Reform of the Pension System Lucio Baccaro 27 April 2009
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?
Selection Effect and Deliberative Effect • Methodology of propensity score matching
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