From the August 2008 issue of Research Magazine • Subscribe!

From Bismarck to Bush

On November 17, 1881, German Kaiser Wilhelm I issued an imperial decree stating that "those who are disabled from work by age and invalidity have a well-grounded claim to care from the state." The driving force behind this pronouncement was Chancellor Otto von Bismarck, who had unified Germany, unleashed victorious wars against Austria and France and was now intent on creating the world's first broadly available pension system.

Throughout the 1880s, Bismarck pushed for the creation of government social programs. The German pension system, financed by mandatory contributions from employers and employees, was enacted in 1889. When critics contended that such measures were socialistic, Bismarck replied insouciantly: "Call it socialism or whatever you like. It is the same to me."

At the same time, Bismarck sought to inoculate the public against more radical types of socialism. His goal, above all, was to secure the power of the authoritarian state he had built over the decades. And in seeking to set up retirement pay, the chancellor was pretty candid about these political calculations. "Whoever has a pension for his old age," he said, "is far more content and far easier to handle than one who has no such prospect."

The German system initially adopted a retirement age of 70, which in 1916 was lowered to 65. Bismarck himself was 74 when the system was established. Nonetheless, a myth arose that the retirement age of 65 -- adopted later by Social Security as well -- was based on Bismarck's own age. As it happened, Bismarck was pushed into retirement in 1890, due to difficulty getting along with the young and ill-fated Kaiser Wilhelm II.

Other European nations followed Germany in adopting state-run pension systems over the next several decades. In the more free-market United States, however, there was little political momentum for such a move. When Theodore Roosevelt made his failed "Bull Moose" run to regain the presidency in 1912, his platform included a plank for a national pension system. But the issue did not reemerge until the Depression-slammed 1930s.

Instead, the U.S. was in the forefront of developing industrial pensions. The American Express Company set up the nation's first employer-provided retirement plan in 1875. A few years later, the Baltimore and Ohio Railroad developed a plan financed by both employer and employee contributions. In 1900, the Pennsylvania Railroad, the country's biggest private employer, created a pension that became a widely used model. The plan covered all workers, set mandatory retirement at 70 and paid 1 percent of an employee's average wage during the last 10 years of work, multiplied by years worked.

Pensions became increasingly common in American industry over the next couple of decades. By 1916, more than half of railroad employees were covered. The new arrangements spread into other sectors, including banking, utilities and manufacturing. Some union leaders initially were wary of pensions, seeing them as a way for companies to shift money from current wages into uncertain future obligations. But pensions proved popular among the labor rank-and-file, and in time became a subject of union demands.

Government workers also were more and more likely to get pensions. Payments to war veterans had been a military practice since the American Revolution, and in 1885 the Army had set up its first comprehensive retirement plan for officers and enlisted men. A few large cities such as New York had established pension plans for some municipal workers, such as police, firefighters and teachers, by the late 19th century. In 1911, Massachusetts became the first state to have a retirement plan for state employees, and in 1920 the federal government began providing its first civil-service pension benefits.

In 1923, a company called Morris Packing went out of business, leaving behind a pension fund unable to cover its obligations. This spurred a push toward reforms, such as having funds managed by independent fiduciaries. But the tendency toward increased pension coverage continued. New laws making employer contributions to retirement plans tax-deductible helped further this trend.

Gradually, the idea was spreading that retirement could be a time of leisure and financial security. Throughout history, people had typically worked for as long as they were able, and had depended on relatives or charities to support them beyond that point. Now, many were beginning to view retirement as something that could be planned for and enjoyed, with payments earned over decades of labor.

And then the Great Depression arrived.

New Retirement DealWith rising millions unemployed, and many middle-aged and older people suspecting they were never going to get a job again, pressure for some kind of government provision of retirement funds grew rapidly in the early 1930s. The failure of many corporate pensions added fuel to this fire. Even the longstanding railroad pensions were in trouble.

Various figures appeared on the political landscape to offer solutions. In 1933, a 66-year-old California doctor named Francis E. Townsend wrote a letter to a newspaper calling for the federal government to provide the elderly with a sizable pension of $200 per month. Soon, he was heading a movement for this idea, complete with Townsend Clubs. Writer Upton Sinclair included a $50 monthly pension in his plan to End Poverty in California, and campaigned on it in 1934 as candidate for governor of California.

On June 8, 1934, President Franklin D. Roosevelt sent a message to Congress calling for "social insurance ... to provide security against several of the great disturbing factors in life -- especially those which relate to unemployment and old age." This was, he added, "not an untried experiment. Lessons of experience are available from States, from industries and from many Nations of the civilized world."

That same month, FDR set up a Committee on Economic Security with five Cabinet officers including its chairwoman, Labor Secretary Frances Perkins, and a staff headed by economist Edwin Witte. The committee's recommendations became the basis for the Social Security Act, which was signed into law on August 14, 1935. The new law had various provisions, including unemployment insurance and aid for dependent children, but its centerpiece consisted of old-age benefits, beginning at age 65 and paid for through payroll tax contributions. Social Security had been born.

In another major step into the retirement business, the federal government took over the struggling pension plans of the railroads, through several pieces of legislation enacted in the 1930s. A system of social insurance for railroad workers was set up, and it continues to this day, separate from Social Security although similar in many respects.

It might have seemed at this point that corporate pensions would soon become obsolescent in the new era of government expansiveness. But oddly, World War II prevented that scenario from coming to pass. Wartime meant higher tax rates, plus wage controls. So companies became more eager for the tax breaks from pension contributions (even though the Revenue Act of 1942 tightened the rules for favorable tax treatment), and pensions rather than wages became the key to attracting talent. "U.S. industry is enjoying a boom in pension plans," reported Time magazine in its July 10, 1944 issue.

Search for SecurityIn the postwar years, the pension boom continued. A major contributor to that trend was "Engine" Charlie, more formally known as Charles Erwin Wilson, who as president of General Motors in 1950 offered a pension to every GM employee. The United Auto Workers, led by Walter Reuther, had qualms about signing on to this corporate proposal. One concern was that it left non-GM workers out in the cold. Another was that it could cause a rift between older workers eager for pensions, and younger ones wanting cash.

But the deal got done. And business sage Peter Drucker would later describe it as a crucial step in an "unseen revolution," whereby corporate pensions became common in American life. Engine Charlie, for his part, went on to run the Pentagon and to be known for suggesting that what's good for GM is good for the country.

The combination of Big Government, Big Business and Big Labor in the third quarter of the 20th century made retirement a more attractive prospect for many than it had ever been before, complete with gold watches and plenty of time for golf. But such security presupposed that workers would stay with their companies for much of their careers, and that the companies would stay in business for long periods of time -- assumptions that became notably less valid as the century drew nearer to its close.

An early warning of such problems came when the collapsing automaker Studebaker reneged on its generous pension benefits in 1963. That event spurred a push for new regulations to protect pension plan holders. The Employee Retirement Income Security Act of 1974, or ERISA, set new standards for pensions and created the federal Pension Benefit Guaranty Corporation to provide insurance against plan termination.

New types of retirement accounts were soon entering the picture. Congress amended the federal tax code in 1978 to allow 401(k) plans, which employers increasingly embraced as a less costly alternative to defined-benefit pensions. Defined-contribution plans such as the 401(k) also gave more flexibility for employees to choose their retirement investments, creating a vast new market for the financial-advice industry.

The Third RailSocial Security proved to be a highly popular government program over the decades. One reason for Barry Goldwater's lopsided defeat in the 1964 presidential election was his statement, "I think Social Security ought to be voluntary." In the 1980s, House Speaker Tip O'Neill famously called Social Security "the third rail of American politics," because any politician who sought to alter the system would get a major career shock.

But the viability of the pay-as-you-go system became a matter of growing concern, as increased longevity, the aging of the baby boomers and relatively low fertility rates in the boomers' wake raised the prospect of a long-term funding crisis. Adding impetus to calls for reform was the superior performance of the stock market versus the government bonds in which Social Security was required to invest.

According to historian Steven Gillon's new book The Pact, President Bill Clinton and House Speaker Newt Gingrich were jointly planning an overhaul of Social Security in early 1998 when the Monica Lewinsky scandal destroyed the possibility of such cooperation.

President George W. Bush, in his 2005 State of the Union address, said that Social Security in its current form "is headed toward bankruptcy." But his plan to convert part of the program into private investment accounts met stiff opposition and never made it to a vote in Congress. Bush's unpopularity over matters ranging from Iraq to Katrina didn't help him make his case.

Then again, Bismarck would not have been surprised at the difficulties future politicians would have in changing the program he helped inspire. The Iron Chancellor is credited with noting that laws, like sausages, require an unpalatable process to get made.

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Otto von Bismarck's creation of a pension system in Imperial Germany developed the concept of retirement pay, but earlier forms of the idea appear throughout the ages. In ancient Rome, the emperor Augustus established a fund of silver coins, or denarii, to reward legionnaires for their years of service.

Military pensions in the United States date to the early days of the Republic. In the 1780s, Congress authorized payments to veterans of the Revolution, although these often came in the form of bonds and it took years before it became clear the U.S. government would be able to honor these obligations.

Thomas Paine, in his mid-1790s pamphlet Agrarian Justice, called for a pension for the general public, to be financed by a tax on inherited property. Paine proposed annual payments to people who had reached age 50, "to enable them to live in Old Age without Wretchedness, and go decently out of the World."

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Kenneth Silber is a senior editor at Research. His work on science, economics and history has appeared in a variety of publications, including The Wall Street Journal

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