If Former Chancellors Kohl and Schröder Were to Evaluate Pension Reform

[Seoul Sinmun · Open World · May 28, 2015]

Yun Suk-myung, Research Fellow at the Korea Institute for Health and Social Affairs (KIHASA) and Adjunct Professor of Economics at Korea University

Recently, there has been a strong fascination with Germany. This is because Germany, once called the sick man of Europe, succeeded in changing its national structure by reforming its labor market and social security schemes. There also seems to be great interest because Germany is a country that achieved unification after being divided. Interest may also be concentrated on the fact that it was the country that introduced the Bismarckian pension system, the origin of social security schemes with extensive benefits. It is a known fact that half of the costs of German unification went into social security, including pensions. The timing of unification was lucky for Germany. This is because the fiscal conditions, which had been poor, improved rapidly around the time of unification, creating the capacity to cover the costs of unification. Efforts to overhaul the pension system, which did not fit the changed environment of the times, were also steady. Former Chancellor Helmut Kohl seems to have been a person who recognized the importance of sound government finances and of reforming an outdated pension system. That is likely why it was possible to create the foundation for unification and build a framework to minimize confusion after unification.

Former Chancellor Gerhard Schröder, who recently visited Korea, reformed the labor market and social security schemes under "Agenda 2010," even while being called a traitor by his support base, the Social Democratic Party. The point we should note is that he completely changed the basic framework of the traditional German pension system, which had been operated on a pay-as-you-go (PAYG) basis (a method where the working generation supports the retired generation). He introduced an automatic adjustment mechanism so that potential risks caused by low growth, aging, and low fertility are resolved automatically within the pension system. He introduced a pension system that can survive without political controversy even in a changed environment. This happened 11 years ago.

Germany's income replacement rate, which is below the mid-40s, will drop to the low 40s by 2030. The German government's goal is to cap contributions, currently at 19.5%, at 22% by 2030. This is living proof of how much in contributions must be borne to pay an income replacement rate in the low 40s. Former Chancellor Schröder's pension reform means that the paradigm of pension policy has shifted from the traditional view that "a minimum amount of pension must be received" to one that "prioritizes the possibility of cost financing."

For us, who are diligently studying Germany, pension reform has emerged as a national agenda. This is because the Government Employees Pension is unsustainable. When told to reform this Government Employees Pension, the concept of "equalization of public pensions toward the middle" suddenly appeared on the stage. It seems intended to highlight that the National Pension is too low, making the Government Employees Pension appear high. This is despite the fact that there has been no proper review of how much more the burden would increase if the income replacement rate of the National Pension were raised back to 50%.

The German case (an income replacement rate below 45% and contributions at 19.5%) is a vivid indicator showing how much contributions must rise to maintain the income replacement rate of our National Pension, which is currently 46.5% but will drop to 40% by 2028. The "Organisation for Economic Co-operation and Development (OECD) Korea Economic Review" (published in June 2014) also mentioned that contributions should rise to 16.7%. How would Former Chancellor Kohl and Former Chancellor Schröder react if we told them the reality of our National Pension discussions, which consistently ignore the increasing burden while promising only to give more, and the Government Employees Pension reform, which shifts the burden to future generations while maintaining vested interests? They would likely wear expressions as if watching a black comedy that leaves one neither laughing nor crying. They would probably ask, "Why do you call it pension reform while doing that?" This is because Germany is a country where beneficiaries and current employees shared the pain of reform, and both its national and Government Employees pensions were reformed with similar intensity.

While the study of Germany is in full swing in many fields, it seems we are failing to learn the parts we actually need to learn. We must face the fact that the average income replacement rate among OECD member countries is 40.6% and the average contribution burden required to maintain it is 20%. This is because the issues arising from a short pension history and a limited actual contribution period are being misattributed to the problem of low income replacement rates. It seems time to reflect on the words of Bert Rürup, who played a midwife role in German pension reform: "The standard for pension reform that can convince members of society is to ensure that no specific generation suffers too much loss." I do not think it will take long for the results of what we are doing now to be revealed. This is because the state's finances are deteriorating rapidly, unlike in the past. When that time comes, what excuses will today's leading figures make? That is why I feel more sorry for the "Jang Geu-rae generation."

Source: Seoul Sinmun (original article)