The debate surrounding the viability of our current pension system has been at the forefront for many years and many economists have been sounding the alarm about the system’s fragility and inviability. Before analyzing the Spanish pension system, its current situation, and the legitimacy or illegitimacy of the pensioners’ demands, we must understand what we consider pensions. Even though retirement pensions are the first thing that come to mind, there are indeed other kinds of pensions to be included under this umbrella. There are five types of pensions in the Spanish social security system: retirement, permanent disability, widows’, orphans’, and other survivors’. This article will mainly focus on retirement pensions, which absorb 71% of the funds allocated to all pensions in Spain.
Spain currently has an allocation system that allots contributions from current workers to pay the pensions due in the same period. This means that what we contribute as workers is not allocated to paying our own future pensions, but rather to paying the monthly payments of today’s pensioners. There are, of course, alternatives to this system, namely the capitalization system and the mixed system. The capitalization system consists of each worker’s contributions being capitalized over the course of their working life, i.e., they are reinvested during the years in which the worker is active so that when they retire they have their own capitalized savings, with accumulated interest. An alternative to these two systems is the mixed system, where a portion of the contributions will be paid out to current pensioners while another portion acts as a personal piggy bank for each wage earner.
The justice or injustice of the current allocation system can be debated. However, what is increasingly clear and now doubted by almost no academics is that the current allocation system is incredibly beneficial for today’s pensioners. Estimates indicate that pensioners in Spain receive (consume) all the contributions made (and those paid in by their company) over the course of their working life within the first 15 years of retirement. This means that if current pensioners had a capitalization system in which they only received what they put in, and not the allocation system they currently enjoy, they would receive payments until they were 80-82 years old at the current pension rates. At that time they would stop receiving payments.
The data easily prove these figures. If we assume that a worker contributing to the general scheme with an average contribution of 2,500 euros over the course of their working life (they would contribute less at the beginning and more at the end), between contributions from the worker themself and their company, they would pay 725 euros per month (in 14 installments, 10,150 euros/year). With 40 years of contribution and capitalizing those payments, they would come close to 550,000 euros of current value, i.e., in “today’s euros.” If that worker is currently receiving the maximum pension (37,231 euros/year), or close to the maximum (which is common if they made larger contributions in their final working years), we find that the figure of 15 years is accurate and not at all far from the truth.
Let’s now analyze the data about the average pension and its evolution in order to contextualize it vis-à-vis wage earners in Spain. According to data from the end of April 2009, the average retirement pension in Spain was €1,135.25, following the upward trend in the pension system over the course of time. According to 2019 data, in the period from January to March, retirement pensions went up 0.56% per quarter. This percentage may seem low, but if you consider it as an annual figure, it is 2.25% per year. There are several reasons for these increases. First, there has been an increase in the number of people retiring and accessing pensions. Additionally, these new pensioners earn more, i.e., they contributed at higher rates than those who were already in the system and they enter into that system with higher-than-average pensions. Finally, and separately, the 2018 decisions on pension revaluations need to be factored in. In 2013, a budgetary agreement was reached linking the growth of pension payments to the growth of the Spanish economy and the balance in the social security coffers. This agreement was revised upward in 2018, linking the rise in pensions to the consumer price index and increasing them 1.6% (consumer price index estimate) generally and 3% for minimum pensions. Considering that estimates from the Bank of Spain put inflation in 2020 and 2021 at 1.60% and 1.70%, respectively, it is clear that the cost of this line item will continue to grow with a linked system.
So are the demands that we have seen in the streets of Spain over the last year from pensioners (mostly retirees) fair? In order to answer that question we must analyze a great deal of data and contextualize the situation of these pensioners with regard to the situation of workers.
The average wage in Spain in 2018 reached 1,677 euros per month. With the average retirement pension of 1,135 euros/month, a retiree in Spain earns, on average, 67% of what a worker earns, a high percentage compared to other comparable countries. Upon analyzing how high this percentage is, we should consider the kinds of expenses workers and retirees have. The former case is comprised of families with heavy financial burdens and a number of dependents, while latter have largely paid off their debts previously. Therefore, there are a great deal of pensioners today with higher incomes than workers.
The evolution since 2008 both for pensions and wages has widened favorably for pensioners. Since the global financial crisis in 2008, the average wage in Spain increased around 20% over 10 years. Retirement pensions far exceed this increase, with the average pension of 806.42 euros in January 2008 rising to the current average pension of 1,135 euros (+40%).
Connecting these two data points with the advantageousness of the current allocation system for pensioners, it can be said that the system is far from sustainable and the demands for increased pensions are certainly not an act of solidarity for the people who currently fund them, the workers. And an increase in contributions would not help, but rather aggravate the problem. Increasing contributions for companies will automatically increase variable costs and have the ensuing consequence of lowering hiring rates. Moreover, diverting greater amounts of resources from workers to pensioners would have a detrimental impact on the economy that is worth discussing. The marginal propensity toward consumption, i.e., what each person spends per euro earned is much higher in the segment of wage earners than in the segment of retirees. Demanding greater contributions from the former inevitably deprives the economy of consumption spending, detracting resources from one of the segments of the population that consumes the most and is also one of the most dynamic with regard to investing, and gives it to a segment that is much more conservative.
The viability of the system is another problem. The increase in the average pension discussed above is combined with an increase in overall pension expenditure. Without delving too deep into this topic, I’ll provide some data. The deficit generated by pensions in 2018 in Spain was 0.9% of the GDP, while government estimates for the coming years set that deficit at 14 billion euros in 2019, 11 billion euros in 2020, and 5 billion euros in 2021. Even if these notably optimistic projections are met, the aggregate deficit from these three years would be 30 billion euros, and this deficit must be financed by something, i.e., by issuing debt or increasing taxes. If this figure is divided by population of 47 million Spanish people, each citizen, including children, would be required to pay almost 640 euros only for this line item. Remember this is in the event that the optimistic projections are realized. We are therefore clearly facing a sustainability problem whose solution is not to attempt to indiscriminately increase pensions or contributions, much less taxes.
The first option is quite unsympathetic, while the second and third are ineffective from an economic perspective. Current politicians dance around these two points and, to borrow a medical metaphor, attempt to treat infections with aspirin, in other words, to fight the symptoms, but not the root cause. The root cause of the problem in Spain is twofold: employment and low birth rates. Employment policies where companies and universities work together to enrich society with high-quality workers should be urgently promoted as a national priority. Secondly, the government must put forth policies that incentivize an increased birth rate, though no longer with subsidies, which has been proven to be little more than a diversion of income. These policies must be fiscal, incentivizing working couples to have children with significant tax benefits on their tax returns. Only this way, with more high-quality jobs and incentives to increase the birth rate, will we be able to attack this problem at its source and have a healthier and more balanced society in which we all participate and get our fair share in the future.