EmerytGRAPE presentation at ICMAIF2014

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, Jan Hagemejer and Karolina Goraus)

Joanna TyrowiczFaculty of Economics, University of Warsaw

ICMAIF 2014May 2014


Table of contents

1 Motivation and insights from literature

2 Model setup

3 Calibration

4 Baseline and reform scenarios

5 ResultsGeneral findingsHow different are these economies?DecompositionRobustness 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!



Literature review

Two streams of literature:

1 Optimal retirement age: Gruber and Wise (2007), Galasso (2008), Heijdraand Romp (2009)

2 Comparing the increase of retirement age vs. cut in benefits/privatizationof the system: Auerbach et al. (1989), Hviding and Marette (1998), Fehr(2000), Boersch-Supan and Ludwig (2010), Vogel et al. (2012)

Fehr(2000): Macroeconomic effects of retirement age increase maydepend on the existing relation between contributions and benefits!

Still unknown: when we increase RA

how the macroeconomic effects differ between various pension systems?

what happens to the welfare of different generations?



What we do

Tool

OLG models with first steady states calibrated to result in the samereplacement rate (Auerbach and Kotlikoff, 1987)

Expectations

under DB: leisure ↓, taxes ↓, welfare?

under NDC: leisure ↓, pensions ↑, welfare?

under FDC: leisure ↓, pensions ↑, welfare?

additional source of question marks: → labor supply adjustments

general equilibrium effects...


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:

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

Firms solve the following problem:

max(Yt ,Kt ,Lt )

Yt − wtLt − (r kt + d)Kt (4)

s.t. Yt = Kαt (ztLt)

1−α

Standard firm optimization 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 andNDC system

subsidyt = τt · wtLt −J∑

j=J̄

pj,tπj,tNt−j (5)

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

Tt = τl,t

(wtLt +

J∑j=J̄

pj,tπj,tNt−j

)+(τc,tct + τk,t rtsj,t−1

) J∑j=1

πj,tNt−j (6)

Γt = Gt + (1 + rgt )Dt−1 − Dt + subsidyt (7)

wants to maintain long run debt/GDP ratio fixed


Calibration

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


Calibration

AWG’s projection of productivity growth


Calibration

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


Baseline and reform scenarios

Pension systems

Defined Benefit → constructed by imposing a mandatory exogenouscontribution rate τ and an exogenous replacement rate ρ

pDBj,t =

{ρtwj−1,t−1, for j = J̄t

κDBt · pDB

j−1,t−1, for j > J̄t(8)

Defined Contribution → constructed by imposing a mandatory exogenouscontribution rate τ and actuarially fair individual accounts

Notional

pNDCj,t =

∑J̄t−1

i=1

[Πis=1(1+r It−i+s−1)

]τNDCJ̄t−i,t−i

wJ̄t−i,t−i lJ̄t−i,t−i∏Js=J̄t

πs,t, for j = J̄t

(1 + r It )pNDCj−1,t−1, for j > J̄t

(9)Funded

pFDCj,t =

∑J̄t−1

i=1

[Πis=1(1+rt−i+s−1)

]τFDCJ̄t−i,t−i

wJ̄t−i,t−i lJ̄t−i,t−i∏Js=J̄t

πs,t, for j = J̄t

(1 + rt)pFDCj−1,t−1, for j > J̄t

(10)



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:



Welfare analysis - like Nishiyama & Smetters (2007)

What happens within each experiment?

1 Run the no policy change scenario ⇒ baseline

2 Run the policy change scenario ⇒ reform

3 For each cohort compare utility, compensate the losers from the winners

4 If net effect positive ⇒ reform efficient

Robustness checks

alternative demographic scenario (stable fertility)

alternative age-productivity pattern (Deaton, 1997)



Demographics: unconditional survival probability from birth to retirement



Demographic scenarios

Total 20-year-olds



Age-productivity profiles (Deaton, 1997)


Results

General findings

Welfare effects of the reform, in consumption equivalent terms

DB NDC FDC

Where from the universal overall improvement in welfare?


Results

How different are these economies?

Baseline levels

Labour supply Capital Interest rate

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


Results


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


Aggregate labour supply

Baseline levels Reform (ratio)


Results


Capital

Baseline levels Reform (ratio)


Results


Interest rate

Baseline levels Reform (pp difference)


Results


Subsidy as % of GDP



Results


Aggregate benefits as % of GDP



Results


Labour tax



Results

Decomposition

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

Robustness checks

Alternative scenarios

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

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


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 strongly 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!

EmerytGRAPE presentation at ICMAIF2014

Economy & Finance

Transcript of EmerytGRAPE presentation at ICMAIF2014