Public pension reform in Europe Richard Disney University of Nottingham & Institute for Fiscal Studies DWP: PUBLIC POLICY SEMINAR ON AGEING AND PENSIONS Feb 5, 2004

Topics in the presentation The state of European public pension programmes Reform strategies Are there lessons for the UK?

The basic facts Europes population is ageing Pension costs are rising Rising dependency ratios have been offset by increased participation of baby boomers (esp. of women) In many countries, greater generosity (benefit levels, early retirement) lies behind increasing pension costs In the future, old age dependency will become the key driver

Note: derived by author using PAYG rule that c* = RR/support ratio

But projections of rising pension costs in future…. Note: These are EC standardised projections

The good news: employment rates of older workers are rising

Classifications of public pension programmes Single pillar v. multi-pillar (World Bank) Beveridge v. Bismarck Extent of public v. private provision Extent of actuarial fairness in programme (esp. of public component)

Reform strategies (not exclusive) Parametric reforms (IMF jargon) e.g. less generous indexation, Italy 1992 Greater actuarial fairness in public programme e.g. Italy 1995, Sweden, new German proposals Top up funded component or prefunded public component e.g like US Trust Fund; various proposals from France, Ireland etc Greater selectivity (UK) Fixing up retirement incentives

Parametric reforms IMF (Chand & Jaeger, 1996) Designed to restore fiscal stability Cutbacks in generosity Political credibility – how to stop backsliding? Likely to affect existing pensioners as well as future pensioners

Actuarial-based reforms Goes to back to point systems used in France & Germany Reconstitute pension claims as notional accounts (Sweden, Italy) Contributions earn a sustainable return (Aaron-Samuelson condition) Indexation of key parameters (longevity, growth of accrued rights, indexation) to sustainability indicators

Pros of actuarial reforms Gets rid of ad hoc nature of parametric reforms Return on contributions transparent (willingness to pay /improve incentives?) Guarantees long run sustainability, if properly implemented

Cons of actuarial reforms Does not guarantee short run sustainability? If actuarial fairness the key, why not introduce funding (especially if r > g)? Rarely fully implemented e.g. Italy first age of retirement not indexed to longevity, also what happens if g < inflation? Long transition to steady state (e.g. Italy 2040 – but then transition SERPS to S2P no better!)

Pre-funding? Follow US example – accumulate trust fund for when baby boomers retire Proposed in Ireland, France, elsewhere… Main problem – can trust fund be ring-fenced (otherwise softens the govts budget constraint) (Example: Kotlikoff on US trust fund buying govt securities)

Top-up funding? Attempts to establish a funded pillar over and above reformed public programme Examples: Germany, Italy, Sweden How to start from scratch? (Additional contributions on already high level) Find existing pot and convert to pension fund? (Italy and TFRs) Divert contributions to funded component (e.g Sweden, but what happens if r>g?)

Greater selectivity? Only UK seems to follow this road with break between BSP and MIG/RTC Australia is obvious comparator – pure tax and transfer plus mandatory saving Without mandatory saving, clear disincentives to save (wrong to say RTC has less disincentives than MIG given more people affected) But mandatory saving is then implemented because people have no incentive to save!

Fixing up retirement incentives Many countries allow generous early retirement provisions (in public programme) And implement retirement tests on workers Moves to have latter abolished e.g. US, partially, 2000 UK looks OK by this criterion – Disney & Smith (2002) estimate 1989 abolition of earnings rule had small +ve impact on hours.

MIG v. Pension Credit: Impact on incentives? Basic state pension Minimum Income Guarantee Post-benefit income Pre- benefit income Pension Credit PC v MI G ? PC v. MIG ? PC v MI G ?

Lesson for UK? We can discuss, but…. UK has gone its own way (much more funding, greater selectivity of public programme Methods of indexation (e.g. retirement age to longevity, pensions-in-payment neither to prices or earnings) are of interest UK programme has become exceptionally complex – some efforts elsewhere to simplify (but multi-pillar will always be more complex…)