The result will be downward pressure on living standards which will be felt from about 2010 onwards, when the percentage of the population in employment is projected to fall. If productivity continues at its post-1973 average growth rate of 1.5% annually, this decline in employment means that the growth in material living standards will be cut in half in the decades after 2010. The fiscal consequences result from relatively fewer tax-payers to pay the costs of increased pensions and health care (Figure 3). Without changes in programme benefits, there will have to be large tax increases or a new spiral of rising deficits and debt. Reduced growth in material living standards caused by continuing to fund existing pension arrangements would not be a problem if it resulted in an increased overall quality of life. Ever-longer periods of leisure time in retirement might appear to be a worthy, if costly, social goal to be financed by taxes or payroll contributions. But spending money to this end would be at the expense of higher priorities, such as investment to improve the opportunities of poor children or unemployed youth, lifelong learning or better health.

Of course, many people now choose to retire early – but their decisions are deeply influenced by financial disincentives to continue working that are built into pension and other social programming and by the lack of flexible working arrangements. If these disincentives were reduced or eliminated, a sizable proportion of these would-be retirees would work longer, opting for a more gradual transition into retirement. The current lack of job opportunities for older workers also plays a major role. The evidence on what the demand for older workers might be in the future is not clear; at least some part of the problem may lie in the lower education and skills of the current generation of older workers rather than being a function of age itself – and many of the newer jobs in the knowledge-based economy are well suited to an older workforce.

Policy measures intended to foster improvements in the quality of life should ensure that pensions and other social programmes provide adequate support for people who choose retirement without imposing disincentives on those who prefer to remain in work. People should be free to choose when and how they retire: there should be no artificial incentives built into the system.

More generally, social and employment policies – and the operations of institutions providing health care and education – do not yet fully reflect the new realities of smaller families, longer and healthier lives, and much longer periods of schooling and retirement. On balance, existing policies inadvertently create incentives that result in inflexible arrangements for care-giving, learning and leisure over the course of life. The result is that social programmes and working-life arrangements now provide disincentives to choosing gradual retirement, lifelong learning or working-time flexibility.

The failure to keep up with demographic realities can cause a misallocation of resources between older and younger people. Although there are still many problems in assuring adequate income in retirement, particularly for the very old, most retired people are now much better-off than they would have been in an earlier age, so that their average income is now close to that of the population as a whole. Retired people, indeed, already have disposable incomes that, on average, are as large as those of people in young households.

There is no necessary link between the generosity of public pensions on average and the extent to which retirement income is adequate and equitably distributed. Further, a continuation of existing arrangements will result in more money being transferred to older people than they now spend. Many retirees are now providing financial support to their children and grandchildren, sometimes in substantial amounts. Indeed, even the poorest among older people often continue to save. The result is certainly inefficient since public benefits are being transferred to those who do not use them but rather pass part of those benefits on to others. It is probably inequitable as well – perpetuating the gap between rich and poor families, especially since pensions are given tax advantages in many countries.

There is therefore a strong reason on grounds of social priorities to reform pensions and under-take related changes to labour-market and social policies in ways that will reduce, or offset, trends to increasing time spent in receipt of public pensions, and to reduce the relative generosity of benefits in countries where they are now particularly high. Corrective action to pensions must begin early – a basic ‘contract’ such as that embedded in public pension arrangements cannot, and should not, be changed quickly or without the prior notice that will allow people to adjust their plans. There is also a question of trust. Many young people do not believe that decent public pensions will still be available when they retire. And fears have been expressed that the very large increases in taxes which would be necessary to maintain existing arrangements might reinforce resistance to paying taxes and, possibly, to inter-generational conflict, even if there is currently little evidence of it. Since the main effects of ageing will only be felt after 2010, this lack of conflict may be the calm before the storm. But it may also reflect large inter-generational transfers to young people in families. As noted above, many young people are themselves dependent (directly or indirectly) on the income their parents or grandparents receive, and do not recognise that the difficulties they encounter in finding employment or in earning adequate take-home pay may be related to the payroll-based taxes which finance the pensions and other social transfers received by their parents and grand-parents.

What Directions for Reform?

Tackling the fiscal challenge, the threat to living standards and quality of life and the potential for generational imbalances simultaneously is a daunting endeavour. It requires a package of reforms that, taken as a whole, will result in:

• reduced growth in government spending on pensions and a slowing or reversal of trends towards longer periods of retirement
• more productive investment of private savings for retirement
• wider choice for individuals about the course of life, not least by removing both artificial incentives that now favour sudden and early retirement and disincentives to choice built into existing programming
• a general re-orientation of health, training, care and other policies so they better support people, as they grow older, in leading productive lives.

Taken one at a time, these reforms are desirable on both social and economic grounds, quite apart from considerations imposed by population ageing. By and large, they are prudent policies that should be pursued more forcefully and over a prolonged period. Taken together, they represent nonetheless a considerable shift in both the substance and process of policy-making. Approaches to pension reform illustrate the new directions policy should take. In recent years, pension reform has largely been driven by fiscal concerns alone – which will become increasingly insistent in the period after 2010 unless actions are taken now. But new social-policy considerations are beginning to influence the pension reforms being considered as the debate shifts to examine the nature of retirement itself, not only its financing. The traditional concentration on choice between competing sources of pensions – often between public pay-as-you-go schemes and advance-funded individual-account schemes – is being dropped in favour of an analysis of the best balance among multiple pillars or tiers, often involving new mixes of pension elements and non-pension sources of retirement income. Attention is likewise shifting from an almost exclusive focus on the relative generosity of pension benefits to include their duration.

More generally, there is a new focus on the role of generational issues and on the interaction between changes in families and markets. The concept of ‘active ageing’ plays a central role in this new focus: active-ageing policies are those that are designed to support people, as they grow older, in leading productive lives in the economy and society. Especially important is flexibility in the choice of whether or not to retire and how gradually. And the links between social and economic policies take on new importance, as is reflected by the new priority on lifelong learning and the effectiveness of health and long-term care.

These reforms also represent a considerable new challenge to the manner in which governments formulate policy. Part of the challenge involves adopting and sustaining perspectives that are much longer-term than is usual. Further-more, the reforms are unlikely to be successful if they are tackled in isolation; and new kinds of statistical information and applied research are required to support them. The long time-frames involved, and the complexity of the issues like-wise require the building of public understanding and engagement and the establishment of viable political support.