A Generous Pension System in Need of Reform

German workers will have to pay more into the state pension fund under a controversial agreement by Chancellor Gerhard Schröder's coalition government announced Tuesday.

The hike, which will require workers and their employers to increase their contribution from 19.1 percent of their monthly earnings to 19.5 percent, faced heavy opposition from Schröder's coalition partners, the Green Party. After a late-night Monday negotiating session, Schröder prevailed over his Green partners, pushing a hike his party says the pension fund desperately needs.

Round 3 billion euro will be missing from the pension fund, into which employees and their employers share monthly contributions, before the end of the year. The deficit would mean current retirees at the very least wouldn't have gotten the annual pension payment increase legally guaranteed them this year.

The increase appears to assure them their money. But critics say the government's "first aid action" is like putting a bandaid on a gaping wound.

Demographic time bomb

Like many other countries with similar pay-as-you-go state pension schemes, Germany faces a demographic time bomb.

Over the next 30 years the number of Germans above the age of 60 is expected to increase 9.9 million, mainly due to low birth rates and higher life expectancies. As a result, the number of workers shouldering the pension burden is expected to fall.

Currently, a little more than two working Germans support every German retiree. In even 20 years time, that ratio will be 1:1, according to Commerzbank statistics.

With the recent introduction of privately funded, state- supported pension schemes, the German government hoped to find a way of avoiding further cuts in state benefits and rises in state contributions. As a result, the government promised the average pensioner's benefits would not fall below 67 percent of the national wage on retirement, against the current 69 percent. The catch was that the pensioner would have to contribute for at least 45 years, as opposed to the current average 37 years.

In addition, compulsory contributions to the pension scheme, now 19.1 percent, jointly paid by employer and employee, were not set to rise above 20 percent for the next 20 years.

"First aid action"

But on Saturday, Germany's Health Minister Ulla Schmidt disclosed plans to raise pension contributions to 19.5 percent in 2003, saying she regarded this step as a kind of "first aid action" to make way for further and wider structural reforms.

With her proposals, which will be up for decision in the Bundestag on Thursday, Schmidt hopes to cut costs in the welfare system by some 3.5 billion euro.

The proposal faced initial opposition from the Greens who agreed on a percentage increase of only 0.2 percent in the government's coalition agreement signed last week. On Tuesday, those issues appeared to have been ironed out.

Business cries foul

Schmidt still faces tremendous opposition from business lobbies, who are calling for cuts, not increases, in Germany's rising social welfare levies which are driving up the costs of labor.

Industrial labor costs in Germany are higher than in any other country and Germany's tax and social-welfare burden is one of the heaviest in the world.

When Chancellor Gerhard Schröder took over from Helmut Kohl in 1998 after 16 years of conservative rule, the largely untouched labor market, health, pensions and school systems were crying out for reform.

The red-green coalition has been struggling with economic reform ever since, aiming to cut the combined costs of compulsory pension health, unemployment and disability insurance fees to under 40 percent of gross wages. However, the figure is now at 40.4 per cent – and still rising fast.

Recognizing the need for major reform, Schröder's coalition accompanied the percentage increase with the announcement that it was calling together a commission to recommend reforms. The recommendations are due out in Fall 2003.