28 May 2013

Deutsche Bank: Deficits in French pension schemes – Need for reform

The predecessors of President François Hollande have already made efforts to mitigate the financing of pensions to former civil servants and of the public basic pension schemes for private-sector employees. Thus, by the end of the decade – this means faster than in Germany – the retirement age for a full pension will be raised from 65 to 67 years. Nevertheless, rising deficits in the pay-as-you-go basic pension system indicate further need for action.

The rising deficits of the pension schemes reflect high, too rapidly expanding expenditure which in view of high unemployment and continuing weak growth is increasingly difficult to finance. At 15 per cent of GDP (2011), France spends most on state pensions EU-wide, after Italy at 16.5 per cent. At 11.6 per cent, Germany ranks below the eurozone average (2010: 12.2 per cent). In 2000, the German government spent more in terms of GDP (12.3 per cent) on pensioners, retirees and surviving spouses than France (12.2 per cent). The current French pension expenditure ratio is a surprise in view of France's relatively favourable population structure. For every 100 persons of working age from 15 to 64 years, there are just below 26 persons aged 65 and above in France. By contrast, this compares to roughly 31 in Germany and just below 28 in the eurozone on average. 

If the demographic situation is not to blame, the level of pensions could be taken into consideration. Workers' basic pensions are not overly generous, though. The gross (wage) replacement rate after working 40 years is close to 56 per cent (due, among other things, to a minimum pension) for a low-earner and slightly above 49 per cent of the final salary for an average earner. This means France is roughly in the middle between the relatively high level of Italy, at 64.5 per cent, and the lower coverage in Germany, at 42 per cent.

All in all, the level of pensions in France – at least in the private sector – is not excessive. Rather, major problems are due to the mode of pension calculation and, in particular, wide-spread early retirement. In contrast to the statutory pension insurance in Germany, the level of individual pensions in the French basic system is not geared to total life income (subject to mandatory contributions) but to the "best" 25 years with the highest incomes. This tends to favour persons whose income in the course of their working life rises strongly or fluctuates considerably. Above all though, early retirement possibilities weaken French pension schemes. After 2017 as well, the end of the ongoing adjustment since 2011, long-term insured in France may retire with a full pension already at the age of 62. Before the correction, the minimum retirement age was even only 60 years. However, the early drawing of a full pension presupposes a minimum period for which contributions must have been paid that is currently being raised as well – from 40 years for people born before 1951 to 41.5 years for those born after 1956.  Only 10 years ago, just 37.5 insurance years sufficed for a full pension from the age of 60. 

Given France's labour market problems a hike in social security contributions is rightly not on the agenda. The French economy is already overburdened by social security spending that is equivalent to more than one-third of labour costs and thus reduces the price competitiveness of French industry. At €35.91 per hour (in 2011) France has the second-highest  industrial labour costs in the eurozone after Belgium – and ahead of Germany (€35.66).

Adjustments will thus have to be made to benefits. This applies even more so given that the gradual entry into retirement of the baby boomer generation is also sending expenditure rising in France. Experience gathered in Germany suggests that early retirement schemes should be strictly limited. However, President Hollande has repeatedly opposed another increase in the minimum pension age. One alternative would be to increase further the duration of employment required to receive a full pension and/or to speed up the current adjustment process. There is also discussion about basing individual pensions on the total length of time that contributions have been paid rather than the best 25 years.

Full analysis

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