The existing French pension system was set up in a bygone era when circumstances were different. Change is afoot, the kind of change that requires a firm hand on the tiller. However, problems can occur when policymaking is influenced by external forces, such as the ‘markets’ or the mood of the electorate, which are not easy to control. If the chosen course is not navigated correctly, the ruling party may find itself on a collision course.
The French government has recognized the need to protect the national pension system from its demographic imbalances to ensure that it remains financially sustainable. The French pension reform bill, newly passed by the National Assembly and likely to be approved by the Senate, is a major step in addressing the shortfall in the nation’s mandatory, state-run pension system.
To keep a sinking ship buoyant, it is necessary to bail out the water weighing it down. France’s growing budget deficit currently stands at 7.5 percent of GDP, significantly above the 3 percent target set by the EU. The new policy is designed to reduce the country’s pension costs and bring public borrowing down. It is forecast that measures undertaken by the reform would rein in the deficit to the tune of €70 billion by 2018 and bring the pension system back onto an even keel.
France has one of the world’s highest life expectancy rates, with the most recent statistics revealing a lifespan of 77.8 for men and 84.5 for women. The problems associated with an ageing population are compounded when a country also has a falling birth rate. As a result, the dependency ratio of those aged 65 and over as a proportion to those aged 20-64 is expected to rise from the present figure of 25% to 50% by 2050. This means that as time goes by, the onus will be on a dwindling number of working-age people to support those in retirement. These demographic trends are putting tremendous pressure on the French pension system.
To put the PAYG pension system on a sounder financial footing, it was necessary to consider the reform options and their likely consequences. The three choices open to policymakers were as follows:
- To lower retirees’ pensions;
- To increase compulsory contributions;
- To raise the retirement age.
The French government decided that the best way to respond to the demographic imbalances was to raise the retirement age and the number of years of contributions to the state-run system needed to receive a full pension. The new government policy increases the standard retirement age to 62 years from its current 60 and will raise the age of entitlement to a full pension to 67. This change will be phased in from now until 2018 with a four-month increase in the legal retirement age per year. The reforms will require both men and women to have paid social security contributions for a minimum of 41.5 years, instead of the current 40, to qualify for a full pension. Thus, the objective is to have the contribution term increase in line with the rise in life expectancy so that the ratio of ‘period of pension payment’ to the ‘working period’ remains constant.
Far away fields are not necessarily green
It is up to each individual country to decide which system is most suitable for its people and how it should be structured to cope with the changing demographic background and economic situation. There is always a trade-off when reforming current systems between the prevention of pensioner poverty and the ability of a state to honour the promises they make.
National retirement-income systems are complex, with French pension benefits depending on a wide range of factors. Differences in retirement ages, required years of service, benefit calculation methods, and adjustment of paid-out pensions make it very difficult to compare pension systems. There are, however, some useful metrics that facilitate cross-country comparisons.
The replacement rate, which measures French pension entitlements as a share of individual lifetime average earnings, amounts to 50%. This is below the OECD rate, which equates to 70% of earnings after tax. However, the French spend an average of 24.5 years in retirement, compared to 19.8 for other OECD countries.
France currently spends 12.4% of national income on public pension provision; the OECD average is 7.2%. This accounts for 23% of government expenditure in comparison to the OECD average of 16%. This obligation to provide retirement benefits over an extended retirement period has made the pension promise too expensive to maintain.
In 2007, Germany opted to gradually increase its standard retirement age to 67 from 65 to deal with the impact of an ageing population on its pension system. The Netherlands and Denmark have followed suit setting their retirement age at 67 by 2025, whereas Spain and Italy have recently increased their retirement age to 65. Meanwhile, the United Kingdom has pledged to raise its retirement age to 68 by 2046. The newly passed reforms will thus bring France more into line with other European countries.
All hands on deck
To accommodate the shift in demographics, there is a need for a real change in attitude from all stakeholders. In the first instance, the government needs to address the issue of employment of the over fifties. The employment rate in France for the 55-64 age bracket is just 38.9% compared to the European average of 46%. In reality, French people stop working on average at 58, which effectively deprives the retirement system of their potential contributions. The anomaly, however, is that they do not actually retire at that age; they are usually made redundant. As such, a significant proportion of people claiming their French pension for the first time are effectively unemployed.
It is important that private and public employers adapt the work environment to facilitate the integration of older workers, invest in training, and make changes in production processes to have more ergonomic production lines.
Another solution is to do away with incentives that subsidize early withdrawal from working life while aligning the mandatory pension contribution periods for workers in the public sector with those in the private sector. Such a move could prove to be a contentious issue. The social security pension for private-sector workers in France is calculated on the average of their ‘best’ 25 years of salaries. In comparison, public workers’ retirement is calculated on their last six months of salary, which is a much more favourable proposition.
The government’s new retirement policy is designed to reduce benefit dependency. For their part, workers need to understand that early retirement is not a right and that, unless they can afford otherwise, they must get used to working over a longer-term. Public pensions for workers entering the labour market today will be significantly lower than those offered to their parents and grandparents. People will also need voluntary, private provisions for retirement to maintain future living standards.
Pension reform has to be credible both economically and politically; markets need to be convinced by the nuts and bolts of the government’s economic policy. France currently shares the same high credit rating as Germany in terms of government borrowings, reflecting confidence in Sarkozy’s action on pushing through reforms and trimming the budget deficit.
But the issues at stake for the French government are not just solely about numbers; they are also about strategy and how to deal with a much wider political problem that the pension reform has posed. Deficit levels and how to service them are important; other factors come into the equation, such as employment levels and how much pain the public can endure before they bite back. The reform measures will harm public spending power; President Sarkozy may not just be ‘cutting his own cloth’, but that of consumer demand as well. To bring the people along with it, the government has to convince the masses that they have a shared vision of a better road ahead.
With indicators suggesting that economic growth this year will struggle to reach 2%, the OECD is showing signs of nerves. Although pensions are indeed liabilities of the future, the timing of pension reform cannot be conditional on how the economy fares. When setting policy, there is a broad range of elements in the mix, including workers, employers, unions, the bond markets, the IMF, and voters. Policymaking is often a balancing act wherein the platform underfoot is always moving while the balls are being juggled in the air.
Government decisions on pension policy are a reflection of the ideology of the party in power. Of course, no particular ideology has all the answers; reform will always lead to heated debate and can result in street protests that may force the hand of the government. It is therefore important to have a strong government in office. Fortunately, Mr. Sarkozy’s ruling UMP party has a majority in the French Assembly. To an extent, they are taking a gamble in forcing through such a significant piece of legislation in the run-up to the 2012 presidential election. However, the government views structural reform as essential to France’s long-term economic prospects and fiscal solvency.
Given the various challenges that lie ahead, it may not all be plain sailing for the government; any ‘headwinds’ need to be met with a degree of nimbleness on the part of the policymakers. However, by undertaking this task now, the anticipated political hurricane may be downgraded to a tropical storm in time for the election.
There are ways for expats to address their retirement planning needs without being reliant on the French pension. Those that have retired to France with UK pensions can transfer them to a QROPS. They can also use Assurance Vie products for pension planning in France.