EmerytGRAPE presentation at WIEM2014

Welfare Effects of the Pension Reform in Poland


(with Marcin Bielecki, Jan Hagemejer, Krzysztof Makarski and Joanna Tyrowicz)

Karolina GorausFaculty of Economics, University of Warsaw

WIEM 201412 July 2014


Table of contents

1 Motivation

2 Model setup

3 Calibration and baseline

4 Results


Motivation

Broad picture

A scientific project at the University of Warsaw

OLG modeling of the pension system reform in Poland

Questions

Aggregate efficiency of the reform?

Effects across generations?

The importance of fiscal closure?


Motivation

Pension reform

Common propositions

fiscal side: raising contributions rates, contribution base and/or loweringbenefits

demographic side: fertility or immigration fostering policies

Polish case (reform of 1999)

the original system was a DB PAYG scheme

then introduction of a three pillar system1 notional defined contribution (NDC) scheme ⇒ managed by Social

Insurance Fund (SIF)2 fully funded DC (FDC) scheme ⇒ managed by Open Pension Funds (OPFs)3 voluntary pension schemes


Motivation

Highlights

1 Assesing the aggregate efficiency ⇒ reform was welfare enhancing

2 Decomposing the welfare effects to the part attributable to changing theway pensions are financed (PAYG → pre-funding) and to changing the waypensions are computed (DB → DC) ⇒ the majority of the welfare effectscomes from the downward adjustment of pensions and not fromestablishing the pre-funded capital pillar

3 Assesing the impact of fiscal closure on welfare assessment ⇒approximately 15-20% of the overall welfare effect

4 Comparing main types of fiscal closures ⇒ financing the gap with publicdebt allows more intergenerational equality


Model setup

1 Motivation

2 Model setup


4 Results


Model setup

Model overview

OLG model with endogenous labor and savings

Heterogeneity across cohorts (mortality and labor productivity)

No heterogeneity within cohorts

Agents might have time inconsistent preferences

Exogenous retirement age and demographics

Competitive producers with CD production function

Pension system + pension system reform

Inter-generational transfers + utility to compare welfare across time withchanging demographics

Different fiscal closures (to do fiscal rules)

Calibrated to the Polish economy


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:

Uj(cj,t , lj,t) = uj(cj,t , lj,t) + β

J−j∑s=1

δsπj+s,t+s

πj,tu (cj+s,t+s , lj+s,t+s) (1)

where β is the time inconsistency parameter, δ is the time discountingfactor and πj,t denotes the unconditional probability of a household ofhaving survived from birth to age j at time period t.

The instantaneous utility function:

u(c, l) = φ log(c) + (1− φ) log(1− l), (2)


Model setup

Model structure - consumer II

is paid a market clearing wage for labor 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 - government

collects social security contributions and pays out pensions of DB andNDC system

subsidyt = τt · wtLt −J∑

j=J̄

pj,tπj,tNt−j (4)

collects taxes on earnings, interest and consumption + spends GDP fixed amountof money on unproductive (but necessary) stuff + services 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 (5)

Γt = Gt + (1 + rgt )Dt−1 − Dt + subsidyt (6)

wants to maintain long run debt/GDP ratio fixed


Model setup

Pension system I

Baseline scenario:PAYG Defined Benefit (DB) → constructed by imposing a mandatoryexogenous contribution rate τ and an exogenous replacement rate ρ

pDBj,t =

{ρtwj−1,t−1, for j = J̄t

κtpDBj−1,t−1, for j > J̄t

(7)

Reform scenario:Defined Contribution → constructed by imposing a mandatory exogenouscontribution rate τ and actuarially fair individual accounts in two pillarsNDC + FDC


Model setup

Pension system II

NDC = contributions indexed with growth of payroll + benefit actuariallyfair + post retirement indexation with 25% of payroll growth

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

κtpNDCj−1,t−1, for j > J̄t

(8)FDC = contributions earn interest + benefit actuarially fair + postretirement also earn interest

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

(9)


Model setup

What we do not know before simulations?

1999 reform: DB PAYG ⇒ NDC + FDC = partially funded DCpart of contributions stay in the PAYG system (SIF)part of contributions shifted away (OPFs) + fiscal tension todaylower replacement rates + ease fiscal tension in futurecomparing the steady states is not enough - transitory welfare effects

BUT SIF gap needs to be financed ⇒ possible fiscal closures with ownwelfare effects

five closures: lump sum, labor tax, consumption tax, debt + labor tax, debt+ consumption taxwe cannot tell ex ante

which fiscal closure is more efficient?what are the effects for different cohorts?


Model setup

What happens within each experiment?

Welfare analysis - like Nishiyama & Smetters (2007)

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

with and without time inconsistency

alternative age-productivity patterns (flat and according to Deaton, 1997)


Calibration and baseline

1 Motivation

2 Model setup


4 Results



Demographics

No of 20-year-olds arriving in the model in each period (left) and mortalityrates across time for a selected cohort (right).

Source: EUROSTAT demographic forecast until 2060.



Productivity growth and retirement age

Labor augmenting productivity growth rate projection (left) and actualretirement age in economy, past values and forecasts (right).

Source: European Commission. Effective retirement age based on SIF annual reports, own projection



Calibrated parameters

β = 1 β = 0.9ω = 1 ω - D97 ω = 1 ω - D97

α capital share 0.31 0.31 0.31 0.31τl labor tax 0.11 0.11 0.11 0.11φ preference for leisure 0.532 0.564 0.534 0.567δ discounting rate 0.983 1.004 0.988 1.008d depreciation rate 0.06 0.06 0.06 0.06τ total soc. security contr. 0.061 0.061 0.061 0.061ρ replacement rate 0.253 0.152 0.255 0.153

resulting∆kt/yt investment rate 21.6 21.4 21.4 21.1

r interest rate 7.2 7.3 7.3 7.5



Fiscal burden of the pension system

Pension share in GDP and cumulated changes in SIF balance in the baselinescenario of no policy change (with no time inconsistency).


Results

1 Motivation

2 Model setup


4 Results


Results

Welfare effects of various fiscal closures

Consumption equivalents (in % terms of permanent consumption) under theparametrization of β = 1 and productivity following Deaton (1997).

Fiscal closure Fiscal closure in reform min−maxin baseline Υ τc debt + τc τl debt + τl (in %)

Υ 2.586 2.439 2.576 2.791 2.900 18.8τc 2.442 2.338 2.505 2.682 2.793 19.4debt + τc 2.444 2.345 2.383 2.683 2.682 14.4τl 2.393 2.299 2.440 2.601 2.729 18.7debt + τl 2.387 2.280 2.391 2.589 2.624 15.1


Results

Decomposition of welfare effects I

lump sum tax


Results

Decomposition of welfare effects II

consumption tax (left) and debt with consumption tax (right)


Results

Decomposition of welfare effects III

labor tax (left) and debt with labor tax (right)


Results

Changes to taxes and debt share

Changes to taxes and debt share (lump sum tax in baseline scenario).


Results

Alternative scenarios

time inconsistent preferences

Uj(cj,t , lj,t) = uj(cj,t , lj,t) + β

J−j∑s=1

δsπj+s,t+s

πj,tu (cj+s,t+s , lj+s,t+s) (10)

age-productivity profile according to Deaton (1997)


Results

Welfare effects in alternative scenarios

Consumption equivalents (in % terms of permanent consumption). In thebaseline scenario fiscal closure given by lump sum taxation.

Fiscal closure β = 1 β = 0.9in reform scenario ω = 1 ω - D97 ω = 1 ω - D97

Υ 2.79 2.59 1.94 1.78τc 3.01 2.44 2.17 1.75debt + τc 3.11 2.58 2.24 1.84τl 3.28 2.79 2.36 1.97debt + τl 3.37 2.90 2.42 2.06


Results

Conclusions

Pension reform in Poland was welfare enhancing and the majority of thewelfare effects comes from the downward adjustment of pensions (notfrom establishing the pre-funded capital pillar).

Fiscal closure itself can contribute/deduct up to app. 15-20% of theoverall welfare effect of the pension system reform.

Financing the reform with public debt allows to spread the costs ofestablishing the pre-funded pillar fairly across all generations.

Results are robust to a number of parametric choices (time inconsistencyand life cycle productivity patterns).


Results

Questions or suggestions?

Thank you!

EmerytGRAPE presentation at WIEM2014

Economy & Finance

Transcript of EmerytGRAPE presentation at WIEM2014