The Health, Labor and Welfare Ministry’s Social Security Council in late August released its report to examine sustainability of the public pension system every five years. This time, the report received particular attention since it followed the recent controversy as to whether public pension benefits are enough to cover people’s retirement expenses. However, misguided comments on the issue flooded social media and blogs, and some of the mass-media reports tended to present a one-sided coverage.

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What was conspicuous first were the comments expressing concern — and those that seemed aimed at fueling people’s anxiety — that the public pension system might collapse and leave future retirees without the benefits.

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Today’s pubic pension system in Japan is operated by the pay-as-you-go method, instead of the funded system. Under the funded system, people lay aside premiums while they are working and receive the benefits including investment gains after they retire. While the simplest method is to invest premiums from an individual account, it is not impossible to invest pooled premiums.

In the pay-as-you-go method, which is designed for the younger generations to support the older generations, premiums that people currently working pay into the system are used to pay the benefits for people in retirement. As long as the working generations of the future continue to pay premiums, public pension finance cannot collapse and payment of the benefits will not stop. However, benefits for future generations will have to decline in relative terms under an aging population with a falling number of births.

Concerning this point, there is an argument that the government had no choice but to shift to the pay-as-you-go system without sufficient discussions since the 1980s on because its fundamental errors undermined public pension finance. What the argument means is as follows: In setting the amount of premiums to be paid up to the 1970s, it was assumed that while growth of wages and the economy would be flat, investment gains on the premiums would reach 5 to 6 percent — an unreasonably high level. Thus the estimate of investment gains on the pool of premiums was excessively high.

As a result, it became inevitable for the government to raise the premiums whenever it reviewed its levels, which eventually forced the government to transition to the pay-as-you-go system, according to economist Yukio Noguchi (in his Sept. 11 and 25, 2010 articles on Diamond Online).

Noguchi appears to think that the government’s errors on this point had a more serious impact on the public pension system than the aging of Japan’s population that progressed faster than had been anticipated. But I think that his contention is open to question.

At any rate, it will be extremely difficult to go back to the funded method. Since pension benefits have already been paid to retirees for such a long period by using the premiums set aside by people in working generations under the pay-as-you-go method, a future shift back to the funded system will require funding to close the gap that will far exceed the current reserves of some ¥200 trillion.

The second popular misunderstanding is the argument that even if payment of pension benefits continues, significant cuts to the amount of the benefits will be unavoidable — and that to cover up such a prospect, the scenarios of economic conditions used in the pension finance report are set in optimistic terms. Under the revision of the public pension system in 2004, the level of premium payments was fixed at a certain level in order to prevent increases in future premium payments. Automatic adjustment of the benefits based on macroeconomic indexation has also been introduced so that benefits will be paid out of the financial resources within that range.

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