Quotes of the Day

Whose job is it to pay your pension? That's a crucial question that has long divided Europe between two approaches: one named after Otto von Bismarck, the 19th century German Chancellor, the other after William Beveridge, the liberal economist who laid the groundwork for the British welfare state in the 1940s. The Bismarckian philosophy, adopted by countries such as Germany, Austria, Italy, France and Spain, is that it's the state's role to insure people against losses of income in old age. In countries taking the Beveridge approach, such as Britain, Switzerland and the Netherlands, the state provides a modest pension to all that is complemented by company-funded occupational pensions, and topped up by individual tax-advantaged schemes.

Both systems have run into problems. The biggest troubles afflict Bismarckian countries, where huge demographic shifts have made the state's pay-as-you-go schemes unsustainable. They take social-security contributions from people working today to pay the pensions of those already retired. With people living longer, working less and having fewer children — and with the baby-boom generation heading toward retirement — the burden on the shrinking work force and public finances is becoming intolerable. A recent World Bank study shows that unless something is changed, the deficit in public pensions in Europe will total 51% of GDP in 2050 in today's money, up from 4% now. But all is not rosy with Beveridge, either. Passing part of the burden to companies removes some of the demographic pressures but leaves the system open to financial and regulatory risks. In the U.K., the big drop in stock prices over the past three years, for example, has blown a hole in corporate pension accounts, which tend to be heavily invested in equities.

Some countries are attempting hybrid solutions that seek to complement the state's role with a greater private-sector involvement. The most dramatic shift in Western Europe is taking place in Sweden, which used to have a large and unsustainable Bismarckian pay-as-you-go scheme. In 1999 it made a philosophical switch, seeking to give individual Swedes at least some direct responsibility for their own pensions. To that end, 2.5% of their pensionable income is now automatically put into an individual account for them, and they can choose to invest it in up to five of 600 authorized funds. The funds themselves are tightly regulated by the government, which tries to ensure that administrative costs are kept low and abuses don't happen. But the Swedish changeover pales in comparison with what's happening in Poland and Hungary, which are adopting the idea of mandatory individual retirement accounts that go even further than those in the U.S. In both countries 7% to 8% of payroll social-security taxes are automatically swept into these accounts. Says Alex Waite at actuaries Lane Clark & Peacock: "They are going straight into the solution without going through the problem."

• PETER GUMBEL
• Can Europe's pensions time bomb be defused?