Pensions in Japan

Transcription

Welcome. My name is Jan Libich and I'm really thrilled to be sitting here with Professor John Piggott from the University of New South Wales. Welcome John, thank you very much for joining me. Thank you Jan. We're here to talk about pension economics and retirement financing, which is a very topical area. John has a lot of expertise, both on the research front and on the policy front. You've advised many governments over the years on pension reforms. That's right. So let's start with the main problem. What's the main problem with many countries' (in continental Europe) pension system? What's all this fuss about? Most countries are now looking at their pension systems and they're looking to change them in some way, and the underlying motivation for that comes from population ageing. So, population ageing has two pieces to it. It's got more than two pieces to it. It's got two important pieces to it and they are: increasing lifespan - so people are now living a lot longer and I'll talk about that in a minute - and people having less children. Both of those changes in the way human lives are being played out, and society is being played out, have a dramatic effect on the institutions we have around pensions and retirement. So, what's the problem financially? Well many countries have very generous pension promises that governments have made and they finance those pension promises from workers. So the workers pay a contribution and then when it comes to retirement they receive a retirement income, but the retirement income that they receive is actually being financed by the newer generation; the younger generation of workers who are making their contribution. So we call this 'Pay As You Go' (PAYG). So the contribution doesn't actually go to a separate fund or an individual account, it just goes to a common pot of money? It goes to a common pot of money. Sometimes reserves are built up because you'll go through a period where there are a lot of workers and relatively few retirees and then that might switch and you might have fewer workers and lots of retirees. So there's a build-up of reserves through that first period but that's very different than pre-funding. It's very different from a situation where an individual might save assets to accumulate for his retirement. I think that's a quite different kind of reserving. So due to population ageing if we have few workers and we have a lot more retirees, could it be the situation that someone has contributed all their life towards their pension but then the money dries out and there's really no pension that the government can pay that person? Could that hypothetically happen? Well I think that's very extreme but I think it's certainly true that ... Well, we must make a number of distinctions. Let's think about developed economies. For example, you mentioned Europe - developed economies in Western Europe, or in North America, the US or Canada. What's been happening there is that some of the promises are broken. It's not that you don't get any pension anymore, I think that's a very unlikely scenario but, for example, pensions are indexed. A lot of pensions were initially indexed to wages - to wage growth. So as wages increased in the community at large, pensions would go up. Then countries switched that, they said: "No, we can't afford that. We'll only index to prices." That amounts to cutting the pension... That's a form of a pension cut. Or they'll say: "Well, we promised this at age 60 but we can't really afford that anymore, so we're going to move that to 65." Or they'll say: "We have this survivor benefit (once you die) for your spouse. That used to be three quarters, we'll make that two thirds." So these are all kind of hidden ways that governments are taking away... These are all kinds of hidden ways of reducing the pension liability that these countries are confronting. The underlying reason for that, is that they're either already - in some countries like Japan, or Germany or Italy - or anticipated in other countries, like France - there is going to be a financing problem. The only way to solve that financing problem, other than by breaking promises, is to increase contribution rates. The increase in contribution rates is going to be a big negative around labour supply. So countries are now finding themselves kind of between a rock and a hard place with demographic transition. You mentioned population ageing that's underlying a lot of this and you're Director of an Australian Research Council centre for population ageing research. So can you just outline what the Centre does and how it feeds through... there are obviously other areas that we're not going to focus on - other areas like healthcare and other potential negative consequences of ageing. Sure. So I got involved with pension economics in the early 1990s and once I'd been in that area for five years, it was clear to me this was a multi-disciplinary issue. It's easy to find examples of that... so, the link for example, between retirement and health. Immediately you bring in healthcare. The link between trying to manage your own financial assets in retirement and cognitive decline. Immediately you're looking at economics, you're looking at psychology. The whole question of where increases in life expectancy come from is a demographic question, it's an actuarial question, it's an epidemiological question - not an economic question. That's very interesting. Let me take that last example. If you take the period between 1950 and 1980 in many countries in the world, life expectancy at birth increased, but life expectancy at age 50 didn't do very much. Between 1980 and 2010, life expectancy at birth has sort of continued to trend up a little. Life expectancy at 50 has exploded. So, in Australia's case, between 1980 and 2010, life expectancy at age 50 went up by seven years. That's huge! And all of that is pension-years. All of that is liability for pensions because most of that increase in life expectancy occurs after people expect to retire. You mentioned Australia and obviously we will talk about the Australian pension or what's called superannuation system a bit later, but just coming back to the main problems many countries are facing - what are some of the solutions? I mean the World Bank distinguishes these Four Pillars. Let's talk a little bit more about that and the way it fits into the pension reform. Well, one possible approach to thinking about it is to think about countries' stages. So, if you go back a few centuries in Europe, or if you go back half a century in much of Asia, you have economies and social systems where people didn't move very much. Where the most important source of retirement support - 'old-age support' I suppose you'd call it - people pretty much worked until they couldn't work anymore; but then, they relied on their family and their family was close by. That's changed completely. Families now scatter. We have a globalised economy and with that distance comes a weakening of family commitment. So, if you take China at the moment, I mean Asia is very keen on promoting the idea of filial piety- and support for parents - but that's beginning to break down. How many migrants are there in China? There are 150 million migrants in China, regional migrants - people who have moved out of rural areas into urban areas. They send money back home for some time, but it would be a big ask for many of them to return home and look after frail parents. So you need other systems to build in and as soon as you stop relying on the family and start relying on something else... well, what else is there? Well, there's markets. Markets work very badly unstructured in this area. You can make markets work in certain circumstances but you need strong governance and you need a strong financial system and you need good government regulation to make that work. And again, that's one of the challenges at the moment for Australia. If you don't have that, the only other way is to have direct government payments, and that's where most countries have gone. And they've gone there over the last century. And we should say the idea of the government stepping in and looking after the pension system, the idea is the government kind of playing the role of risk manager. There's a risk that everyone's facing - that they'll live for a long time - although that's a nice type of risk, and that the assets that they might have accumulated are not going to be enough. So, the government's kind of insuring people, 'look if you die earlier, you're going to contribute more, if you live longer, we're going to look after you'. But again, the demographics is making this system unsustainable. Well, it depends how you do it, but yes. The sorts of pension promises - social security promises if you like - that were made in Germany were very generous and retirement age (what I think of as 'pension access age' - often you don't actually have to retire), pension access age started quite early and people were living very long with these very generous pensions, which were not flat rate. They were geared to your final salary or maybe the average of the best ten years of your career, or something like that - and that's what's become unsustainable. So Germany at the moment spends ten per cent of GDP on social security - on pensions. Australia's figure is more like 3.6... Australia's figure is about three per cent. So you can see how different that is. Now some of that is Germany's old and we are young. Australia is a younger country. Some of it is also the nature of the promise that is made. And in terms of the ageing, just for people to get a sense of the magnitude... If we look back forty years ago, there would've been say 6-7 workers per one retiree. And that's obviously changed. It's now more like 3-4. What's the projection for forty years into the future? A number that strikes me is the Japanese number, it's around 2.5 now. It'll be 1.2 by 2050... 1.2 workers for every retiree. I mean, how can you manage that? That seems extraordinary. That is quite extraordinary. We talked about the World Bank, so let's think about 'The Pillars', for people to get an idea where it fits. So we mentioned the Pay As You Go system, generally the First public Pillar. And Australia moved and put all the emphasis on to the Second Pillar. Can you briefly describe what it's about? Well, the way I like to think about the Pillars, is the First Pillar is around poverty alleviation and that's almost always government funded. Now if you do that in a way that is linked with everyone's wages, then high-wage people get a lot of money and that's costly to whatever source it is - the current workers' contributions in most cases. What we did in Australia was to have a flat rate pension which is set at a level which takes most people out of poverty, and in addition, we did something else. So this is the Zero Pillar in Australia I think... Yeah, well I would call it the First Pillar. I mean there are many different ways of thinking about Pillars, right. So I work with a Three Pillar system. The First Pillar is around poverty alleviation, the Second Pillar is around income replacement, the Third Pillar is around encouraging further saving through tax breaks. So there's those Three Pillars. The Third Pillar is voluntary. The Second Pillar is some sort of compulsory participation in income replacement. The First Pillar is poverty alleviation. Now many countries combine those first two Pillars. They have a social security system which is paid out of current tax dollars and which is linked to income and then it's kind of got a minimum associated with it and that's the poverty alleviation piece. But you've got to contribute to belong. So that means if you don't contribute, you fall outside that net. And you still have an old-age poverty problem - lots of people fall outside the net. So what we did in Australia - and I'm a strong advocate of this - is to take that poverty alleviation piece and say that flat rate, we'll make it at a level that's just enough to take people out of poverty but we'll means test it. So if you're very rich, you won't get it. So it's not like many means tests around the world, which is sort of targeting a payment at someone who is destitute. What it does is it excludes the affluent. So I think of it as affluence tested. And that saves maybe a third of the bill relative to something which is flat. And you want progressivity built in the system. And there's some progressivity in that. Basically, it's taking a lot of people out of old-age poverty. Half the elderly population get a full pension and a quarter get nothing and a quarter get something in-between, roughly speaking - they're the rough numbers. And that seems to work pretty well for us. As you said earlier, at the moment that's costing us three per cent, and in 2050, even after our population ages, it will cost us five per cent or thereabouts, of GDP. Belgium, by contrast, in 2050, will be paying seventeen per cent. So when people say, "oh, what we have is unsustainable" as a pension system in Australia, I'm never persuaded. Again, the reason it works and the reason the bill is fairly small is because we have the Second Pillar. Can you describe what it's about? Well, yes, I mean that's actually putting it backwards because we had the First Pillar for a long time and no Second Pillar. We had that aged pension for a long time before we made income-related pensions compulsory. So that only happened in the 1980s and 1990s. We've had the aged pension since 1909, which is early on, not too many countries had anything prior to that. So nine years after Federation we had an aged pension system. It's worth noting that - it's quite an achievement in a way. And we didn't have a population ageing problem back then. Back then we did not have a population ageing problem! So, in terms of the Second Pillar, how does that work? It's private, it's funded ... So, in contrast to most OECD countries, I think that's the first thing to say, but not everywhere - a few countries have this - we have something which I think of as 'pre-funded'. So it's compelling individuals to save for their own retirement. And they save through - it's workplace based - and the workplace is compelled to put a portion of wages into a separate account which is administered by an insurance company or by a wealth management firm (something which is registered). And that accumulates and when you reach the point which you need it, which is pretty much after the age of sixty, except in exceptional circumstances, you have a lump sum which you can use towards your retirement. That's how it works. So, this goes under the defined contribution system... It's a defined contribution system. When we talk about the superannuation guarantee in Australia, the only thing that's guaranteed is the contribution. Not the benefit. Not the benefit. Some countries tend to have both the contribution defined and the benefit. So ageing basically makes a discrepancy between the two. That's right. So if you preordain the benefit relative to salary and then social or economic circumstances change, like you're going to live for longer, or interest rates are lower, then the only way you can make that system continue to balance is to vary the contribution. If you've pre-set both, you're going to have a system which is unsustainable. And when we talk about the division, there are a number of ways that you can have the individual accounts where people or the employers put the money to. This is what we have in Australia, it's what's called the FDC, the Financial Defined Contribution system, so it's the pre-funded system. Some countries have gone the route of not having it managed by the private sector, but having these notional or non-financial accounts. How does that work? So it's kind of a hybrid... Well the non-financial, sometimes more commonly called Notional Defined Contribution (the NDC system) is usually a place countries go as a way of systematically modifying the unsustainable promises they previously made. So you begin with a defined benefit Pay As You Go system. You've made this promise and now you realise that demographic change is going to make that promise unsustainable. So you say, we're going to reform the pension system and what we're going to do instead, is we're going to pretend that you have accumulated an amount of money through the contributions you make in working life. We're going to come up with a notional asset value at the end of your working life and then we're going to pretend that you buy an annuity - and we'll price that annuity in terms of your life expectancy, then in terms of prevailing interest rates, and so forth, and whatever that is, that's what we'll give you. So, no longer are we making a defined benefit promise, we're making a promise based upon a notional accumulation. So that's why it's called a notional defined contribution. I mean, the money may still not be there. The money is not there. But at least people know how much they've contributed to the system. They know how much they've contributed. What they don't know is how much they're going to get. So it's a more systematic way of doing the reforms that other countries have done in the way that I was describing earlier - by raising the retirement age, by changing the indexation or the survivor benefit. Instead of doing that, you're saying: "Well now it's all up for grabs, we're going to pretend this is in the market and offer you what the market might have offered." And the advantage of doing it more systematically is that you can have some kind of inbuilt mechanism. Some countries have a reserve fund, some countries have a balancing mechanism ... can you briefly describe this? What happens there is those countries say: Well we're not going to leave this completely up to the market. So, if interest rates go down, we're not going to reduce your annuity payment automatically, however, if things get too bad we'll introduce this balancing mechanism where everything suddenly gets changed. So Japan, I think, has done that. Sweden has done that. How does it work? When you add up all the liabilities of the system, you add up all the assets, and if the liabilities exceed the assets... Yeah, by some margin I think then there's some sort of cut off. There's a cut across the board. That's right. Some people argue that the system where the government gets involved might in some ways be superior, maybe cheaper. Three weeks ago I interviewed Professor Bruce Chapman who was the architect of the Australian system of government-run student loans that are contingent on income. One of the advantages of the system is, because the government can do it in bulk, and because it can use the existing tax system for collection and so on, it does it much more cheaply than if the student loans are financed through private banks. Indeed, and I think the private pension system that we have is expensive in terms of the administrative burden. What are the average costs of pension funds in Australia? Oh, they vary a lot. Numbers like one per cent come to mind, but that needs to be checked because there's a large range of costs associated. One reason there's a large range of costs is we're pushing individuals to take more control. This is something that is happening world-wide - individuals' responsibility for their own retirement. That means they've got to know stuff they never used to have to know, and so there is an advice market. So an important reason why some of these are expensive and others cheap is that the expensive ones usually come with advice. Now, the advice may not be good, it might be but it mightn't be, but I think that's an important component of the underlying cost which is missing in the cheaper funds. That's true and it seems like another part of the cost is the fact that there's usually active asset management on the part of the fund. Yes, that doesn't always happen, but that's true. And you know, some of the critics of the system say that there should be a lot more emphasis on using some passive index funds and so on. I think there's good sense to that, because administrative costs can make quite a big difference. They don't sound like a lot because they're expressed as a proportion of assets but that means actually they're a deduction from the rate of return. So if you have a system which is offering you, let's say five per cent and then you add on an extra one per cent of costs, so now it's four per cent, that can make... And you're talking nominal, so in real terms that might be... if you had inflation... Yeah, in real terms you might be going from two to one. So you get to retirement it can make a difference of thirty per cent in how much you've accumulated, just that one percentage point difference. So it's more significant than people think, and it is, I think, a legitimate reservation about the arrangement that we've come to here. There might be some potential other disadvantages we might talk about later, but let's think about the advantages of the system compared to unfunded Pay As You Go systems. So we mentioned the transparency. People can see how much they've saved and so on. Are there any other advantages? For me, the important advantage is its sustainability. As I said earlier, when people tell me the system is not sustainable I can't really believe it when you look at these comparative numbers. I think what we have is a system which is sustainable for half a century, maybe longer, maybe a century. Over which time fertility behaviour could alter dramatically. I mean there are assumptions made about what fertility will be like in 2050 or 2080 but you're talking about the fertility behaviour of women who are yet to be born. I think that's a very risky thing to do. So we might go back to having 4 or 5 kids! I think sometimes people criticise these predictions for ageing, saying that they're based on shaky numbers, but it seems to be one of the most robust facts in economics that when people get more prosperous, in other words, they get more income, fertility rates go down. And there's been an immense change of the world, even countries that we always thought about as low income and high fertility countries now have basically half the fertility rate...Bangladesh, I think, now have 2.5 kids per family, and going down from five just twenty years ago. I mean the whole world is a very different place compared to what it was thirty years ago in terms of fertility. Yeah. There's never really been a comprehensive study to explain why fertility rates decline in different countries at different times. So everybody knows that Japan is the oldest economy in the world. The reason is, its fertility plummeted in 1952 or 1953. So, why did it plummet then, and not ten years later like in Australia? Well that's not clear. It would be very interesting I think to try to put together a study which looked at the timing of fertility declines around the world, because that would tell us a lot about what the underlying causes of fertility are. So that's that. But you're right that population ageing is a global phenomenon, that median age is going up in almost every country in the world, and that the two reasons for that are: people are living longer and they're having less kids. That's certainly the case. It seems to have implications for other areas, not just pensions, but financial markets, healthcare, housing markets and so on. We might discuss those a bit later, but going back to the advantages of the system, it seems like it's a lot more flexible. So you can choose your fund, that you're going to accumulate your savings through, you can choose the investment strategy, so people that are more risk averse can be more conservative in their investment, you can retire earlier if you have accumulated enough assets. It is more flexible. Its flexibility is, other things equal, good. There's a lot of evidence though that people aren't all that wonderful at committing to things that are a long way off. We all know that. And it's getting worse, actually. I think a generation ago people were a little bit more patient, and had a lower discount rate... Yes. I gave a talk at Aged Care UST last week, and I said "if I asked you before this session begins whether you're going to have an apple or a chocolate brownie at morning tea, you'll tell me an apple. When you go out at morning tea time, you'll have the chocolate brownie." So the idea of committing in advance is at odds with flexibility. So I think that's one reason why we have these kinds of structures. If we really believed people made optimal decisions throughout their whole lives then social security would not exist. This is one of the things that critics point out. Why do we need the government to get involved in the first place? Why do they have to mandate people's savings? Is it the psychology that we're impatient? I think that's the reason. Well, impatient and I mean, in some ways we know, we'd be prepared to pay something to organise a commitment to the future. And that's kind of what we're doing with social security and kind of what we're doing with the Australian system. Some say it's costly. Yes it is, but it does ensure there's something there when you're 65. And I think increasingly, it's going to be - there's something there when you're 80. And that's a whole new issue around cognitive decline, and how we do that. That's an open area of policy debate. One of the things that get debated about the Australian system is whether it's fair. Is it fair that when someone passes away prematurely the family can inherit it? Is it a good thing or is it a bad thing? I am an advocate of greater equality and if you came to me with a credible proposal to increase aged pension benefits, for example, or to say that instead of the top quarter not getting it, maybe the top third should not get it, I think you'd be able to persuade me if the case was a reasonable one. So I'm supportive of that. I think there are two pieces that people miss in this whole question of inequality. The first is that if you take taxes and transfers generally in Australia and you compare how the dollars go from rich to poor between Australia and other OECD countries, we are far in the way the best. We are the most efficient at getting rich tax dollars into the hands of the poor, and an important reason for that is that we do not have conventional social security which pays benefits to rich people. So, that's an important reason, not the only reason why, but it's an important reason. I think it says something about how bad the other systems are because there's a lot of middle class welfare in Australia. There's a lot of tax churning... That's true. I'm not saying we're perfect by any means. We're not. There's huge room for improvement and I agree about middle class welfare that we could do more to rein that in - I agree with that entirely. But I find much of the debate around inequality and retirement incomes in Australia rests on the notion of tax expenditures associated with superannuation payments. So superannuation is tax-preferred and the tax expenditure estimates that are generated presume that the best system, or the benchmark system is a comprehensive income tax. Well, it just isn't! We don't want a comprehensive income tax and it's never existed anywhere and countries which have tried to approximate it have done badly. It's extremely bad for growth, it's extremely bad for asset allocation. Because of labour market distortions? Yeah, well because it messes up the ways in which different assets are taxed. The owner-occupied housing for example is always omitted. So, that's a major lifecycle asset. If you tax the only other major lifecycle asset - which is your pension accumulation - differently, very differently, then people will move into housing. And that happens. So the housing market goes out of control then. You need a system which recognises that there are some kinds of saving and investment which is for your retirement, it's not for a trip next year or something; it's for your retirement. And that needs to be treated where the tax system does not distort the prices of that future consumption from the price of your present consumption. To do that, you need not a tax on income, but a tax on expenditure. Once you do that, these enormous numbers that people quote as to the cost or the lack of sustainability of the superannuation system goes away. Not completely, and we could improve it, we could make it more like an expenditure tax than it is, but the vast bulk of it, the big quantitative wave of that argument goes away. And I think that's the second thing that's missed. Those two pieces. First of all, overall we do well, comparatively speaking, in getting rich tax dollars to the poor in terms of transfers and secondly, we should not be using comprehensive income as a benchmark to measure the tax cost of superannuation or owner-occupied housing. And it's true that the general sales tax or some kind of indirect taxes are much bigger as a proportion of the tax revenue in many European countries than they are in Australia. That's true. And we could use more of that; we're going to have to use more of that, because we're going to need more taxes with an ageing population. Whether it's health or pensions or whatever, we're going to need more, and we're going to have to increase those. I think we will have to increase consumption taxes such as the GST. As part of the flexibility of the system, we mentioned you can actually choose your investment strategy. It seems - and one thing that always puzzles me, there's academic literature on that, is people tend to invest much more into domestic asset as opposed to the foreign asset, the home bias. Is that the case in Australia and why is it, and is it a problem? Yes. It's less of a case in Australia than it is in many other countries. It can be a problem. I think it happens in Australia for two reasons. First of all, we have a corporate tax which pays dividend imputation to Australians - not to people overseas. So there's a kind of tax advantage to buying an Australian equity relative to a foreign equity. That's the first thing, foreign share. The second thing is, for example, if a superannuation fund decides to invest very heavily overseas, then it faces exchange rate risk. Now you can cover exchange rate risk. You can hedge it in short period. You can hedge it for a year or three years. But often the assets and liability matching are around thirty years. A forty year old is going to need this when they're sixty-five, right? So you don't want to take too much risk on the exchange rate when that's the pattern of liabilities you're going to have to meet. Now, it's probably the case that it would be better if we invested more broadly than we do, but they're the two reasons why I think there is this home-bias that you observe in Australia. And Australia doesn't face an immediate risk. If we go back a few months or years, looking at countries like Greece or Cyprus, there was a big problem in the sense that the countries have some kind of weakness. Most countries have a weakness, like the banking system in Cyprus, or the welfare system in Greece, and it seems like when you have a Pay As You Go pension system, where all the assets are kept - it accounts to investing domestically because the money is just not invested. If they had a capital accumulation pension system that was invested overseas, then the country might get in trouble. People might lose their job, they might lose their income, but at least they would not lose the pension that is invested overseas. So this is another advantage of the capital accumulation system. It kind of insures you against some of the country-risks when you diversify internationally. I think that's true. I think that's a fair point. I think there's something to be said for what I call 'system diversity.' So if this first poverty alleviation pillar, if you're relying on the government for that, then maybe it's worth relying upon the market for the second pillar and then the government could let you down or the market could let you down, but maybe they both won't let you down. So, it gives you a bit of risk diversification like that. So if you could design a pension system from scratch for some country, what kind of attributes would it have? You mentioned that there would probably be a combination of the public and the private sector. I think that's the first thing. I think our tax system is very messy in Australia and I think the way we deal with distribution or draw down or de-accumulation is just not present, I mean we need to do a lot more work in policy there. But if you fixed those two things up, the broad design of the Australian system is very close to what I would advocate if I was starting de novo. So, I'd have a flat rate pension which is non-contributory, like the Australian aged pension. So you don't have to be a member or pay anything. It's there if you are resident for some period of years, so we don't have people coming and living for six months and picking it up. I think the figure in Australia is ten years. Resident for ten years, you're entitled to this, subject to the other means that you might have. That makes good sense to me. I think then you need pretty tight tapers. So you need to set this at a minimal level which takes people out of poverty and when you get to it, you need a tight taper that is probably tighter than what we have now. It's probably sixty to seventy percent. I know people say that's a very high effective marginal tax rate, but what it is, is it's affecting fewer and fewer people. The tighter you have it, the fewer people are around that income area. Probably not 100 per cent, but it could be tightened. So that would be the first piece that I would have. I would index it. I think it should be indexed to wages - the payment. But the age should be indexed to life expectancy at age sixty or sixty-five. Not at birth. Not at birth. So sudden increases in life expectancy, I think you need to take account of that. So retirement age gradually goes up as life expectancy goes up. Not the amount that's paid, but the access age. I think that needs to be indexed. So that's where I would begin. And then I think I would have a system not that dissimilar from ours, but I would have the specification of the payment as the amount going into the account. So we have nine per cent going to twelve per cent, at the moment, of wages. But the payment that the employer makes to the insurance company or to the fund, then fees are taken out of that before it ends up in the account. So, I think it's better to specify, instead of twelve per cent, you specify ten per cent, let's say, but the ten per cent is net. The ten per cent ends up in the account. And so far, there are no taxes. And there are no taxes on the earnings either. So the fund goes away and earns and invests your money and that happens. And then when you retire, you pay tax. You pay an income tax on whatever you draw out. So it's just treated under the normal income tax. And that way you get progressivity, you get a taxation of the benefit. And you get, in the situation where you have a demographic change, the government picking up revenue from those benefits at the same time that it's facing liabilities for things like healthcare. We don't have that system. We have a different kind of tax system. We don't do anything about the income stream in retirement, which is another piece that I think we should have. Better income streams than we currently have, exactly how I don't know, but there should be more than we have. So I think those things I would have as part of it. But I think we've got the building blocks in Australia now. And how can a country that already has some system, generally Pay As You Go, the first pillar... how can it successfully move on to this? Australia did that more than twenty years ago and it somehow worked. Well Australia didn't have a social security system. It had this aged pension. It had that flat rate. It never had to replace a social security system with something pre-funded and that was a huge advantage for us. Now, two other countries, three other countries, have done something similar and they've done it from scratch, pretty much. So, the Netherlands and Switzerland both have pre-funding and they both pretty much did it from the beginning. Chile is a country which has started with a social security system and changed it around. And it's getting there. It's better than it was, but it's been very hard. I think some of the reasons it's been hard in Chile relate to its stage of development. So although Chile is a middle income country and coming along well, it's got quite a large informal sector. And people noted that when they converted, they gave what they called 'recognition bonds' to people who'd made payments into the old social security system, so you began with an asset in the new DC system, and then that accumulated further with your contributions. And people looked at these contributions and said, "oh, membership is very high." But they didn't look at what's called the density of contributions. So people would work for a few months in the formal sector and then they would go work in the cash economy for a few years and then they'd come back and work for a few months. So when it came to maturity time, which takes twenty years, and people started looking at payouts, the payouts were virtually nothing. Because people had not contributed continuously for the twenty years as everyone had assumed they would, they had contributed for three or four. So you've identified one of the important pre-requisites for the system to work and that's the country having stable and transparent institutions that actually work. I think actually that's true in both a Pay As You Go system and in a pre-funded system. So Pay As You Go systems can be completely messed up by governments - and they have been - particularly in the developing world, but we've talked about how promises have been compromised in the developed world as well. So, that can happen without strong governments and then, I think that unless you have strong governments around the financial sector and considerable financial sophistication, that these very long-term contracts on investment and saving that you're talking about with retirement income are very difficult to guarantee. And that's precisely why many countries that are trying to move in the direction towards sustainability and have implemented some second pillar Australian-type system, they seem to be back-tracking now. Poland's kind of reversing the policy, Czech Republic (my home country) has implemented the system and now basically scrapped it. So it seems there's a lot of political opposition. Also partly because some people worry that if it's run by the private sector there's always this danger of bankruptcy. You know, someone kind of running away with the money and that sort of thing. I think there are a couple of reasons. Particularly in Central and Eastern Europe, the countries you mentioned, this has happened several times. I think there's a combination of reasons for that. The first is that probably they did not have sufficiently strong governance or financial sophistication to actually manage it, or maybe even political maturity. So there have been cases where governments have expropriated the assets that have been accumulated and simply moved them back into consolidated revenue. The other thing is that many of these countries started this system in the first half of the 2000s and they just got going and the financial crisis hit. So it was very inopportune timing. Maybe if it had happened at the beginning of the 1990s then things would have developed differently. And I should mention that you've actually advised a number of governments on these matters. You worked with the government of Japan for more than ten years, and Russia and Indonesia. A lot of that's just information provision, but in the case of Russia, for example, they wanted a system of benefits which took out the systematic risk and so it was quite a complicated thing to design. I don't think it was ever implemented because the pension system moved on, but that was the assignment that I was given, and it was very interesting to do. I mean, I learned a lot about Russia, and I learned a lot about the Russian pension system, and I learned a lot about pension economics and that problem had never really been analysed properly previously. We're rapidly running out of time, so let's look at some of the other aspects of population ageing. What about financial markets, housing markets, and maybe healthcare. These are the three areas we can briefly talk about. What are going to be the implications of ageing? Well, there are two stories about asset pricing. One is that the old own the assets and if you take the case of housing, they've expropriated those assets to themselves and house prices have gone up and that generation has benefited at the cost of younger generations because now it's impossible to buy into mature housing markets in large cities. Is that narrative accurate? There are examples. I don't know how much it's a plot; I mean it's just something that has happened. I mean, in the Australian case, a lot of it lies on the supply side. And that we need to radically re-think things like zoning, and density and the associated infrastructure and then I think housing would become more affordable. We're in an unusual situation in having an economy which is very agglomerized in which there are only four cities and everyone wants to live in those four cities so the site rents around housing are extremely high. This is partly the reason why, unlike in most countries where after 2008 property prices fell quite dramatically, it didn't happen here. That really didn't happen here. Australia did better out of the global financial crisis (GFC), or survived it better than many other countries, that's true. The housing market itself had not gone through a boom, so if you looked at the US, the housing prices actually went up quite rapidly prior to 2008. If you look at the Sydney market for example, it hadn't gone up much at all in the five years prior to the crisis. So maybe the increase in prices we've seen in the last year would've occurred two or three years earlier without the crisis, right. But there was room for an upward adjustment and so I think that helped cushion potential falls. Especially relative to income, because incomes were rising faster in Australia than the US, Incomes were rising very fast in Australia. Financial assets, I'm not sure. It seems to me that there are many opportunities for investment with high returns. I think the broader, long-term story on population ageing - the verdict isn't in. So what happens when global population starts shrinking, supposing fertility is as people project and that starts occurring at the end of the century? Is there going to be the same demand for new capital that there is now? For the moment, I don't subscribe to the asset meltdown scenario. Can you briefly outline what that is? Well the idea is the Baby Boomers have accumulated assets for their retirement. Now they're going to spend them down. The only way they can spend them down is to sell them. So the market for these assets will become a buyer's market because everyone will be seeking to sell and the prices will plummet and that will mean that what people thought they had, which was enough assets, enough wealth, to go through their retirement years, will not be there any longer. This hypothesis, I was told by some of my German colleagues, that when a pension reform was being discussed, this was one of the counter arguments: okay, we're going to have all these private funds and so on, but because the price of assets is going to decrease dramatically, it is basically going to face the same kind of problems as the public system. I think, as I said near the beginning, it's a very globalised economy we're operating in, and although population aging is occurring everywhere, it's occurring at very different rates and at very different stages. And so I think there are opportunities for investment in Asia. I mean, look at Asia. There's decades of investment in Asia before the marginal return on capital declines to a point where you would have an asset meltdown. Now it might be true in Germany if it was just a national market, but I think in a global market, it's very unlikely. I agree. I've seen several studies that basically show that the asset meltdown hypothesis might be correct in theory, but quantitatively it's just going to lead to a very small reduction in the return on assets. What about healthcare, just to finish up. Are there any lessons from the pension reforms on to healthcare, which seems to be a big problem in many countries? Healthcare is important and it's a major part of government expenditure. I think the basic story is that in order to continue to provide healthcare which is commensurate with where technology is - this is partially technologically-driven as well - that tax increases are inevitable. I really don't see a way around it; it's very difficult to pre-fund healthcare. Once again, I'm not opposed to the arrangement in Australia where a private insurance option is available that people can take up and relieve a bit of the pressure on the public system. But eventually you have a healthcare system which delivers to the populus and the primary funder of that is going to be the tax payer. The tax payer of course is the primary beneficiary as well and I think that needs to be taken into account. Something else along that same theme is that new policy imperatives will grow with population ageing, and an important one would be aged care. So long-term care or aged care is something which this country has not paid much attention to until recently and then a year or two ago we had an aged care policy and that's, I guess, proceeding and gradually being developed over the next ten years. Not a moment too soon, but actually, in time. There are going to be these areas where there will be new demands on the public purse as a result of the ageing demographic. Take cognitive decline. Here is an area where for financial commitments for people making their own decisions later in life, cognitive decline - I'm not really talking about dementia, although that's a piece of it - just people not being able to figure things out so well when they're eighty as when they're sixty, or when they're forty, that's going to mean that perhaps there's room for a policy of pre-commitment at late age. Germany has this pre-funded pension that you alluded to, the Reister pension, and part of that is, whatever else you do with your benefits, you have considerable freedom over your benefits, but there's a piece that has to be preserved to age eighty-five, and then it's a pension. And that's to cope with cognitive decline. So that's another element of population ageing where you get this interaction between health, psychology, economics, finance and policy. It seems like ageing has many different facets that it's going to influence our society in many ways. Very much. I'd say climate change and population ageing are going to be the two twenty-first century stories really, from a social point of view. The World Economic Forum has this barometer of global risks and I think fiscal crises is number one in terms of the financial impact and global warming is number two. There you go! Professor John Piggott, thank you very much for your time and for your ongoing contribution to not only the research on population ageing and pensions but also in the policy making arena and let's hope countries will be able to work it out and achieve sustainable pension systems. Let me wish you all the best for the future and thank you again. Thank you very much indeed. Thank you.