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Reforming pension systems – opportunities and obstacles
Workshop in Malmö 17th of Nov. 2009 Agneta Kruse Department of Economics, Lund University
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Background: Most countries in the industrialised world:
Pay-as-you-go systems, i.e. today’s contributions are used for the contemporary pensioners’ benefits Pensions are life-cycle savings where the insurance part is an insurance against an extra-ordinary long life.
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How to organise? Public Private Obligatory Voluntary
Basic Supplementary Selective General Pay-as-you-go Funded Redistributive Actuarial - within a generation - between generations Defined-benefit, DB Defined-contribution, DC Indexing contributions and/or benefits by Growth, prices, interest in the capital market Pay-as-you-go Funded
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Pay-as-you-go system [vs. a funded one]
Today’s working generation pays contributions which are used for paying today’s pensioners’ pensions. An (implicit) social contract between generations. q w L = b R where q contribution rate, w wage, L labour force, b pension benefit and R number of pensioners. Left hand side: Sum of contributions; Right hand side: Sum of benefits
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q = b/w R/L i.e. the contribution rate has to equal the replacement rate times the dependency ratio. It is (intuitively) obvious that indexing is by the growth rate in the wage sum.
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Challenges to pay-as- you-go pension systems
Demographic ageing; fertility, mortality, working years/hours Economic growth rate: productivity, the functioning of labour market • Political expansion beyond the optimal level
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Challenges to funded systems
Demographic ?? Economic rate of return in the capital market ● Political non-efficient use of funds
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Ageing: reduced fertility, increased longevity … R/L ↑
R/L ↑ means that q has to be increased or b (b/w) decreased: q w L = b R; q = b/w R/L Most systems are defined-benefit; → the ”burden” of ageing falls on the working generation.
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The contribution rate at different combinations of b/w and R/L:
0.33* ** b/w *) corresponds to a life with 45 working years (20-64) and 15 years as a pensioner (65-80) **) close to prognoses for Italy and Spain in 2050.
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The demographic dependency ratio (65+/15-64) for a selection of countries: (Source: UN, World Pop. Prospects) 2010 2050 Czech republic 22 48 France 26 47 Germany 31 59 Italy 25 62 Poland 19 52 Spain Sweden 28 41 UK 38
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Ageing (+ reduction in growth prospectives):
make the public pay-as-you-go systems unsustainable: Reform proposals and activities … …. easier said than done! Vested interests from politicians, pensioners’s organisations and labour unions (?)
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Reform resistance: Results from economic theory as well as empirical findings show that pay-as-you-go systems expand beyond the optimal level Ageing increases the tendency of expansion The median voter becomes older!
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… nevertheless: a number of reforms
Major reforms, paradigm shifts (NDC): Italy, Lithuania, Poland, Sweden … Parameter changes (calculation methods, indexation, pension age): France, Germany, Hungary, Portugal …
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The Swedish reform as an example
From unsustainable and unfair DB payg to a NDC, financially stable without perverse redistribution Transition rules for those born between 1938 and 1953. Demographic strain reduced by work incentives and life expectancy in the benefit formula.
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1980s: A parliamentary commission + social partners: good investigation; no changes!
1990s: Small working group of politicians from all parties. No social partners. Awareness of the system’s unsustainability. Economic crises.
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Reform options Path dependency …
Honouring the social contract … (even it the contract means taxing still not born?) Transition rules. Incentives? Delayed retirement, increased working hours? Fairness (redistribution?).
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Fairness within a generation;
outcome for men and women; socio- economic groups: Benefit level Replacement rate Rate of return
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Fairness between generations?
Indexing with growth / wages means that co-living generations share the fruits of good years and the burden of lean years But – of course – reduced labour supply reduces the growth rate ….
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