy likely to fall, which is surely something to be welcomed. Rather than being alarmed by this situation and thinking that France will do even worse than its neighbors, it can paradoxically emphasize its privileged position: France is probably the only major developed country to still have considerable financial leeway.

The UK’s new Labour government has clearly understood this leverage effect.

All we need to do is create a national fund dedicated to pensions, which would receive a portion of policyholders’ contributions and invest them over the long term — 20 to 30 years — for example. This way, a major new resource could be generated by the simple game of compound interest over a long period, which the investment horizon of a pension fund easily allows.

For example, if this fund were endowed with 50 billion euros, invested at 5% over 20 years, nearly 80 billion euros in interest would be generated over the period.

The UK’s new Labour government has clearly understood this leverage effect, and will cleverly set up a national sovereign wealth fund of almost 10 billion euros to finance its green transition investments.

As Albert Einstein reminded us: “Compound interest is the greatest force in the universe.” Let’s hope France quickly seizes this opportunity.