Europe’s pension crisis looms large in discussions of the region’s future. Suggestions of sweeping structural redesign—like raising the retirement age—are often met with fierce public resistance, leaving many countries facing a fiscal cliff.
The good news: Europe can achieve meaningful progress by reforming the financial architecture of pensions so that a greater share of retirements will be paid for with invested assets. Shifting more of Europe’s retirement systems toward funded schemes won’t be easy to implement across the board, but a strong argument can be made for the long-term benefits of doing so.
What’s more, the money invested would be a boon for Europe’s underfunded capital markets. According to our modeling, the introduction of three reforms—national pension funds, individually funded first‑pillar accounts, and universally funded occupational pension plans—could cumulatively build up to €4.1 trillion in assets by 2040 across Germany, France, Italy, and Spain. Of that sum, as much as €2 trillion would likely be invested in Europe—or up to 28% of the incremental investment called for by the Draghi Report.
These figures are the result of the optimistic scenario we modeled. But even when modeled conservatively, our proposed reforms would contribute meaningfully to Europe’s investment pool. (The full report, available as a downloadable PDF, provides a detailed methodology.)
The Link Between Pensions and Growth
Other countries have embraced these reforms, despite the associated transition costs.
For example, New Zealand started allocating government monies to create a national pension fund in 2001 to support future public pensions. The fund has grown to a size equivalent to 20% of the nation’s GDP.
In the late 1990s, Sweden began diverting a portion of payroll taxes to government-administered, individual investment accounts, which have since reached roughly 45% of Swedish GDP in size.
And about 90% of the workforce in the Netherlands, Sweden, and Denmark are covered by funded occupational pensions, leading to higher retirement income and less fiscal strain on government.
(To read more about the global pension crisis and how some countries are addressing it, see The Pension System Is Cracking—Here’s How to Fix It.)
We studied the four largest economies in the EU—Germany, France, Italy, and Spain—to model the feasibility and impact of each reform. These countries are overwhelmingly reliant on the first pillar of their pension systems—the government-run, public pension schemes in which active workers’ contributions are used to make payments to retirees. This system is particularly vulnerable to demographic shifts and already runs deep deficits of 2% to 6% of GDP.
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The three reforms we explore—national pension funds, individually funded accounts within the first-pillar system, and expanded coverage of funded occupational pensions—all contribute to alleviating the fiscal strain of the pension systems in Western Europe while channeling capital toward productive investment.
Although all three reforms may not be fiscally viable in each of those countries, the lessons learned here can ultimately be applied across nations seeking to expand and improve their respective pension systems.
National Pension Funds. The first solution, debt-financed national funds, can invest into assets in the long run and, over time, cover a sizable portion of government pension outlays. Because more debt makes all debt costlier, it is important to consider how setting up such a fund would impact public finances depending on each country’s current level and cost of debt.
Germany and Spain would be able to pursue such a reform given their lower debt levels. Collectively, they could amass €0.9 trillion to €1.1 trillion (15% to 17% of GDP in Germany; 10% to 12% in Spain). From the mid‑2040s, annual returns could cover 6% to 12% of government pensions in Germany and 4% to 7% in Spain, depending on returns.
France and Italy face a significantly tighter fiscal space—making this type of reform more difficult.
Individually Funded First‑Pillar Accounts. Most governments today use incoming taxes from active workers to pay for the pensions of current retirees. Sweden introduced a model in the late 1990s in which active workers contribute both to the existing system and to individual investment accounts. Implemented correctly, this solution will ultimately have future retirees’ income come from both the government and from a market-based investment account. This means that future pension income will bear some market risk—but will also be less exposed to demographic shifts.
Our modeling suggests that this reform would ultimately be viable for Germany, France, Italy, and Spain and would collectively build €0.8 trillion to €1.1 trillion in assets (about 5% to 9% of GDP per country).
Funded Occupational Pensions. In addition to the public pension system that covers almost all citizens, workers can also have added retirement savings through schemes offered through their employers. The opportunity presented by this third solution: today, not all workers have an occupational pension, and among those who do, many don’t have it funded by invested assets. The Netherlands’ sectoral funds, which are more than 150% of Dutch GDP, and the US 401(k)s, which alone hold $9 trillion in assets, show that scale is transformative when coverage is wide and contributions are meaningful.
At the country level, both the transition costs and the impact of this reform will vary given national contexts. In short, we found that this reform isn’t viable in France, but Germany, Spain, and Italy all have paths to implementing it.
If these three countries reach coverage of roughly 90% of their workforce, funded occupational pension assets could total up to €1.8 trillion. A stronger occupational pension system also creates political room for future adjustments to public pensions if necessary.
A Path to Feasible Reform
Recent proposals—including calls to pool European savings for EU investment—reflect a growing appetite for connecting retirement reform with growth. But policymakers will need to navigate some challenges.
- While international precedents (notably New Zealand’s Superannuation Fund) show that a national pension fund can work, governance is the linchpin for the model’s success. Such a fund would need to ensure independent management, prudent investor mandates, transparent reporting, and clearly defined purposes to ultimately build trust and performance.
- For individually funded first‑pillar accounts, the most likely obstacle is citizens’ acceptance of some market exposure for part of their public pension—but policymakers can build support through mitigating measures such as low-fee defaults, consumer protections, and clear communications.
- Funded occupational pensions face challenges including higher costs for some employers and slower disposable income growth for some workers during the transition for some workers—but this model will ultimately ensure higher income for those very workers when they retire.
Still, although such reforms will have transition costs across stakeholders, they may benefit from occupying a middle ground between inaction (which won’t be an option in the foreseeable future) and a complete overhaul of the social safety net. A disciplined, well‑governed expansion of funded pensions—implemented with clear fiscal guardrails and public accountability—can lower tomorrow’s fiscal burden. The accumulation of up to €4.1 trillion in assets can in turn raise today’s investment, aligning the interests of governments, businesses, and future retirees.
