A Persistent Thorn for Europe: Funding of Pensions

By: John Tagliabue
International Herald Tribune, December 27, 2000

PARIS-Like most people in France, Jean-Pierre Thomas does not come from a long line of stock owners.

"If my grandmother had owned stock," he said, "I'd be rich today."

Still, in 1996, as a member of Parliament, Mr. Thomas, now a 43-year-old investment banker, pushed through legislation to establish tax-subsidized personal pension funds in hopes of turning France into a nation of shareholders. At the time, fewer than two in 10 French adults owned stock, less than half the level in the United States.

While the bill was passed, labor unions and the Socialist Party resisted what they saw as a weakening of state pensions, and the private retirement funds were never introduced.

Such ambivalence toward private pensions is not unique to France. A similar reluctance to adopt private pensions has long been evident in much of Western Europe. But shifting demographics - chiefly falling birthrates and increased longevity - are squeezing government-run pension systems that tax workers to pay their elders. As the number of workers shrinks and the pool of pensioners grows, such plans are coming under strain.

Acknowledging the quandary, several governments have begun experimenting with alternatives, though there is still no agreement within Western Europe on how or even whether to supplement state-run programs with tax-deductible private retirement plans. Sweden recently allowed its citizens to invest part of their government pension payments themselves in mutual funds or other savings plans. The Social Democratic government in Germany has proposed a similar idea.

In France, far tamer alternatives have been put forth, but still, all action has been postponed until after national elections in 2002.

A growing number of individuals are not waiting for governments to decide. Encouraged by bankers - including Mr. Thomas, who now works at Lazard Freres - they are investing on their own, pushing up the amount of mutual fund assets under management in Europe to the equivalent of $3.5 trillion this year. While less than half of the $7.2 trillion invested in funds in the United States, it is more than double the $1.7 trillion set aside in Europe five years ago.

"People are reacting to shortfalls in the retirement system," said Michael Saunders, head of European economics at Schroder Salomon Smith Barney in London.

The effects are striking: Increased equity investment, coinciding with the adoption of the euro as a single currency, has spawned a huge new capital market that has lowered financing costs and enabled governments gradually to lower taxes. At the same time, it has given private businesses a cheaper alternative to bank financing.

To accelerate change, the European Commission recently proposed guidelines for a single European market in pension funds, to make it easier for funds to invest beyond national borders and to shift from government bonds and other fixed-income securities to stocks. Moreover, it aims to unify national tax laws and make it easier for retail investors to move their money across national boundaries.

Ultimately, the question of whether to introduce private pension funds will depend on national governments. The commission has forecast that pension fund assets in Europe will grow in the next five years to about 3 trillion ($2.77 trillion) from 2 trillion today. But more than half of that amount is managed in just two countries, Britain and the Netherlands.

In recent months, the German government of Chancellor Gerhard Schroeder has announced sweeping plans to reduce retirement benefits while allowing Germans to channel a portion of their retirement-tax payments into private pension plans. The changes, if they come, will be revolutionary for Germany, where comprehensive government pension programs were invented in the 19th century.

Still, obstacles remain. The government has not been able to agree on tax credits to sweeten investment in private pension plans, and a lobbying battle is raging among banks, brokerages and life insurance companies over the relative tax relief each hopes to achieve for its type of investment product.

Moreover, the German government has made frequent changes to its proposals and recently announced that the changes, if approved, would not come until the start of 2002, one year later than anticipated. Thomas Weisgerber, a specialist on retirement at the Association of German Banks in Berlin, said the frequent changes had made critical discussion of the legislation akin to "target shooting at a carnival."

In Sweden, long known for cradle-to grave security, the change has been even more extensive. Retirement benefits are no longer fixed but vary according to average life expectancy.

Under the most significant change, Swedes as of January will begin to funnel a part of their social security payments into investments in mutual funds. Swedes will have roughly 500 funds to choose from, offered by domestic and international asset managers.

Hence, the trend toward stock investment is expected to continue.

In Sweden, the changes could produce a gradual shift as much as to $16 billion from bonds to stocks; in Germany, the banking association expects private pension funds to take in as much as $28 billion annually by 2008.

Italy scaled back pension benefits in the early 1990s and introduced private pension funds, and Rome recently announced tax credits to make investment more palatable.

But Tito Boeri, a pensions specialist at Bocconi University business school in Milan, said that Italians, after paying high social security taxes to support the pensions of their parents' generation, have little set aside for their own retirements. Moreover, pension funds are often too restrictive in their asset management.

"Their portfolios are mainly bonds, and that's too conservative for young people," he said.

In contrast with the United States, where the Social Security system continues to record surpluses, the retirement funds in several European countries already operate with losses that must be made up from the general government budget, contributing pressure toward increasing taxes. Italy, for instance, has an unfunded retirement pension obligation amounting to an estimated 1.5 percent of gross domestic product, or about $18 billion annually, so that in recent years it has had to devote 3 percent of the general budget to cover the gap.

Complicating the debate is the way that retirement plans influence the competitiveness of individual European countries, because of the effect pensions have on the level of payroll taxes companies pay. Moreover, many European politicians and business leaders argue for the creation of private pension funds as a counterweight to U.S. and British funds, which have poured billions of dollars into the Continent as European industry has reorganized to increase its competitiveness.

"At the moment, our companies are paying dividends to American funds," said Mr. Thomas of Lazard, "benefiting retirees in Texas."

Of course, as in the United States, the debate over retirement in Europe has also led to ideological sniping. Nowhere is the clash more evident than in France.

On one side stand the Socialist-led government and the labor unions, which accept the need for an overhaul of the retirement savings plan but fear that introducing government support for private pensions will favor mainly the wealthy. Opposing them are French business leaders and a growing number of citizens who have been touched by the new culture of share ownership.

In recent months, the government has proposed changes, including the creation of a reserve fund, a plan to equalize benefits in government and private employment, and a proposal for 10-year saving plans with tax credits for small and medium-sized companies. (France does have private pension funds, but they are only accessible to government civil servants. There are also short-term tax-deferred savings funds, but they are not considered adequate for retirement savings.)

The Communist-led labor union CGT has called the savings plans "close to pension funds" and hence a threat to a fair distribution of benefits.

At the more moderate CFDT labor union, Jean-Marie Toulisse, the chief pensions negotiator, approved of the savings plans as long as they resulted from union-employer negotiations and all workers had equal access. But he criticized the government for postponing most pension decisions until after the next elections.

"The longer we wait to make decisions," he said, "the more brutal the decisions will have to be."

Meanwhile, French business pushes ahead, offering employees stakes in their future through share ownership.

Take Alcatel, the French global electrical manufacturing giant.

This year the company introduced a stock-purchase plan for its employees, and 59,000, roughly half the total, signed up - including 60 percent of the French employees. Pierre Le Roux, the executive who created the plan, said it was "completely independent of the pensions issue" and was intended to motivate workers.

The embrace of shareholder culture is one sign that French workers may be more amenable to risk than the elites assume. Another is the willingness of Alcatel engineers to work abroad. After a series of acquisitions in the United States, the company began a "Go USA" program to recruit 250 French engineers willing to relocate. More than 1,000 French employees applied.

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