Rational pension reform

Pension reform is called the ‘third rail’ in politics, referring to the high-voltage rail in underground transportation. Touching it spells trouble. Pension reform attempts have caused violent demonstrations in countries with a strong leftist movement such as France and Greece, but pension reform has also failed in the archetypical capitalist country of the USA, where the last significant reform took place in 1983, followed by 25 years of debate and several commissions without producing much of a tangible result. On the other hand, pension reforms are needed since the social, economic and demographic environments are constantly changing. Arguably most important for pension systems is the fundamental demographic transition of population aging, which will make public pension systems unsustainable all over the world in the very foreseeable future. Given that pension reforms are a necessity, but also given that they are likely to hurt politicians, an attractive idea is to automate inevitable adjustments of the pension system through indexation rules and other self-stabilization mechanisms. This is the topic of this contribution. It reflects on the design and the success of pension reforms that attempt to minimize discretionary decisions by political institutions that easily get pressured into doing nothing because short-run costs for the current actors are higher than long-run benefits for society as a whole.