Living Standards in an Aging Germany: The Benefits of Reforms and the Costs of Resistance

Abstract

Summary The extent of the demographic change in Europe and especially Germany is dramatic and will deeply affect future labor, financial and goods markets. The expected strain on public budgets and especially social security has received prominent attention, but aging poses many other economic challenges that threaten growth and living standards if they remain unaddressed. This paper investigates the potential benefits of pension and labor market reform for growth and living standards, taking into account behavioral reactions to specific reforms. Which behavioral reactions will strengthen, which will weaken reform policies? While Germany has a large unfunded pension system and vulnerable labor markets, Germans show remarkable resistance against pension and labor market reform. Can Germany maintain its standard of living even if behavioral reactions offset some of the current reform efforts? The paper uses a novel modeling approach to distinguish between exogenous and endogenous components of labor supply in order to shed light on these questions.