Did the Chilean Pension Reform Postpone Retirement?

1. Did the Chilean Pension Reform Postpone Retirement? Evidence from Chile Alejandra C. Edwards and Estelle James Presented at OECD, Paris, 2006

2. Chilean reform of 1981 • Research shows large impact of pension systems on retirement age, but no empirical test of DC • Chilean reform replaced DB with DC—contributions go into individual accounts, pension depends on accumulation, on actuarial basis • Old system had incentives to pension early and deterrents to work after pension—high payroll tax, no incremental benefit, work in same job restricted • New system removed these biases and cut payroll tax, especially for pensioners who were exempt

3. System as a whole is actuarially fair, but may not be actuarially fair to each individual • Some individuals have higher time preference, want to save less or start dissaving sooner, want to invest in different (riskier?) portfolio, want more flexible payouts, expect to die early • These individuals won’t view system as actuarially fair to them and still face substantial tax component

4. New system should raise lfpr of older workers thru 2 channels: • Higher retirement age and deterred early pension, so liquidity constrained workers work—is later pensioning due to incentives from actuarial fairness or new constraints? • Increased work propensities among pensioners—is this due to actuarial fairness or exemption from payroll tax, therefore higher net wage? • We expect smaller change among non-pensioners—not exempt from payroll tax and many are not in any pension system

5. Pension probabilities among 50-64 fall after 1981 reform (up before)

6. LFP trends reverse after reform(went down before, up afterwards)

7. particularly among pensioners

8. Aggregate trends are consistent with our hypotheses. • Can we isolate the effect of reform from variations in individual and macro-economic variables? Answer: Yes, with some caveats • We use a difference in differences approach • We measure marginal behavioral change by cohort after reform

9. Data set from Greater Santiago Area Household Surveys 1960-2004 • Individual level data on • Labor force participation • Demographic characteristics • Labor and pension income • Shortcomings: • It is not longitudinal, no retrospective data • But we can build synthetic cohorts--people with same birth year, observed at different ages. • We don’t know whether individual is affiliated, which system, age pension started, or type pension , but we use birth cohort as proxy for new system membership

10. Birth cohort proxies new system membership • Those under age 50 in 1981 were more likely to joint new system and fraction in new system is larger for each birth year after 1931. • We define post-reform cohorts as those born after 1931. Reform effect is predicted to grow with each cohort after 1931, until everyone is in the new system and has adapted to its incentives.

11. We organize data by cohort • 31,500 observations – men 50-70 years old • 35 birth cohorts, born 1916-50, pre-reform born 1916-30; post-reform born 1931-50 • Continuous analysis: prob. of new system membership proxied by birth year minus 1931 • Discrete analysis: 5 or 10 birth years grouped and assigned dummies • COH1 and 2 are pre-reform, born 1916-25 & 1926-30, COH3, 4, 5 and 6 are post-reform, born 1931-35, 1936-40, 1941-45, 1946-50 • we interact dummies with age • we calculate marginal effect for each cohort • Interact reform variables with pension status to separate impact on pensioners and non-pensioners

12. Probit analysis estimates 1) pension probabilities and 2) lfp rates as function of : • Individual characteristics measuring the relative value of time: Age, schooling, marital status, presence of young children, nonlabor income • Time-specific labor market conditions: economic cycle, unemployment rate, GDP trend • Lfp rate also a function of pension status, amount, pseudo-replacement rate • Pre and post-reform cohorts and age group interactions

13. Results: pension prob. by age fall • Pension rates vary with individual characteristics as expected, and increase with unemployment • Pension rates fall if worker reaches 50 after reform • Coh31 is significantly negative for all ages > 50 • Discrete dummies for each 5-year cohort: • For 50-59, pension rates start falling with COH3 (46-50 in 1981), accumulated reduction is 12.7 points by COH6 • This is 67% of starting pension rate for age group • For 60-64, pension rates start falling with COH4 (41-45 in 1981) by 5.2 points, 15% of starting pension rate • Full cohorts not yet observed; total effect larger • For 65-70, pension rates stay the same (few observations, no new restrictions apply after age 65) • Reason for postponement: keeping money in new system rewarded, early pension restricted in new system

14. Results: labor force participation rates of older workers rise • Participation rates vary with individual characteristics and macro variables as expected • Pension status, size of pension and pseudo-replacement rate have strong negative effect on lfpr, as expected. Real pension size rose, but not as fast as wages so pseudo-replacement rate fell over this period, explaining part of aggregate increase • After all controls, participation rates rise sharply for individuals reaching 50 after reform • (1) more people remain non-pensioners, much higher lfpr than pensioners (77 percentage points) • (2) lfpr among pensioners increases • Participation rates of prime age males and older non-pensioners stable

15. Reform effects among pensioners • In continuous model, interaction of pension and coh31 is 1.8 pp per birth year since 1931 for age 50-65, .6 pp for > 65 • In discrete cohort model, effect also concentrated in pensioners, starts with COH3 or 4 • For ages 50-59, accumulated increase is 20 pp—100% higher than starting lfpr • For ages 60-65, accumulated increase is 18 pp—125% higher than starting lfpr • For 65-70, accumulated increase is 5 pp—incomplete • System is still in transition—positive marginal effect for last cohort observed

16. Macroeconomic effects • This implies 22% increase in older labor force, or 4.4 increase in aggregate labor force and GDP • Implies growth rate increases .21% per year over 20 years • Total increase will be higher once new steady state is reached and as % in older age groups grows

17. Policy implications • Incentives from shift to new system have had positive effects on supply of older workers • Normal pension age raised, conditions for early pension tightened and penalties for postponement removed • Pension growth is actuarially fair with contributions • Pensioners exempted from payroll tax • Which is more important—actuarial fairness or early pension constraints & exemption from taxes? • Large drop in pension prob before 65 not after, suggests that early retirement constraints play major role • Large lfp effect among pensioners suggests that exemption from payroll tax plays a key role • Absence of lfpr effect among non-pensioners implies that actuarial fairness is less important, or that most non-pensioners aren’t in any formal system

18. Future research with new longitudinal data set • Do workers take pension as soon as eligible? • Has lfp increased among old system and no-system affiliates? What is the differential effect of new system, once individual identity is known? • Do workers near MPG behave differently from other workers (different work incentives)