The European Union is grappling with two interlinked crises that threaten its long-term economic stability: a severe shortfall in risk capital and an impending pension crisis exacerbated by demographic aging. Recent reports by Mario Draghi and Enrico Letta have sounded the alarm on the EU’s moribund growth prospects, highlighting a critical lack of investment liquidity for innovation and infrastructure. At the same time, Europe’s dominant pay-as-you-go pension systems are in an actuarial death spiral as the working-age population shrinks and the number of retirees rapidly grows.
Could this dilemma of twin crises be transformed into a vast economic opportunity? The solution may lie in rethinking pension finance—specifically, a major expansion of funded retirement solutions such as defined contribution workplace savings.
Across the globe, countries with robust funded private retirement finance systems—the U.S., Australia and European nations like Denmark, Sweden and the Netherlands—each have amassed retirement finance assets worth nearly 200% of GDP. These systems have thrown off trillions of dollars in patient, long-term investment capital—the very type of capital the EU’s economy desperately needs.
Retirement Entropy in Europe
Ironically, Europeans are, for the most part, substantially better savers than are Americans. But Europeans channel these savings into guaranteed investment products with yields that barely beat inflation. Were these savings diverted into the kind of defined contribution retirement investment programs like those seen in the U.S., Canada and the Nordic countries, the EU could ignite a new era of “retirement finance.”
Despite being home to some of the world’s largest economies, Europe struggles with risk capital shortages that hinder capital formation, venture investing and the funding of new companies built on the foundation of the continent’s highly educated technologists, engineers and entrepreneurs. The Draghi and Letta reports both highlighted:
- Overreliance on Bank Lending: Unlike the U.S., where capital markets play a dominant role in financing companies, Europe’s financial system is disproportionately dependent on bank lending. This model inherently favors incumbents with collateral assets rather than high-growth sectors such as technology and renewable energy that rely on risk capital.
- Fragmented Capital Markets: Despite a multi-year effort to create a Capital Markets Union, Europe still lacks a unified, deep and liquid capital market. With idiosyncratic national finance systems and captive, jealously protected national markets, investment flows are both fragmented and constrained.
- Subscale Institutional Investment: Compared with the U.S., Europe has far fewer institutional investors with the risk appetite and liquidity needed to drive venture capital and infrastructure financing.
Ticking Pension Bomb
The EU’s pension crisis is equally daunting. Most European pension systems rely heavily on pay-as-you-go structures, in which current workers’ contributions finance retirees’ benefits. This model worked well in decades past, when demographic ratios were favorable and economic growth was robust. But with the old-age dependency ratio rising across Europe, pay-as-you-go pensions are becoming increasingly unsustainable.
The European Commission estimates that by 2050, the working-age population will shrink by nearly 50 million people, while the number of retirees will surge. Many EU countries already spend more than 10% of GDP on public pensions, and aging is pushing this level higher. Countries with high debt levels and a dearth of private retirement wealth, such as France and Italy, are constrained in their ability to finance pension shortfalls, raising the risk of either benefit cuts or tax hikes.
The irony of the situation is that European households are terrific savers. According to recent surveys from the European Federation of Financial Advisers and Intermediaries, Europeans collectively hold about 15 trillion euros in bank deposits and insurance products. The reallocation of even a fraction of this capital into long-term retirement investment vehicles could alleviate pressure on pay-as-you-go systems and release bank deposits into investment markets.
Lessons From Other Countries
- U.S.: With more than $40 trillion in private retirement finance assets—about two-thirds of the world’s $60 trillion in pension assets—the U.S. has a ready source of long-term funding for innovation, venture capital and infrastructure.
- Australia: The superannuation system, which mandates employer contributions, has amassed pension assets worth more than 200% of Australia’s GDP, making it a powerhouse for investment capital. Within a decade, eight superannuation retirement savings funds may each top $150 billion in assets under management.
- Denmark, Sweden, Netherlands: These European nations are routinely cited as among the best-funded pension systems in the world, exceeding 150% to 200% of their respective GDPs, insulating them from demographic stress and fueling their economies with long-term capital.
The common thread in these systems is the presence of large, well-funded workplace retirement schemes that accumulate assets over a worker’s lifetime, investing in equities, bonds, infrastructure and alternative assets that drive long-term growth.
Blueprint for Europe’s ‘Retirement Finance Revolution’
For Europe to replicate these successes, bold reforms are needed:
- Expand Defined Contribution Savings Programs: European governments should actively promote employer-sponsored, tax-incentivized DC plans.
- Mobilize Existing Household Savings: Policymakers should do all they can to “nudge” these savings out of deposit accounts and into globally diversified, professionally managed retirement savings vehicles.
- Deepen European Capital Markets: Deep, liquid and digitally-linked capital markets allow pension funds to invest more efficiently across borders, generating investment flows for innovation and infrastructure.
- Incentivize Institutional Investment: European banks, insurers and asset managers all have a critical institutional role in channeling long-term investment flows. But these flows must be created in the retirement finance channel.
- Leverage Public-Private Partnerships: Draghi and Letta made clear that European government funds must be blended with private funding for renewable energy, digital infrastructure and housing. In the U.S., partnerships such as those foreseen by the Inflation Reduction Act and other post-COVID initiatives typically envision $3 to $10 of private assets for every $1 of public assets.
20-Trillion-Euro Opportunity
What might be a blueprint for European retirement finance transformation?
- Let’s start by transitioning 15 trillion euros in European retail savings from bank accounts and insurance products into retirement investment vehicles;
- Add to this a hypothetical expansion of private retirement finance in France, Germany, Italy and Spain. According to the OECD, these markets—with a combined population of 270 million and a combined GDP of 10 trillion euros—have only 1 trillion euros, or 10% of their GDP, in retirement finance assets under management; and
- Were this to ratchet up to 100% of GDP—a level achieved a generation ago by the U.S., Australia, Canada, the U.K. and the Nordics—and be added to the re-purposed savings, Europe would experience a windfall of more than 20 trillion euros in new long-term investment.
This new era of funded retirement finance would alleviate pressure on government pay-as-you-go pensions; alleviate fiscal stress on governments; unlock investment for innovation and infrastructure; enhance retirement security; and kickstart a new era of growth for European capital markets.
Retirement finance reinvention could reboot the EU economy for the 21st Century.
John Mitchem is a strategic consultant for financial stakeholders worldwide and co-founder of the Jasper Forum, a global retirement finance discussion group.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of ISS STOXX or its affiliates.
Tags: Capital Markets, Defined Contribution, European Union, institutional investment