Download Labor market impacts

The Economic Impact of
Pension Reform and its
Implementation
by
Estelle James
Populations Are Aging
• By 2030 the proportion of the world’s
population that is > 60 will nearly double,
from 9% to 16%
• % > 60 15% in ECA/FSA region. Wide
variation--much higher in Eastern Europe,
lower in Stans. But aging is increasing in
all.
Percentage of the Population Over 60 Years Old,
by Region, 1990 and 2030
1990
OECD countries
2030
Transitional Socialist Economies
China
Latin America and the Caribbean
Asia (excluding China)
North Africa and the Middle East
Subsaharan Africa
WORLD
0
10
20
30
Percentage of population over 60
When Populations Age, Public
Pension Spending Increases
• Many industrialized countries now spend
more than 10% of their GDP on pensions
• Public spending on health and pensions now
exceed 20% of GDP in some countries
• ECA/FSA region spends more than average
for its demography
Relationship Between Percentage of the Population
over 60 Years Old and Public Pension Spending
Pension spending as
percentage of GDP
16
Austria
Italy
Poland
Luxembourg
12
Greece
France
Sweden
Uruguay
U.K.
8
Panama
U.S.
Costa Rica
4
Israel
Japan
Australia
China
0
Jamaica
5
10
15
Percentage of population over 60 years old
20
Public Health and Pension Spending
versus Population Aging
Spending as a percentage of GDP
Austria
20
Czechoslovakia
Sweden
Poland
15
U.K.
New Zealand
Iceland
Canada
Switzerland
Spending on health and pension
10
Brazil
Trinidad &
Tobago
5
Japan
Australia
Cyprus
Spending on health
China
Jamaica
Swaziland
Zambia
S. Korea
Indonesia
0
0
5
10
15
20
Percentage of population over 60 years old
25
With such large sums, social security
affects entire economy. It influences:
• Peoples’ incentive to work (espec. near retirement)
• Employers’ willingness to hire labor
• Labor allocation between formal-informal sectors
• Level of national saving and its allocation
• Financial market development
• Government’s fiscal position
• Therefore quantity and productivity of labor
and capital and level of GNP
• Important to choose system that increases
size of the pie--this is good both for old and
young
• This is the rationale for multi-pillar systems
that include funding and defined
contribution pillars
• But--System design and implementation
both matter.
Labor market: 1)impact of payroll
tax on wages and employment
• If employers bear tax, this raises labor costs,
lowers competitiveness, employment, output:
employers less willing to hire
• If workers bear tax in form of lower takehome pay: less willing to work, exert effort
(in most OECD countries workers bear tax)
• Labor may shift to informal sector--lower
productivity-problem in transition economies
Impact on employment (cont’d)
• Payroll tax > 20% in many countries in
region, even greater than 30% or 40% in
some--in contrast to Asia where < 5%, US
where = 15%
• Old age security should cost < 20% in well
run system in long run
• Distortions increase exponentially with tax.
Important to choose system that keeps tax
low and avoids peak rates--rationale for prefunding
Biggest impact on work-retirement age
• Workers retire early if can receive benefits for
more years without actuarially fair decrease in
pension (6-7% decrease per year of early
retirement) (Gruber-Wise)
• Yet, many systems permit this--big problem in
transition economies
• Women often allowed to retire earlier, live longer
• Longevity increases require periodic hikes in
retirement age--but politically difficult to do this
• So experienced labor supply declines; less
productivity and output
Retirement age (Cont’d)
• Important to choose system that encourages
continued work--rationale for multi-pillar system
with DC plan
• In DC plan, when worker retires and converts
savings to annuity in competitive market:
– Pension is automatically lower for early retirees
– Annual benefit decreases as longevity increases
– This encourages more years of work, helps economy
and fund
• But details matter. If DC plan is notional DC:
– Government sets conversion rate to annuity
– DC advantage is lost if conversion does not depend on
expected lifetime at retirement
Impact on national saving
• New PAYG system decreases national saving
– due to increased consumption of first
generation covered and expectation that
government will pay on-going benefits
• Mandatory pre-funding can increase saving
– builds up fund of investable resources,
providing not offset by decrease in voluntary
savings or public dissaving (deficits)
• Many countries in this region need more capital,
can use funded pension system to increase saving
But: how transition is financed
affects national saving
• Suppose given contribution rate is diverted
from PAYG to funded system; this is saved.
But promised benefits still must be paid.
– If financed through increased government
borrowing: doesn’t increase national saving,
because public dissaving offsets private saving
– If financed through taxes or cuts in government
spending: increases national saving, but heavy
current burden
• Mix is possible and probably best
Impact on capital productivity
• Most important, pension funds shift type of
saving--committed for long term--can be used
for equity investment, venture capital,
infrastructure, long term government debt
• Productivity of savings depends on how funds
are managed and allocated--rationale for
private competitive management
• Regulation needed; but--not over-regulation
Impact on financial market
development
• Privately managed funds stimulate stock
markets, secondary bond markets, new
financial instruments, credit rating
agencies, info disclosure (Chile, OECD).
• Aid in corporate governance, minority
rights, accountability--if regulated to avoid
conflicts of interest
• Credit for large growth effect in Chile
• But: regulations and guarantees accused of
distorting financial markets
Impact on government’s fiscal position
• Pension deficits may lead to general revenue
finance, less money for important public
goods, inflationary deficit finance
• Deficits can be avoided by prefunding
• Transition to prefunding makes implicit debt
explicit, increases explicit debt in short run
• Important to have plan to pay off transition
debt in long run or advantage is lost
Impact on intra-generational
income distribution
• Many people think social security should avoid
old age poverty and redistribute to low earners-but most DB plans don’t do this: Studies show
little or no lifetime redistribution to the poor
–
–
–
–
–
Rich live longer, collect benefits for more years
Only labor income is taxed
Ceiling on taxable income
Pension often based on wage in last 1-5 years
People who retire early are subsidized
• New system can avoid this but may not--important
to include social safety net for the poor
Impact on inter-generational
distribution
• In PAYG schemes largest redistribution is to
first generations covered, future generations
lose
• Reduced savings hurts future generations
• Shift to pre-funding helps future generations
• But--distributional effect depends on how
transition costs are financed, since the old
promises must be kept: taxes hurt present,
debt finance hurts future
How have multi-pillar systems
worked? Reform has helped Chilean
economy since 1981
• Employment and wages rose--5%
• National saving increased--7% annually
• Financial markets developed
• Total factor productivity increased--.4-1%
per year
• Average annual rate of return over 10% real
Many gains have been made but
implementation problems remain
• How can countries cover transition costs-increasing explicit debt v. taxes?
• Administrative costs--are they too high?
• Demand for guarantees and regulations that
may distortion markets (herding)
• How do investors choose when uninformed?
• Collection and record-keeping problems
• Annuities markets--how to organize?
• This seminar deals with these issues, which
influence economic impact of the reform
Conclusion
• Important to choose system that
– is sustainable so promises can be kept,
– distributes tax burden and benefits fairly
– maximizes size of GNP pie, by beneficial labor
and financial market effect
• Pre-funding, defined contribution, good fund
management and regulations, social safety
net and transition finance plan help to satisfy
these criteria. But details matter as well as
basic design.