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Ranking countries on retirement issues [ClearOnMoney]
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Ranking countries on retirement issues

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Commentary

Ranking countries on retirement issues

12 Dec 2012 by Jim Fickett.

A common problem for many nations today is rising retirement costs, often due both to an aging population and unrealistic government promises; and difficulty funding those costs, due to already-high deficits and debt. As one looks at international investing options, it would be nice to have a summary of how the problem, and its likely outcomes, differ from one nation to another. This post is about a study that provides at least a partial answer.

I was particularly motivated to find some comparative information when, in my ongoing study of Brazil, I was very disappointed to see that the demographic advantage of a relatively young population had been squandered by Lula's government, when Brazil put in place truly extravagant pension promises. So Brazil also has a problem, but how does it compare to other nations?

The Global Aging Preparedness Index, an October 2010 report from the Center for Strategic International Studies, provides very insightful analysis across 20 countries – Australia, Brazil, Canada, Chile, China, France, Germany, India, Italy, Japan, Korea, Mexico, Netherlands, Poland, Russia, Spain, Sweden, Switzerland, UK, and US.

The GAP Index study ranks these 20 nations on two main scales. One, the Fiscal Sustainability Index, is meant to measure whether retirement costs, on current trends, will be affordable in the future. The other, the Income Adequacy Index, is meant to measure whether elderly people will have enough to live on. Obviously, there is some tradeoff between the two.

The rankings within each of the two main indices are in turn based on rankings within several contributing factors. The Fiscal Sustainability Index, for example, has three component factors: (1) The overall cost, as a fraction of GDP, (2) the fiscal room for maneuver, and (3) a measure of how dependent the elderly are on government programs, and hence how much political resistance there may be to reform. There are further levels of component breakdown. The fiscal room for maneuver looks at whether it would be feasible to raise taxes (looking at how high taxes would go if all of the cost were funded in this way), whether is would be feasible to borrow (looking at how high government debt would go if all of the cost were funded in this way), and whether it would be feasible to crowd out other spending (looking at what fraction of the total budget would end up paying retirement costs). At each level of breakdown, countries are ranked, and then the rankings are weighted and combined.

All projections are based on current law and middle-of-the-road economic assumptions. They are thus certain to be wrong in detail, but do at least provide a reasonable basis for comparison.

Here are the GAP Index rankings (1 is best, 20 is worst):

Fiscal Sustainability Rank Country Income Adequacy Rank Country
1 India 1 Netherlands
2 Mexico 2 Brazil
3 Chile 3 US
4 China 4 Germany
5 Russia 5 UK
6 Poland 6 Australia
7 Australia 7 Sweden
8 Japan 8 Chile
9 Canada 9 Spain
10 Sweden 10 India
11 US 11 Canada
12 Korea 12 Japan
13 Switzerland 13 Poland
14 Germany 14 Switzerland
15 UK 15 Russia
16 Italy 16 France
17 France 17 Italy
18 Brazil 18 China
19 Netherlands 19 Korea
20 Spain 20 Mexico

Note that being high on one of the rankings does not necessarily mean the country has found an optimal solution. India came out number one on fiscal sustainability simply because there is almost no social safety net, not because they have carefully planned ahead and funded a program adequately.

Adequate income for the elderly may mean an unaffordable burden for the country, as in the case of the Netherlands, or vice versa, as in the case of Mexico. But some countries seem to have found a way to provide reasonably well for the elderly with a program that is still affordable, like Australia, while some seem to have an unaffordable program which still provides inadequate income, like France and Italy.

Brazil, despite having a fairly young population, with the proportion of the over-60 population to working-age population projected to be quite favorable for decades, has the third worst Fiscal Sustainability rank. So, indeed, those horrified by Lula's pension promises are not exaggerating – Brazil has a serious problem.

It is easy to argue with some details of the methodology. For example, the fiscal room to maneuver index uses net rather than gross government debt, which severely weakens that component of the rankings. But overall I think the methods are solid enough to give a useful ranking, and to help one understand a number of investing situations. For example:

  • The fact that Japan comes out in the middle of both rankings shows that pensions are not the main problem springing from the aging population. Rather, the problems are (1) a shrinking workforce, and hence weakness in the overall economy, and (2) as the elderly spend their savings, there are fewer buyers of government debt.
  • This is very discouraging for the overall case to invest in Brazil. Many people cite favorable demographics as one of Brazil's great strengths. But with a pension system that encourages people in their prime not to work, much of this advantage is gone. And with government spending on retirement taking a rapidly increasing share of the budget, badly needed improvements in roads and ports become less likely.

It is worth consulting this study any time one is considering a new investment destination.