political (in)stability of pension system reforms
TRANSCRIPT
Motivation Model Motivation Results
Political (In)Stability of Social Security Reform
Krzysztof Makarski Joanna Tyrowiczwith help from Marcin Bielecki, Oliwia Komada and Magda Malec
Economic Institute, National Bank of PolandFaculty of Economics, University of Warsaw
Warsaw School of Economics
Royal Economic Society - 2016 - Brighton
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Motivation Model Motivation Results
Literature review
A wave of reforms: Holzman and Stiglitz (2001), Bonoli and Shikinawa (2006),Gruber and Wise (2009)
Reform = introduce some notion of funding into the systemPolitical economy of pension systems: will the reform be implemented
Cooley and Soares (1999), Galasso and Profeta (2002), subsequent literaturereviewed by de Waque (2005)extant literature on whether or not privatization is in fact welfare enhancing:Conesa and Kruger (1999), Nishiyama and Smetters (2007), Fehr (2009)
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Motivation Model Motivation Results
Literature review
A wave of reforms: Holzman and Stiglitz (2001), Bonoli and Shikinawa (2006),Gruber and Wise (2009)
Reform = introduce some notion of funding into the system
Political economy of pension systems: will the reform be implementedCooley and Soares (1999), Galasso and Profeta (2002), subsequent literaturereviewed by de Waque (2005)extant literature on whether or not privatization is in fact welfare enhancing:Conesa and Kruger (1999), Nishiyama and Smetters (2007), Fehr (2009)
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Motivation Model Motivation Results
Literature review
A wave of reforms: Holzman and Stiglitz (2001), Bonoli and Shikinawa (2006),Gruber and Wise (2009)
Reform = introduce some notion of funding into the systemPolitical economy of pension systems: will the reform be implemented
Cooley and Soares (1999), Galasso and Profeta (2002), subsequent literaturereviewed by de Waque (2005)extant literature on whether or not privatization is in fact welfare enhancing:Conesa and Kruger (1999), Nishiyama and Smetters (2007), Fehr (2009)
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Motivation Model Motivation Results
Motivation
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Literature review - continued
Despite general welfare gains...... most of these reforms got reversed: Jarrett (2011); Schwarz et al. (2014)(At least) Some of the reversals are welfare deteriorating: Hagemejer et al(2015)
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Goals and expectations
GoalSuppose there already is a reform, with stable gains in the long-run:does it eventually become politically stable?
Expectations
With passing of the initially old cohorts, welfare gains become majoritarianUnderstand/explain the reversing of reforms
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Motivation Model Motivation Results
Goals and expectations
GoalSuppose there already is a reform, with stable gains in the long-run:does it eventually become politically stable?
Expectations
With passing of the initially old cohorts, welfare gains become majoritarianUnderstand/explain the reversing of reforms
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Motivation Model Motivation Results
Outline
1 Motivation
2 Model
3 Motivation
4 Results
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Motivation Model Motivation Results
Agents
”born” at age 20 (j = 1) and live up to 100 years (J = 80)subject to time and cohort dependent survival probability πchoose labor supply l endogenously until exogenous retirement age J̄ (forced toretire)
optimize remaining lifetime utility derived from leisure 1− l and consumption c
Uj,t =J−j∑s=0
[δsπj+s,t+sπj,t
u(cj+s,t+s, lj+s,t+s)]
with
u(c, l) = log(cφ(1− l)1−φ)
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Motivation Model Motivation Results
Agents
”born” at age 20 (j = 1) and live up to 100 years (J = 80)subject to time and cohort dependent survival probability πchoose labor supply l endogenously until exogenous retirement age J̄ (forced toretire)
optimize remaining lifetime utility derived from leisure 1− l and consumption c
Uj,t =J−j∑s=0
[δsπj+s,t+sπj,t
u(cj+s,t+s, lj+s,t+s)]
with
u(c, l) = log(cφ(1− l)1−φ)
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Motivation Model Motivation Results
Agents
receive market clearing wage for laborreceive market clearing interest rate on private savingsreceive pension income + unintentional bequestspay taxes
Subject to the budget constraint
(1 + τ ct )cj,t + sj,t = (1− τ lt )(1− τ ι)wj,tlj,t ← labor income
+ (1 + (1− τkt )rt)sj−1,t−1 ← capital income
+ (1− τ lt )pιj,t ← pension income+ bj,t ← bequests−Υt ← lump-sum tax
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Motivation Model Motivation Results
Agents
receive market clearing wage for laborreceive market clearing interest rate on private savingsreceive pension income + unintentional bequestspay taxes
Subject to the budget constraint
(1 + τ ct )cj,t + sj,t = (1− τ lt )(1− τ ι)wj,tlj,t ← labor income
+ (1 + (1− τkt )rt)sj−1,t−1 ← capital income
+ (1− τ lt )pιj,t ← pension income+ bj,t ← bequests−Υt ← lump-sum tax
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Motivation Model Motivation Results
Firms
Perfectly competitive representative firmStandard Cobb-Douglas production function
Yt = Kαt (ztLt)1−α
Profit maximization implies
wt = zt(1− α)kαtrt = αkα−1
t − d
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Government
collects taxes on earnings, interest and consumption (sum up to T )spends a fixed share of GDP on government consumption Gcollects social security contributions and pays out pensionsof the DB and NDC systems
subsidyt = τ ιJ̄−1∑j=1
wj,tlj,t −J∑j=J̄
pj,tNj,t
services debt D and targets a fixed long-run debt/GDP ratiolump sum tax Υ adjusts to satisfy the government budget constraint in steadystateconsumption tax τC adjusts to satisfy the long-term debt/GDP target
Gt + subsidyt + (1 + rt)Dt−1 = Tt +Dt + Υt
J∑j=1
Nj,t
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Motivation Model Motivation Results
Pension system
Initial steady state: defined benefit
Exogenous contribution rate τ and an exogenous replacement rate ρ
pDBJ̄,t = ρ · wage in last working year
indexed by 25% of total payroll growth
Reform: partially funded defined contribution
Exogenous contribution rate τ and actuarially fair individual accounts
pDCJ̄,t =accumulated sum of contributionsJ̄,t
expected remaining lifetimeJ̄,t
In PAYG: Contributions and pensions are indexed by 25% of total payroll growthIn funded part: return on capital, tax free
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Motivation Model Motivation Results
Pension system
Initial steady state: defined benefit
Exogenous contribution rate τ and an exogenous replacement rate ρ
pDBJ̄,t = ρ · wage in last working year
indexed by 25% of total payroll growth
Reform: partially funded defined contribution
Exogenous contribution rate τ and actuarially fair individual accounts
pDCJ̄,t =accumulated sum of contributionsJ̄,t
expected remaining lifetimeJ̄,t
In PAYG: Contributions and pensions are indexed by 25% of total payroll growthIn funded part: return on capital, tax free
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What do we actually do? Two exercises
Exercise 1 - democracy from the scratch
Compensate cohorts living at t = 0 for whatever their loss due to fundingAllow all living people to voteUse a fiscal rule: coordinated reductions in taxes and debt if reform reversedFinal steady state: debt share same as t = 0, gradual convergence
Exercise 2 - pension responsibility for fiscal responsibility
Reform at t = 0 is not compensated for (enlightened central planner)Allow all living people to voteUse all resources captured from funded pillar to reduce debt, only then allowlower taxesFinal steady state: debt share at 30pp less than t = 0, gradual convergence
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Motivation Model Motivation Results
What do we actually do? Two exercises
Exercise 1 - democracy from the scratch
Compensate cohorts living at t = 0 for whatever their loss due to fundingAllow all living people to voteUse a fiscal rule: coordinated reductions in taxes and debt if reform reversedFinal steady state: debt share same as t = 0, gradual convergence
Exercise 2 - pension responsibility for fiscal responsibility
Reform at t = 0 is not compensated for (enlightened central planner)Allow all living people to voteUse all resources captured from funded pillar to reduce debt, only then allowlower taxesFinal steady state: debt share at 30pp less than t = 0, gradual convergence
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Motivation
“Democracy” vs. “trading responsibilities”
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Political economy
What happens within each voting round?
Policy 1 - shift of contributions: funded ⇒ PAYGPolicy 2 - shift of pensions: annuity ⇒ benefitPolicy 3 - a combination of the two
We run these votes in subsequent yearsIf consumption equivalent positive, a cohort is in favorIf a policy gains majority, it is put in placeOrder of voting:Policy 1 vs status quo → winner vs Policy 2 → winner vs Policy 3(Dhami and al Nowaihi (2010): transitivity of preferences)
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Political economy
What happens within each voting round?
Policy 1 - shift of contributions: funded ⇒ PAYGPolicy 2 - shift of pensions: annuity ⇒ benefitPolicy 3 - a combination of the two
We run these votes in subsequent yearsIf consumption equivalent positive, a cohort is in favorIf a policy gains majority, it is put in placeOrder of voting:Policy 1 vs status quo → winner vs Policy 2 → winner vs Policy 3(Dhami and al Nowaihi (2010): transitivity of preferences)
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Voting results: reforms are never stable
Figure: Political support for reversing the reform
“Democracy” vs. “trading responsibilities”
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Even though reversals deteriorate welfare in the long run
Figure: Welfare effects of shifting contributions (Policy 1)
“Democracy” vs. “trading responsibilities”
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Even though reversals deteriorate welfare in the long run
Figure: Welfare effects of shifting pensions (Policy 2)
“Democracy” vs. “trading responsibilities”
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Even though reversals deteriorate welfare in the long run (Policy 4)
Figure: Welfare effects of combined policies (shifting both contributions and pensions)
“Democracy” vs. “trading responsibilities”
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Shift of pensions becomes inviable quite fast
Because it reduces pensions too much relative to delayed gains.
Winning scenarios
Voting year Winning policywith democracy with trading resp.
2012 P3 P02022 P3 P32032 3 12042 1 12052 1 12062 1 12072 1 12082 1 12152 1 1
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Why are reforms never stable? Lower pension benefits distant
Figure: Pension benefits for voting in 2022
“Democracy” vs. “trading responsibilities”
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... taxes lower immediately...
Figure: Taxes for voting in 2022
“Democracy” vs. “trading responsibilities”
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... ultimately, due to lower debt.
Figure: Pension benefits for voting in 2022
“Democracy” vs. “trading responsibilities”
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Conclusions
We simulate subsequent voting rounds on potential pension reform reversalsto find out when does the initial reform become politically stableThe voting scenarios contain policies deteriorating welfare in the long runWe find that
funded system is never politically stable vis-a-vis to PAYG systemannuity becomes preferred to benefithow internally consistent is that?
Our model does not need political risk, business cycles, etc.Pension reform reversion is preferred if it reduces taxes for the living cohorts
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Thank you for your attention!
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