Another threat to pensions

Much has been said about the impact of aging on public pensions, but there is another, less visible threat that could further aggravate their financial sustainability: the decline in the share of labor income in GDP.

In a recent study, based on long-term simulations of the Spanish economy, we analyzed the consequences of this trend. The results are worrying: if the share of labor income continues to fall, the public pension system deficit will widen significantly in the coming decades. The problem is not just that there are fewer workers supporting more pensioners. Furthermore, even if employment increases, it may be that workers as a whole contribute less and less to the economy, further calling into question the financial sustainability of pensions.

In the 1990s, wages represented approximately 55% of GDP; today, that figure is around 50%. The other 50% corresponds to what is technically known as mixed income, i.e., income from land, capital, and business profits, interest, dividends, rent, capital gains... In other words, income generated by all the other factors involved in production other than human labor.

In this case, it can happen, and is happening, that even though the size of the pie grows, the share of the pie allocated to wages and salaries decreases. Since public pay-as-you-go pension systems—like Spain's—are financed primarily by contributions to wages, a lower share of wages in GDP reduces the system's revenue relative to GDP. This problem is further exacerbated because pension spending does not adjust at the same speed as contributions. Since pensions are calculated based on past wages, there is a gap between the decrease in revenue and the decrease in expenditure, resulting in an increase in the system's deficit.

Consider a 45-year-old worker earning €40,000 annually. If their salary drops to €35,000, their contributions will also fall, but their future pension, based on their employment history, will take decades to reflect this decrease in salary. Thus, the system's revenues decrease today, but the decrease in expenditures will only occur much later. This gap threatens to make pension system deficits chronic if corrective measures are not taken immediately.

To measure the magnitude of this problem, in our study we simulated two possible scenarios for Spanish pensions. In the first scenario, the share of labor income in GDP remains stable; in the second, it decreases from 52% in 2018 to 40% in 2060. The difference is substantial: in the second scenario, contribution revenues decrease immediately, while spending barely corrects, increasing the deficit as a proportion of GDP for decades.

Although our analysis focuses on Spain, this problem can be extrapolated to any country with a pay-as-you-go pension system. Our study shows that the sustainability of pensions is not exclusively a demographic issue; it also depends on technological developments that reduce the share of labor income in our economies.

In our opinion, the pension debate needs to be broadened as soon as possible. Until now, the most discussed solutions have been limited to familiar formulas: raising the retirement age, increasing contributions, or cutting pensions. However, these measures, while necessary in some cases, are insufficient to address this technological challenge.

The current problem is not just how long we work or how much we contribute, but how the system is structured in a changing economic environment, where the weight of wages in wealth creation is persistently declining. Given this structural change, the sustainability of pensions requires much deeper reforms: we should move toward a mixed model that combines a pay-as-you-go system in which pensions depend strictly on contributions made throughout workers' working lives with a mandatory capitalization system.

Under this scheme, a portion of contributions would be allocated to productive and diversified investments, providing each worker with a complementary source of income for retirement. The goal is not to replace intergenerational solidarity, but rather to reinforce it with mechanisms that strengthen the system's sustainability in the face of impending demographic and technological changes.

Our research shows that the future of pensions does not depend exclusively on demographics, as has long been assumed. It also depends, crucially, on how GDP is distributed. If wages lose weight in GDP and wealth becomes concentrated in forms of capital less accessible to the majority, the contributory base of pay-as-you-go systems erodes, making their sustainability unviable in the medium and long term.

In this new environment of replacing human labor with machines and algorithms, passivity is not an option. Waiting for the problem to worsen before attempting to solve it would only condemn us to more drastic and socially painful solutions in the future. If we want to preserve the social compact that sustains our public pensions, we must act immediately with bold, technically sound, and socially fair reforms capable of strengthening the system's financial sustainability without sacrificing the cohesion and intergenerational equity that give it meaning.