Population aging in the industrialized nations is rapidly leading to social and economic crisis. But this destabilizing problem could easily be turned into an asset. What is needed, says Ted Halstead, is a complete rethink of national priorities and prejudices –

New social and economic crises are as predictable as those posed by rapidly aging populations in the industrialized nations.

The interaction of falling birth rates and increased longevity in western countries and Japan threatens a downward spiral of fiscal insolvency, labour shortages, economic stagnation, fraying social safety nets and generational warfare.

To escape this fate, the leading democracies of the world must rethink their approaches to aging, pensions, social welfare, labour markets and migration. What they must rethink, in short, is nothing less than the social contracts that have held sway over the last generation.

The challenge of renegotiating the underlying social contracts of western nations is as urgent as it is complex. The optimal division of responsibility among citizens, companies and the government will always vary from country to country, based on their respective values, cultures and circumstances.

Nevertheless, some convergence may be on the horizon because of the inescapable forces of globalization and, in Europe, unification.

Leading democracies are contending with a broadly similar challenge: the obsolescence of norms and institutions devised in a very different era, when the young greatly outnumbered the old, when lifetime employment with single firms was the norm, when most men were the breadwinners and most women stayed at home.

The dramatic reversal in these trends compels all industrialized nations to embark on social reinvention. Along the way, they have much to learn from one another.

If there is a common denominator that could serve as an anchor for social reform in virtually all developed countries, it is surely the need to develop a new conception of the very process of aging.

All too often, the increasing numbers of so-called senior citizens are viewed as a burden on society, rather than as a promising resource. This negative view is perpetuated by outdated attitudes, and is reinforced by perverse labour market and pension incentives that marginalize older workers.

Take the very idea of a fixed retirement age, or the policies of many countries and firms to promote early retirement. Why should we encourage otherwise healthy, capable and highly experienced citizens to leave the workforce before they want to?

Instead of mere chronology, why not make able bodies and able minds the central criteria in determining how long someone should remain in the workforce? Perhaps we should retain a minimum retirement age, but certainly not a maximum one.

Given the choice, many citizens may well choose to remain in the workforce into their seventies and eighties, and nations have everything to gain from encouraging this. Indeed, this could help turn what is shaping up to be a vicious cycle into a virtuous one.

The longer citizens remain in the workforce, the more they will contribute to their own and their nation’s economic wellbeing, the less they will draw on the public purse and, as recent research confirms, the likelier they are to remain healthy.

Abandoning the 20th-century retirement paradigm could go a long way towards alleviating the entitlements crises that will destabilize western nations over the next several decades.

But it would be imprudent to base economic solvency solely on the promise of people working longer and retiring later. Just as important will be reform of basic entitlement programmes themselves, especially in the area of pensions.

Here, the US has much to learn from other nations in terms of public pension reform but it may have something to teach when it comes to private pensions.

To this day, the vast majority of public pension systems in the industrialized world rely on a “pay-as-you-go” system of intergenerational transfers, in which current workers pay for those who are currently retired.

With the ratio of those over 65 to those aged 20 to 64 in the west projected to double over the next 30 years, it is not difficult to understand why these programmes are unsustainable. The best long-term cure is to delink the fates of generations one from one another by enabling all workers to accumulate savings in their own retirement accounts.

Shifting from pay-as-you-go public pension systems to pre-funded ones would help increase savings and promote investment, job creation and economic growth. Moreover, by making the link between what citizens put into the system and what they get out more explicit, workers would be encouraged to stay in the workforce longer, thus decreasing the pressure on public systems.

None of this is to suggest that shifting to pre-funded systems is easy, especially since it imposes significant transition costs. On balance, however, the short-term pain is well worth the long-term benefits, which is why countries as diverse as Chile, Australia, Sweden, the UK and now Germany have been moving in this direction.

Employer-sponsored private pensions plans are no less in need of reform. The majority of these are based on the “defined-benefit” model, under which firms guarantee a certain level of benefits to their workers, typically based on the number of years they have served and on final salary.

Such plans, however, impede labour mobility because workers can only qualify for benefits after staying with their firms for many years. They also create long-term financial liabilities for companies, prompting them to encourage early retirement, which of course only worsens the burden on public pension systems.

Worse still, many private plans are woefully underfunded, which means that taxpayers may ultimately get stuck with the bill.

The main alternative to these defined benefit plans is “defined contribution” ones, in which retirement benefits are based on how much workers and employers contribute annually to each worker’s own account.

The main pioneer in this category is the US, where – thanks to the popularity of tax-deferred 401K accounts – defined contribution plans have now overtaken defined benefit plans in total assets and number of participants.

Because 401Ks are portable from job to job, they facilitate labour mobility; and since benefits are tied directly to contributions rather than to seniority, they encourage workers to stay in the labour force longer.

The US 401K model has its share of drawbacks – particularly when it comes to coverage and employer restrictions on investments – but these could be solved through better policy design.

Beyond rethinking the process of aging and reforming pension systems, leading democracies also need to revise their social welfare provisions and find new ways to assimilate immigrants.

In the US, the only developed nation in the world to lack universal health insurance and paid maternity leave, the obvious challenge is to extend basic benefits. But this need not require that America move to a single-payer healthcare system.

Rather, it could reach the goal of universal coverage by making health insurance both citizen-based (instead of employer-based) and mandatory, while coupling this with public subsidies to those who need them most.

Requiring all those who can to pay for their own health insurance and save for their retirement may strike many Europeans as wrongheaded or miserly but this type of thinking may hold the key to solving the runaway welfare costs and anti-immigrant backlashes now spreading throughout Europe.

Indeed, much anti-immigrant sentiment stems from reluctance on the part of native-born populations to extend generous welfare benefits to newcomers. One answer is to turn immigrants away; a better one would be to reform welfare formulas.

As these examples suggest, the optimal social contract for a 21st-century nation lies somewhere in the middle of the Atlantic. It would combine the flexibility typical of America’s labour markets with the sense of social equality typical of European welfare states.

Reaching this mythic place, however, will require dramatic changes by all three parties to the social contract. Citizens will need to shoulder more responsibility for their own wellbeing and retirement, in exchange for greater choices and freedoms.

Governments, meanwhile, must stop offering cushy hammocks for all citizens and focus instead on providing a true safety net for those who need it most. And firms should adopt more flexible hiring practices that make greater use of older workers, and roll back benefit policies that encourage early retirement and discourage labour mobility.

Combined, these principles could help the industrialized nations to forge a new social contract between citizens and their governments, between employees and their employers, and between the young and the old.

There remains still more to be done in this latter category, however, because the temptation in an aging society will always be to shower ever more resources on the elderly.

This pattern is likely to lead to under-investment in the next generation, which in turn could undermine the collective future of all. For every public dollar spent on the young in the US today, for instance, eight are spent on senior citizens. And the scales could tip even further if current trends continue.

To ensure a more balanced allocation of resources between generations and enhance the life chances of the next, it may be time to add a bold new clause to the social contract – endowing every child with financial assets at birth. At a time when access to capital is a leading prerequisite to getting ahead, why not offer each child a down payment on a productive life? A modest investment at birth – say $6,000 per child – could grow to around $20,000 by the child’s 18th birthday, at which point he or she could begin using the funds for higher education, as a down payment for a first home, or to start a legitimate business.

One purpose of these endowments is to enhance the human and financial capital of their owners, for life. Another is to smooth the transition away from pay-as-you-go benefit formulas by jump-starting the personal savings accounts of the young.

If nations wish to encourage their citizens to shoulder ever more responsibility, they have little choice but to make significant investments in the life chances of each new generation.

Doing so by means of broadening the ownership of financial assets would have this added advantage: it would help turn all citizens into stakeholders who suddenly have a direct interest in the overall success of the economy.

Such stakeholder-citizens would not only be more willing to tolerate the cycles of creative destruction that accompany the most dynamic economies but as a powerful new class of shareholders, they would also compel the companies they own to act more responsibly and to maximize long-term value.

Demography may be destiny, but it is a destiny that all nations have the power to shape – for better or worse – through the social contracts they negotiate. When fixed retirement ages are relegated to the dustbin of history, when the pension fate of one generation no longer depends on the size of the next one, and when all newborns are endowed with financial assets from birth – national destinies will be much brighter indeed.

Ted Halstead
Ted Halstead is president and chief executive officer of the New America Foundation, and co-author of The Radical Center: The Future of American Politics (Doubleday). He was also nominated as a GLT in 2001.