Pension Reform in Germany and Conclusions for China
Author:Markus Kobler and Martin Moryson
One of the main challenges facing any country in today's world is meeting the retirement funding needs of its population. The overarching aim is to meet these needs as adequately, sustainably and effectively as possible, in the context of (i) an ageing society with declining birth rates and increasing life expectancy, (ii) underfinanced and structurally imbalanced social security and pension systems, and (iii) slowing economic development. If these dynamics are not addressed, they may reinforce one another, creating a vicious cycle that appears to offer no clear way out.
Slow economic growth and limited capital distribution often stem from households favouring cash and real estate over productive investments. Additionally, transferring resources from the working population to retirees through taxes and social benefits is placing an increasing burden on public finances. Breaking these cycles requires a combination of measures – there is no quick fix. Such reforms, which demand significant departures from the status quo, are often unpopular and will deliver gradual improvements only over years or even decades.
China and Germany face similar challenges. Meanwhile, as two of the world's largest economies their approaches could transform internal difficulties into opportunities and serve as a model for other nations. Active dialogue, experience-sharing, and learning from countries like Sweden where successful reforms have already been implemented, are an essential step toward addressing this global issue and unlocking further economic development.
Key Challenges
Both China and Germany are facing the pressing challenges of a rapidly ageing population and the resulting surge in the old-age dependency ratio.
In the 1980s, the ratio of working age to old-age populations stood at 4:1 in Germany and 10:1 in China[1]. Today these ratios have declined to about 2.5:1 and 4:1, respectively. Germany's ratio is projected to decrease further to 1.8:1 within the next ten years before stabilizing for the rest of the century. In China, the downward trend is expected to reach its peak in 2085 when there will be 1.2 retired persons for each actively working person. This shift is driven by rising life expectancy and persistently low birth rates, which are well below the replacement level of 2.1 births per woman. Currently, Germany's birth rate stands at 1.4, and it is expected to rise modestly to 1.6 by the end of the century. For China, the United Nations estimates a current birth rate of 1.0, forecasting an increase to a level of 1.3 over the same period.
Besides birth rates, migration also plays a significant role in shaping future dependency ratios. Germany has historically benefited from immigration – from Southern Europe in the 1970-80s, Eastern Europe in the 1990s, and intra-EU migration following the Great Financial Crisis. Without these influxes of migration, Germany would have experienced weaker economic growth and a significantly higher dependency ratio. Looking ahead, the German Council of Economic Experts estimates that the absence of net migration could increase the old-age dependency ratio by at least 10 percentage points within 25 years.
These adverse demographic trends weigh heavily on the growth outlook for both countries. Germany already faces low potential growth due to a shrinking workforce and slow productivity growth. Meanwhile, although China is still enjoying high GDP growth, forecasts by the OECD suggest that it will likely experience a slowdown. This muted growth outlook for both countries will make social security reform both more urgent and more difficult, as resources will grow more slowly than the ageing population.
Another striking similarity between China and Germany is the very high saving rates of households, concentrated in non-productive assets such as gold, cash and bank deposits. Limited allocation to productive investments further constrains long-term growth.
Reform Options
What can be done to overcome these challenges? From an economic standpoint, it is essential to identify appropriate policy responses. Regardless of how pension systems are designed, retirees' consumption must ultimately be financed by drawing down their own savings as well as transfers from the working population. In essence, every pension system redistributes output from the working population to those who are retired. The smaller the working population, the heavier the burden they must bear.
Four fundamental levers can help mitigate the problem. Each lever requires policy action, and, if implemented effectively, will lead to positive economic development. These levers comprise higher birth rates, (ii) higher net migration, (iii) raising the retirement age and (iv) increasing productivity, e.g. through pension reforms.
Unfortunately, all these solutions present inherent challenges. Many countries have tried to increase their birth rates, with limited success. As of today, more than 75% of the world's population lives in countries with birth rates below the replacement level of 2.1. Therefore, policy measures seem to have had a very limited effect to date. Furthermore, even if this trend were to be reversed, demographic benefits would materialize only after 20-30 years.
Increasing net immigration comes with its own challenges, and the "appetite" for immigration is globally declining.
The third option looks more promising. Raising the retirement age would address both sides of the equation by expanding the workforce and reducing the number of retirees. Yet, it is highly unpopular, and implementation is usually staggered over decades. In Germany, the pension reform of 2007 raised the statutory retirement age gradually from 65 years in 2012 to 67 by 2030. With life expectancy now at 78 for men and 83 for women, further increases beyond 67 years will be necessary. Pension reforms in China also move in the same direction albeit at a noticeably quicker pace. Reforms announced in 2024 kicked off in 2025, raising the retirement age from 60 to 63 for men, and for women from 50 to 53 (blue collar) and 55 to 58 (white collar). Given that the average life expectancy at birth is 76 years for men and 81 years for women, additional adjustments are likely to follow.
As increasing the statutory pension age is challenging for any society, a practical solution is to raise the effective retirement age through tax incentives to motivate older generations to work longer. Germany has just introduced "active pensions", allowing retirees to earn up to 2,000 Euros per month tax free. Currently, Germany's actual retirement age is significantly below the statutory retirement age but is rising quickly. In China, the actual retirement age for both men and women is already well above the statutory level, though recent increases have mostly affected women.
The fourth reform option, increasing productivity through better capital allocation that is triggered by the reform of the social security systems offers the biggest potential. Both China and Germany have high household saving rates and less liquid capital markets compared to other advanced economies. A well-designed pension reform could redirect these savings into investments, stimulating increased productivity and higher economic growth.
Currently, both countries face relatively low domestic consumption and rely heavily on export-driven growth. Chinese households save over 35% of their income, whereas Germany's net saving rate is at 11%. China traditionally imposes lower taxes and social security contributions compared to other countries, resulting in limited state-funded pensions and healthcare. This fosters self-reliance and precautionary savings. At the same time saving rates are very high and funds are kept in liquid assets as people prepare privately for adverse scenarios and sudden events. A social security reform that focuses on enhanced basic protection, especially on long-term medical care would reduce the necessity to build (excessive) reserves. People could free their resources, use them for consumption purposes and invest in productive assets, which in turn would boost demand and economic growth.
In Germany, the high savings rate reflects a risk-averse culture, resulting in low-risk and non-productive 'investments' into bank accounts, cash and fixed income. Unlike in China, most Germans rely on a "pay as you go" pension system. Despite the increasing fiscal burden of these demands, Germans remain reluctant to invest in higher-yielding assets due to the perceived risk and lack of tax incentives. The planned reform of the German social security system which we explain in some further detail in the next section aims to address this. It would boost the low returns on private investments and lift the long-term growth outlook, since well-established capital markets enhance growth.[2] An additional long-term benefit for Germany would be a greater acceptance of growth-oriented structural reforms. Although such measures often face short-term resistance, they offer significant advantages over time. Capital markets tend to price in these long-term benefits, which can help build support for reforms (if more people benefit from capital gains) and ultimately increase future pension assets.
Reform Options within the German Pension System
There has been an ongoing debate about the future of the pension system. The German government has set up a reform commission to formulate and present fundamental solutions to the current challenges. Regardless of the reform commission's recommendations, we recognise the need for adjustments to all three pillars of the German pension system: public/statutory pension, occupational retirement provision and private pensions.
Pillar 1: Public/statutory pension
The first pillar is the pension provision by the state, which often works as an unfunded statutory pay-as-you-go system. It is, like all transfer-based systems, financed through contributions from economically active employees. Additionally, it receives allocations from the federal budget to compensate for expenses that are normally not covered by a pension system. Among these so-called non-insurance benefits are compensations for parents for insurance shortfalls due to periods of childcare. Currently, almost a quarter of the federal budget is transferred to the public pension scheme. This proportion is expected to increase due to the design of the pension scheme, which works as follows: A point-based system allows individuals to calculate their expected pension amount upon retirement.[3] Each year of employment at an average salary equates to one pension point. The pension is calculated by multiplying the pension points earned during a person's lifetime by certain factors and the current value of a pension point. The system is designed in such a way that pensions increase over time since the value of a pension point is linked to the growth rate of gross wages and salaries. The ratio of the initial pension compared to the final wage is around 53 percent (net replacement rate). However, pensions continue to increase in line with average wage growth, meaning that pensioners are compensated for inflation and also benefit from the productivity gains of the working population. The formula ensures that pensions can never decrease even if average earnings decrease, as may occur during recessions.
Due to the aforementioned mechanism and the demographic developments, substantial pressure has been placed on pillar 1. This is one of the factors driving a public pension reform that the German government may consider in the coming years. A transition to a fully funded system is often recommended. While this could be a substantial boost to capital markets and thus drive productivity growth, some caution is necessary. Transitioning from a pay-as-you-go system to a funded system would place substantial pressure on young people, who would be required to support the elderly while simultaneously building up reserves for their own retirement during a period of significant increase in the old-age dependency ratio. A transformation of this stature entails a longer implementation period and a substantial financial burden.
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