Reform of the Pension System

Lucio Baccaro

27 April 2009

France

10

15

20

25

30

1980 1990 2000 2010year

france pension expenditures

Germany

10

15

20

25

30

1980 1990 2000 2010year

germany pension expenditures

Italy

10

15

20

25

1980 1990 2000 2010year

italy pension expenditures

Sweden

10

15

20

25

30

35

1980 1990 2000 2010year

sweden pension expenditures

Switzerland

51

01

52

0

1980 1990 2000 2010year

switzerland pension expenditures

UK

51

01

52

02

5

1980 1990 2000 2010year

unitedkingdom pension expenditures

USA

68

10

12

14

16

1980 1990 2000 2010year

unitedstates pension expenditures

Key Concepts

• Pay-as-you-go vs. capitalization

• Defined benefit vs. defined contribution

• Financed through social security contributions vs. general taxation

Institutional Structure of Most Pension Systems

• Pay-as-you-go

• Financed through social security contribution

• Defined benefit

Basic Prerequisites for a Sustainable PAYG System

• Growth rate of GDP > interest rate• Growth rate of GDP depends on:

– Productivity growth, which in turn determines real wage growth

– Labor force growth (which depends on fertility rates)– Low unemployment

• Given the favorable economic and demographic conditions, a PAYG system was more efficient than a funded system for most of the post-war period: virtually all countries moved in that direction– Political benefits of a PAYG system

Economic Challenges of PAYG Systems

• Population aging: fewer young people are required to support a growing number of retired people

• Slowing down in productivity and wage growth• Increase in unemployment• Financial sustainability of the system requires a growing

proportion of wages to be transferred to pensioners (equilibrium rate)

• This leads to growing labor costs and unemployment• Vicious circle • Simultaneously, the return on capital grows much faster

than GDP

Reform Options (I)

• They largely depend on the degree of maturity of the PAYG system

• Transition to a funded system is complicated by the “double payment” problem

• Where the system is young, a transition to a funded occupational system is possible (if the decision-makers can mobilize the necessary consensus)– E.g. SERPS in the UK (1986)– Chile– Hungary

• In most other cases, only more marginal adjustments are feasible

Reform Options (II)

• Increase in retirement age – Equalization of men and women’s retirement age

• Separation between insurance and assistance elements (the latter to be financed through general taxation)

• Increase in social security contributions (often by increasing the taxable base)

• Increase in the number of years on which the final pension is calculated (e.g. from last 5 to last 15 years)

• Elimination of special regimes (e.g. for public sector workers) and homogenization

• Phasing out of early retirements or seniority pensions• Change in indexation from wages to prices

Two Innovative Pension Reforms

• Sweden (1994/1998) and Italy (1995): Introduction of notional accounts– Simulation of a funded, defined benefit system within a PAYG system– Pensions are accumulated as the capitalization of individual

contributions (individual accounts)– These accounts, however, are not funded and pensions continue to be

paid in PAYG fashion– The interest rate is however not a market rate, but is defined

administratively– The capitalized amount is converted into pension installments based on

a conversion rate which takes into account life expectancy at retirement– Close relationship between contributions and pensions– Possibility of flexible retirement age– Introduction of fictional contributions for child care and elder care years

• In Sweden there is in addition a fully-funded individual account (financed with 2% of contributions)

The Politics of Pension Reform

• From political credit-claiming to blame avoidance– Long transition phases (grandfathering rules)– Mix of retrenchment and expansion (quid pro quo)– Alliance with the opposition (grand coalition): blame

sharing– Alliance with the trade unions (corporatist pact)– Pressures from international organizations and expert

circles: blame buffering

• Very difficult to reform pensions unilaterally!

The Politics of the Italian Pension Reform

• 1994: Berlusconi seeks unilateral pension reform– Unions mobilize and the government falls

• 1995: Dini negotiates the reform mentioned above with the trade unions– Unions consult their base through a binding

referendum

• The discursive processes associated with the referendum shape workers’ preferences

The 2007 Italian Pension Reform

• Reform of the transition system

• Data from a random sample of 1,600 workers and pensioners, both participants in the referendum and non-

• Does participation in the union referendum make a difference?

The Attitudes of Participants and Non-Participants

01

23

-1 -.5 0 .5 1 -1 -.5 0 .5 1

0 1D

ensi

ty

1 in favor, 0 don't know, -1 againstGraphs by RECODE of referendum (“q013”)

Selection Effect and Deliberative Effect

• Methodology of propensity score matching

Selection Effect

01

23

0 .5 1 0 .5 1

0 1D

ensi

ty

Estimated propensity scoreGraphs by RECODE of referendum (“q013”)

Deliberative Effect

• 32% of workers move away from the neutral position as a result of participating in the referendum (significant)

• 10.7% of these become negative (significant). • 21.3% become positive (significant). • Preference structuration: those that had no clear views

become either positive or negative • Polarization: the treatment group is simultaneously more

positive and more negative about pension reform than the control group

• The two movements are, however, asymmetric and the positive shift in preferences prevails by about 10 percent, even though this is only marginally statistically significant

Summary

• Multiple pressures on mature pension systems

• Regime change (from PAYG to funded systems) is unlikely

• Reform requires the striking of large alliances– With opposition parties– With trade unions