John Grieve Smith: Why an ageing population is no cause for gloom

The so-called 'demographic time bomb' is a pretext for cutting state pension provision

It is a sad comment on us that the welcome fact that people are living longer and healthier lives has come to be regarded as a potential economic disaster – the so-called "demographic time bomb". It has become a world-wide pretext for cutting back state pension provision, and more recently for employers to start ending pension schemes based on final salary.

It is a sad comment on us that the welcome fact that people are living longer and healthier lives has come to be regarded as a potential economic disaster – the so-called "demographic time bomb". It has become a world-wide pretext for cutting back state pension provision, and more recently for employers to start ending pension schemes based on final salary.

Yet increasing longevity has not historically been in conflict with growing prosperity. Over the past century, the expected length of life in the UK has increased by more than 30 years and standards of living have risen dramatically without people being forced to work longer or reduce their pensions. Just the opposite.

Certainly it is true that, if nothing else changes, the growing proportion of older people in the population will mean that those in work will have to consume a lower proportion of their income to leave room for pensioners to have an adequate standard of living. But the proviso "if nothing else changes" is the key assumption that all too frequently goes unquestioned. The official projections of the future cost of state pensions make assumptions about the numbers of people at work that deserve careful examination on two counts. First, are they a realistic projection of current trends? And second, could they be changed by measures to improve job opportunities for the over-50s?

The government actuary's projections, on which official estimates of pension costs are based, forecast that the proportion of the population at work will have fallen from 47.8 per cent in 1999 to 44.5 per cent by 2030. But a new report from the Catalyst Forum shows that it should be possible to increase the numbers at work by the 2 million needed to keep this ratio constant. This would depend partly on a general willingness to employ older people and partly on measures to stimulate job creation in the older industrial areas, where hidden unemployment is considerable. It is not a matter of compelling people who would like to retire to carry on working, but of giving those who would like to work the chance.

The high numbers of people over 50, particularly men, who are not working is not, as is sometimes suggested, a consequence of more people taking early retirement through choice; it is much more a reflection of the number of people who have lost their jobs in contracting industries, such as steel or coal. In the spring of 2000, 70 per cent of men aged 55-64 were in work in the South-east, compared with only 42 per cent in the North-east. The greatest opportunity for reducing the feared burden of pension provision is in the apparently unrelated field of regional policy.

As well as creating more job opportunities for men and women below normal retirement age, we should be making it easier for those who wish to carry on working beyond that age. Greater flexibility in occupational pensions could be one step forward. Indeed, it is questionable whether firms should have the right to set compulsory retirement ages for their employees – something that is illegal in the US and that a new EU directive may well rule out.

The crying need today is to establish a more stable regime for adequate state and occupational pensions, one that gives people a reasonable view of how they will stand when they retire. At the moment everything seems to be in the melting pot. As far as the basic state pension is concerned, recognition is growing (except in the Treasury) that, if it is to have any future, it must be fixed at an agreed proportion of average national earnings and be indexed to earnings rather than prices. Otherwise it will become increasingly inadequate, and we shall have moved to a means-tested system, which will discourage the lower-paid from making further pension provision.

The question of how best to reliably provide – privately or publicly – for pensions that are earnings-related is less straightforward. Because of the problems caused by people moving jobs, a strong case can be made for the state playing a role – the function of the original State Earnings Related Scheme (Serps). Previous Conservative governments have used demographic trends as an excuse to whittle it away, and now New Labour is to give it the coup de grâce by transmuting it into a second flat-rate pension. It is time to reconsider its future. Only two other EU countries (the Netherlands and Ireland) have no state earnings-related pensions.

As far as private occupational schemes are concerned, the effects of falling share prices have been greatly exaggerated, largely because of new accounting standard (FRS17) being introduced. Employers' contributions to these funds do not necessarily have to be altered in response to short-term fluctuations in asset prices. They depend on the expected earnings from the funds' investment.

Instead of using it as an excuse to cut pensions and force people to work longer, we should be approaching the prospect of increasing longevity in a more positive spirit, both opening up better and more flexible opportunities for older people to work, and assuring them adequate pensions when they retire. It is time to get off the bandwagon of spurious and ill-informed panic about the "demographic time bomb".

'The Challenge of Longer Life' is published next week by Catalyst Forum