Population Dynamics, Macroeconomic Risks, and the Future of Pensions in Finland

Abstract

The hybrid pay-as-you-go system currently in use in Finland could become increasingly untenable in the longer run, should macroeconomic developments turn out weaker than expected. Unfavorable population trends would amplify the effects of adverse macroeconomic shocks on the Finnish pension system and its financial health.  Although Finnish government has demonstrated willingness to respond to challenges facing the pension system and has been successful in building consensus for necessary pension reforms, a more strategic approach would serve policymakers and retirees (current and future) better in the longer run. This study focuses on risks to productivity and investment returns and how they would impact the longer-term health of the Finnish pension system, given unfavorable population dynamics. In order to protect the longer-term finances of the pension system, government should transition away from the pay-as-you-go model to an arrangement where pensions are fully funded from investment returns instead of being dependent on the contributions of current working-age population. We suggest alternative options to achieve that but at the same time emphasize that the authorities need to be mindful of burden-sharing between workers and pensioners in their considerations, as pension cuts would hurt retirees while contribution rates are already quite high.