Download Pension transfers vs. production factors

PENSION TRANSFERS
VS.
PRODUCTION FACTORS:
THE CHALLENGE OF THE 21ST
CENTURY
Marek Góra
War saw School
of Economics
Polish Pension
Group
THREE LEVELS OF ANALYSIS
Level 1
Level 2
Level 3
• Pension system: Social goals and economic fundamentals GDP divided between generations, population structure
• Method: Basic arrangements for acquiring pension rights in
terms of future GDP - DB, DC, private, public, financial markets,
annuitization, type of management
• Regulations: Technicalities of institutions - very many various
institutional arrangements
INTERGENERATIONAL EXCHANGE (1)
The pension system is an institutional framework for intergenerational
exchange.
In order to finance retirement consumption pension rights need to be
exchanged for a part of the real product (irrespective to the form the
rights are expressed in).
The pension problem we face is not the problem of the scale of GDP
but the problem of how to divide current GDP between pensions and
production factors.
INTERGENERATIONAL EXCHANGE (2)
Dcw  L
W
S  zwL
R
1
zc
d
LR
(d  W )
L
DEMOGRAPHIC DIVIDEND
Demographic dividend refers to the extra growth and revenue
made possible when the working -age population expands. The
government can collect more revenue without raising taxes
and finance more programs (including pension systems). The
costs of running deficits falls because tax revenues are rising
due to the population growth. This is temporary, thou.
DEMOGRAPHIC DIVIDEND: FROM STRONG
PLUS TO INCREASING MINUS
 Currently existing pension systems were designed in times when
demographic dividend was positive and large.
 Pension systems have weak automatic adjustment mechanisms.
Political decisions needed instead.
 In late 20th century the dividend turned negative as the working
population shrinked as a percentage of the total population, and
older cohorts expanded. That is continuing and expanding.
 Politicians are afraid of saying people the truth: pensions will be
decreasing.
 Consequently we are loosing control over proportions of GDP spent
on pensions and production factors.
POPULATION STRUCTURE BY AGE
7
WHAT CAN WE DO?
Very little room for manouvre:
• Productivity growth
• Fertility increase
• Immigration
The above can help but only a little.
Redesigning institutions (automatic adjustment) is needed in order
to come back to the intergenerational equilibrium.
INTERGENERATIONAL EQUILIBRIUM
Each generation is first a working generation that buys pension
rights, and afterwards a retired generation selling accumulated
rights.
If each generation’s welfare is equally important then it is the only
Arrow-Debreu equilibrium (Nash equilibrium if we define
generations as players) that is Pareto optimal.
If one generation received more than it paid in, then another
generation would receive less than it paid in. In such situation,
preferences are inconsistent in the period of participation, hence,
there is no equilibrium at all, or the system prefers one generation
over others (allocation not being Nash equilibrium).
GDP DIVIDED BETWEEN PENSIONS AND
PRODUCTION FACTORS
GDP2
GDP1
T1
R1
GDP1
T2
R2
AT-RISK-OF-POVERT Y RATE BY AGE
CHANGE 2005-2010 (2005=100%)
Total
65+
50-64
25-49
18-24
-18
EU (27 countries)
100%
85%
101%
104%
108%
103%
Euro area (17 countries)
106%
80%
105%
114%
119%
114%
Germany
128%
105%
135%
131%
127%
143%
Spain
105%
74%
110%
118%
140%
108%
France
102%
65%
83%
110%
128%
124%
Italy
96%
73%
90%
109%
104%
105%
Poland
86%
195%
101%
76%
84%
77%
United Kingdom
90%
86%
92%
95%
85%
89%
Greece
103%
76%
95%
117%
129%
113%
Portugal
92%
76%
94%
97%
117%
95%
Sweden
136%
153%
137%
133%
116%
128%
11
AT-RISK-OF-POVERT Y RATE BY AGE
(ENTIRE RATE=100%)
CHANNELS OF REDISTRIBUTION
If redistribution is financed via the budget then:
Broader redistribution base;
Social needs can be better addressed (adjustability);
Pension system istransparent.
KEY GOAL FOR PENSION REFORMS
Key objective is to protect remuneration of production factors (net
value of), which means to stop the increase of expenditure on
financing pensions (in terms of GDP).
The goal is to keep the entire pension system within the framework
that can be summarised as:
PV(B) = PV(C)
The above mean a redution of ex ante pension expectations
(expressed in relative terms).
The only other option is to adjust pensions ex post, which means
reduction of pension levels in absolute terms.
PENSION EXPECTATIONS
Reduction of pension expectations ex ante protects remuneration of
production factors which contributes to stronger GDP growth, hence
this also contributes to higher welfare of both the working and the
retired generation
Pension expectations kept at inflated levels require additional reduction
of the remuneration of production factors, which slows down growth
and reduce welfare of both generations. Eventually pensions will have
to be cut ex post anyway.
A NEED TO RETHINK
In terms of the actual and projected population structure in the 21st
century the traditional approach to pension systems seem
inappropriate. So rethinking is needed.
Intergenerational fairness
Effectiveness of redistribution channels
Direction of redistribution channels
Old-age pension is a necessary bad, not good. Remuneration of
economic activity is the good.