EmerytGRAPE presentation at EcoMod2014

The Sooner The Better - The Welfare Effects of the Retirement Age Increase Under Various Pension Schemes

The Sooner The Better - The Welfare Effects of the RetirementAge Increase Under Various Pension Schemes

(with Marcin Bielecki, Karolina Goraus and Joanna Tyrowicz)

Jan HagemejerNational Bank of Poland, University of Warsaw

ECOMODJuly 2014


Table of contents

1 Motivation and insights from literature

2 Model setup

3 Baseline and reform scenariosHow different are these economies?

4 ResultsGeneral findingsSources of gainsRobustness checks


Motivation and insights from literature

Motivation

Current problems with pension systems:

increasing old-age dependency ratio

majority of pension systems fails to assure actuarial fairness

in most countries people tend to retire as early as legally allowed

Typical reform proposals

switching to individual accounts’ systems

raising the social security contributions per worker

introducing general fiscal contraction

increasing the retirement age!


Motivation and insights from literature

What we do

Goal

Analyse macroeconomic and welfare implications of retirement age increase

Tool

OLG models with first steady states calibrated to result in the samereplacement rate

Calibrated to an economy similar to Poland with alternative demographicscenarios

Pure pension systems

DB (defined benefit) - fixed replacement rate

NDC (notional defined contribution) - notional accounts indexed withpayroll growth

FDC (fully funded) - actual accounts indexed with market interest rate


Model setup

Model structure - consumer I

is ”born” at age J = 20 and lives up to J = 100

optimizes lifetime utility derived from leisure and consumption:

U0 =J∑

j=1

δj−1πj,t−1+juj(cj,t−1+j , lj,t−1+j) (1)

where δ is the time discounting factor and πj,t denotes the unconditionalprobability of a household of having survived from birth to age j at timeperiod t (accidental bequests are spreaded equally to all cohorts).

The instantaneous utility function takes the theGreenwood-Hercowitz-Huffman (GHH) form (no wealth effects, pure wageeffects):

u (cj,t , lj,t) =1

1− θ

(cj,t − ψt

l1+ξj,t

1 + ξ

)1−θ

− 1

, (2)


Model setup

Model structure - consumer II

is paid a market clearing wage for labour supplied and receives marketclearing interest on private savings

is free to choose how much to work, but only until retirement age J̄(forced to retire)

The budget constraint of agent j in period t is given by:

(1 + τc,t)cj,t + sj,t + Υt = (1− τ ιj,t − τl,t)wj,t lj,t ← labor income (3)

+ (1 + rt(1− τk,t))sj,t−1 ← capital income

+ (1− τl,t)pj,t + bj,t ← pensions and bequests


Model setup

Model structure - producer

Price taking firms (one sector) produce output using a Cobb-Douglasproduction function (inputs: labour and capital).Profit maximization implies implies:

the average market wage wt = (1− α)Kαt (ztLt)

−α (there might beheterogeneity between cohorts if age-specific productivity is assumed)

interest rate r kt = αKα−1t (ztLt)

1−α − d , where d stands for depreciation


Model setup

Model structure - government

collects social security contributions and pays out pensions of DB and NDCsystem - the deficit of the pension system is covered by the govt budget

collects taxes on earnings, interest and consumption + spends GDP fixedamount of money on unproductive (but necessary) stuff + servicing debt

wants to maintain long run debt/GDP ratio fixed - the labour tax closesthe budget


Baseline and reform scenarios

Reform of the systems

Three experiments:

1 DB with flat retirement age → DB with increasing retirement age

2 NDC with flat retirement age → NDC with increasing retirement age

3 FDC with flat retirement age → FDC with increasing retirement age

What is flat and what is increasing retirement age?

flat: 60 years old increasing:



Aging: unconditional survival probability from birth to retirement



Demographic scenarios

Total 20-year-olds



AWG’s projection of productivity growth



How different are these economies?

Baseline levels

Labour supply Capital Interest rate

Subsidy (% of GDP) Benefits (% of GDP) Labour tax

DB: aging → increase in pension system deficit and tL

FDC: LR fall in labour supply causes an increase of capital per worker anddrop in interest rates → - dynamic inefficiency


Results

Expected outcomes

Increase in FDC and NDC pensions - longer employment, higher savings,shorter retirement time.

DB: lower taxes

Increase in aggregate labour supply, increase in consumption


Results

General findings

Welfare effects of the reform, in consumption equivalent terms

DB NDC FDC

Demographics DB NDC FDCDecreasing fertility 7.7% 8.0% 11.4%Stable fertility 7.7% 8.3% 12.0%

Raising retirement brings welfare gains to all cohorts in all systems

Sources of gains are different for different systems


Results

Sources of gains

Labor supply effects of the reform - decomposition

Table: Labor supply effects of the reform - decomposition

Baseline Reform scenariooverall j < 60 j ≥ 60 TotalLFP LFP baseline=100 LFP baseline=100

DB 57.9% 58.1% 100.2% 58.1% 117.3%NDC 58.8% 58.2% 99.0% 58.2% 115.9%FDC 59.8% 58.9% 98.4% 58.9% 115.2%


Results

Sources of gains

Aggregate labour supply

Baseline Reform (ratio to baseline)

Aggregate labour supply goes up (individual period labour supply falls - up to2%)


Results

Sources of gains

Capital and interest rates (relative to baseline)

Capital Interest rates

In FDC a drop in capital per worker leads to an increase in interest rates. . .


Results

Sources of gains

Pensions as % GDP

Baseline Reform (ratio to baseline)

... which leads to an increase in pensions and boost in welfare.


Results

Sources of gains

Pension system deficit in % GDP

Baseline Reform (relative to baseline)

DB: increasing retirement age decreases the strain on the budget. . .


Results

Sources of gains

Labour tax

Baseline Reform (relative to baseline)

... and the labour tax does not have to spike as much as in the baseline.


Results

Sources of gains

Effects of retirement age increase (relative to the baseline)

Labour supply Capital Interest rate(ratio) (ratio) (p.p. difference)

Subsidy as % of GDP Benefits as % of GDP Labour tax(p.p. difference) (p.p. difference) (p.p. difference)


Results

Robustness checks

Age-productivity profiles (Deaton, 1997)


Results

Robustness checks

Alternative scenarios

Table: Consumption equivalent as % of permanent consumption, Deaton (1997)profile

Demographics DB NDC FDCDecreasing fertility 8.5% 9.5% 12.5%Stable fertility 8.7% 10.0% 13.3%


Results

Robustness checks

Conclusions

extending the retirement age is universally welfare improvingregardless of the pension system, although sources depend on thetype of the system

this effect is enhanced if productivity is increasing in age

agents adjust downwards the average labor supply, but theaggregated supply increases

lower savings imply decrease in per capita capital and output


Results

Robustness checks

Questions or suggestions?

Thank you!


Results

Robustness checks

Calibration of tax rates and pension system parameters

Parameters ω – flat ω – Deaton (1997)

Taxes and governmentτ c consumption tax 0.11 0.11τ l labor income tax 0.11 0.11τ k capital income tax 0.19 0.19γG government spending / GDP 0.2 0.2Pension systemsρ exogenous replacement rate 0.25 0.15τ ι contribution rate 0.61 0.61

Target statisticsbudget deficit (as % of GDP) 0.03 0.03aggregate benefits (as % of GDP) 0.05 0.05subsidyDB (as % of GDP) 0.015 0.015


Results

Robustness checks

Calibration of technology and preference parameters

Parameters ω – flat ω – Deaton (1997)

Technologyα capital share of income 0.31 0.31d depreciation rate 0.055 0.055

Preferencesδ discounting factor 0.99175 1.00693θ relative risk aversion 1 1ξ Frisch elasticity (inverse) 3.846 4.101ψ labour disutility 7.59 4.64

Target statisticsr interest rate 0.0625 0.0625

∆k/y investment rate 0.23 0.23

Economy & Finance

EmerytGRAPE presentation at EcoMod2014