Make them work longer

Public-sector workers must retire later. It’s the fairest way to cut the deficit
June 22, 2010
Firemen retire at 50—but not all their work requires athleticism

The first set of figures released by George Osborne’s new office for budget responsibility on 14th June made grim reading. Government borrowing was down ever so slightly, but so were growth forecasts. So when the chancellor stood up to present his “emergency budget” on 22nd June, he had to offer comprehensive ways to cut spending without further damaging the fragile economic recovery. As Martin Wolf has persuasively argued, “bad cuts” risk not simply a double-dip recession, but a Japanese-style lost decade.

Osborne needs to save a decent amount of money: we are hugely in debt and must pay back enough of it so that the economy can be bailed out next time it crashes. (There will be a next time, after all—capitalist economies are like that.) But the cuts also need to be fair; and they need to credibly reduce the deficit in the future without taking money out of the economy now.

There were plenty of “brave” cuts on the table for the first budget. Freezing public-sector pay was one of them—but history tells us that it catches up again in a few years’ time and so lacks credibility as a long-term measure. Cutting benefits was another—but as Peter Lilley used to remark, to save even £1bn you have to make 1m families £1,000 a year worse off. Raising VAT was there too, but since the VAT reduction that ended in January did boost spending, a VAT rise now risks pushing us into recession once more.

Of all the options Osborne faced on 22nd June, by far the best was to change the rules governing public-sector pensions so that all public-sector workers would get their pensions at 65, not at 60. This is commonplace in the private sector, and has already happened for people joining the civil service. But it should be extended to all existing public employees except the military. Alan Johnson considered this when he was secretary of state for work and pensions, but backed away. Now is the time to be brave. Thanks in part to baby boomers retiring and large pay rises for senior civil servants under Labour, spending on public-sector pensions is forecast to double in the next four years—from £4bn a year in 2010-11 to £9bn a year by 2014-15. Nick Clegg said in mid-June that this was “not affordable” and announced a commission to investigate the problem.

Of course, government cannot tell someone who is due to retire tomorrow that they have to work an extra five years. But we can say that public-sector workers have to work one month longer for every three months they are from retirement. So, for example, someone who is 59 and a half would have to work for two extra months for a full pension. A 54-year-old will work until 62; someone who is 45 or younger will work to 65. Middle-aged civil servants will cope.

Clearly this is a contractual change, and it will not be popular with those affected. It also requires primary legislation. Many private-sector firms have already closed down their pension schemes, and ultimately this is the stick that government can wield: existing workers can be told that a pension age of 65 is the price they must pay to keep their current pension scheme. Most civil servants know that retirement at 60 is completely indefensible, and few are likely to rush to the barricades over this change.

As well as traditional civil servants, this change should also apply to other groups. Police officers can currently retire at 50 on a full pension. Yet there are many police jobs that do not require an officer to be young and fit. Interviewing witnesses and suspects, for example, or running the front desk of a police station can be done by people aged 50 to 65. The firefighters’ pension scheme mirrors that of the police and, similarly, many of the roles undertaken by firefighters do not require physical strength or athleticism. We should create a new norm in which such workers have a second career stage, perhaps at a lower pay level, before retiring on a decent pension related to their highest pay rate.

How did we get into our current affordability crisis, and what can we do to avoid it happening again? The answer is twofold. First, life expectancy increased more quickly than actuaries predicted. Actuaries are good at puzzling out the risks of you dying in an earthquake or a car accident. But they have a mediocre record of predicting improvements in life expectancy. Rather than trusting their calculations, we should just assume that longevity will increase at the same rate in the future as it has done in the past. Legislating today that the retirement age for all jobs, and all pensions, will increase by one month a year in perpetuity would help to overcome sudden shocks in the future.

Second, the public sector currently provides “final-salary” pension schemes, in which the size of the pension relates to how much a person was paid right at the end of their career. This makes their finances vulnerable to workers being given big pay rises just before they retire. It is a particular problem because many public-sector workers received big pay rises after Labour was elected in 1997. Many deserved those rises, and higher pay rates did attract better staff. The cost to the taxpayer, however, was not just a bigger pay bill, but a bigger pension bill for the rest of the person’s life.

We should instead move all public-sector workers, including university faculty such as myself, over to “career average” schemes. Although some will gain and lose from this, the average person will be unaffected—and, to use the jargon, it would be “actuarially fair.” We would not be asking public-sector workers to work longer than private-sector workers; indeed, during the transition period they would still work for fewer years. They would still get a great pension, even at the cost of paying contributions for a few more years. It would be more generous to women, too, as they typically have a smaller difference between their average and final salary. This would reduce pensioner poverty, as women are much more likely to be poor in retirement, making the scheme a more progressive option than final-salary pensions.

Most importantly of all, it would deliver savings for society as a whole, starting in three months’ time. At first these savings would be small, but they would grow every three months for the next 15 years, and beyond that at a slower rate, as the pension age goes beyond 65. Overall, the trajectory is credible, which would please the markets, but it is also not fast enough to drop us into recession again later this year. And it delivers big enough savings that we might just be able to rescue our economy from the recession of 2022 as well.