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20 April 2015

Plen­ty of room for cost sav­ing

Germany’s pension and health care systems need to be future-proofed, argues Ludger Schuknecht. Today, old-age poverty is at historic lows, and people of all ages enjoy better health care than ever before. Nevertheless, our strong economy and flourishing labour market obscure the fact that we are sitting on a demographic, economic and fiscal time bomb.

Dr. Ludger Schuknecht, Chief Economist at the German Finance Ministry

Dr. Ludger Schuknecht, Chief Economist at the German Finance Ministry
Ludger Schuknecht, chief economist at the German Finance Ministry

Today, old-age poverty is at historic lows, and people of all ages enjoy better health care than ever before. In addition, two newly adopted policies – pension increases for mothers of children born before 1992 and full pensions under certain conditions starting at age 63 – have further expanded our social benefit system. Nevertheless, our strong economy and flourishing labour market – which finance all of this with seemingly no trouble at all – obscure the fact that we are sitting on a demographic, economic and fiscal time bomb.

The success of our social benefit system has led to tremendous increases in spending over the past 50 years. In the years up to 1960, state spending on health care in most advanced economies averaged 2-3% of GDP, and 4-5% of GDP for pension payments. Today these figures stand at 8% and 10% of GDP, respectively. This doesn’t even include extra spending for things like long-term care. Today, social spending accounts for one quarter of GDP in Germany.

Moreover, one key factor driving up costs is only just now coming into play: the ageing of our population. In Germany, the share of people over age 65 relative to those aged 15-65 is poised to rise from about 30% today to nearly 60% in 2040. At that point, there will barely be more than one worker for every older person. This trend means that spending will continue to climb significantly. The Bank for International Settlements forecasts that Germany’s spending on health care and pensions will rise by roughly 3% of GDP by 2040.

If we don’t take action, higher and higher spending will leave us with unpleasant alternatives, such as higher taxes and social security contributions, lower spending in other important policy areas, or higher deficits and debt. According to a study by the social and economic policy think tank Politeia, given that Germany’s debt levels are already high and its tax rates are higher than in many countries, there is only one solution: additional reforms to social insurance systems with the aim of cutting costs and improving efficiency.

It is imperative that 67 once again become the benchmark for the expected retirement age. If we are being honest, we must recognise that, over the long term, we will have to keep adapting the retirement age to rising life expectancy. This is only fair to the younger generations that will have to finance such benefits. The parliamentary working group currently addressing issues relating to the extension of working life should use the time remaining in the current legislative period to press for more flexible rules for working later in life and to eliminate all false incentives. We must make it clear to the public that it is crucial for people to invest more in private pension plans, especially given today’s extremely low interest rates.

There is a lot of potential for improvement in Germany’s health care sector as well. Competition between health insurance funds and between health care providers needs to be enhanced. Structural adjustments should be carried out in the hospital sector. Health care costs must be made more transparent. And insured persons need to take more responsibility: we can encourage this by giving them greater freedom of choice in their health care benefits and co-payments.

These steps would give people incentives to keep costs down and to lead healthier lives. But the most important challenge we face in defusing the demographic time bomb is to create a child-friendly culture and better conditions for families with multiple children. After all, children are our society’s future.

This article first appeared in German in Handelsblatt on 20 April 2015.

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