Many will be disappointed by what their pensions pay out © Peter Dazeley
There is something afoot in the developed world: the growth in population that began when the industrial revolution released us from a Malthusian era of agricultural dependence and famine is coming to an end. This is already visible in Japan and in parts of Europe, where the population is shrinking. At the same time the world’s rich are living longer. Projections by the United Nations suggest that the proportion of the European population aged 60 and above will rise from around 15 per cent now to 27 per cent in 2050.
Increasing longevity in the rich world ought to be a matter for rejoicing. Instead it has unleashed deep concern about the affordability of pensions and the welfare state. This is because welfare systems have much in common with Ponzi schemes—fraudulent investment operations that require an ever-increasing flow of money from new investors to fulfil generous promises made to existing investors. With pay-as-you-go state pensions it has been easy for European politicians to promise excessive retirement incomes when huge contributions were coming in from large working populations and little was going out to much smaller retired populations. Until now the stability of private sector financial institutions such as defined benefit pension schemes and life assurance companies has also been underpinned by a steady supply of young new entrants.
Today the tables are turned. Retired populations are set to grow and working age populations to shrink. So a moment of truth is approaching. Public sector debt in the US, Japan, the UK and much of continental Europe is unsustainable, giving rise to fears that governments will default on state pension obligations. In the private sector most defined benefit pensions schemes have been closed to new entrants. The pensions paid out by defined contribution, or money purchase, schemes will for most people be disappointing. The question is whether there is a neat economic escape route from this bind.
The globalisation of capital flows ought to provide a potential solution. According to economic theory, rates of return should be higher in poor countries than in rich ones. Capital might therefore be expected to flow from rich to poor countries to take advantage of these differences in returns and prompt a higher level of investment than the domestic savings of poorer…