Reforming pension systems – opportunities and obstacles Workshop in Malmö 17th of Nov. 2009 Agneta Kruse Department of Economics, Lund University

Background: Most countries in the industrialised world: Pay-as-you-go systems, i.e. today’s contributions are used for the contemporary pensioners’ benefits Pensions are life-cycle savings where the insurance part is an insurance against an extra-ordinary long life.

How to organise? Public Private Obligatory Voluntary Basic Supplementary Selective General Pay-as-you-go Funded Redistributive Actuarial - within a generation - between generations Defined-benefit, DB Defined-contribution, DC Indexing contributions and/or benefits by Growth, prices, interest in the capital market Pay-as-you-go Funded

Pay-as-you-go system [vs. a funded one] Today’s working generation pays contributions which are used for paying today’s pensioners’ pensions. An (implicit) social contract between generations. q w L = b R where q contribution rate, w wage, L labour force, b pension benefit and R number of pensioners. Left hand side: Sum of contributions; Right hand side: Sum of benefits

q = b/w R/L i.e. the contribution rate has to equal the replacement rate times the dependency ratio. It is (intuitively) obvious that indexing is by the growth rate in the wage sum.

Challenges to pay-as- you-go pension systems Demographic ageing; fertility, mortality, working years/hours Economic growth rate: productivity, the functioning of labour market • Political expansion beyond the optimal level

Challenges to funded systems Demographic ?? Economic rate of return in the capital market ● Political non-efficient use of funds

Ageing: reduced fertility, increased longevity … R/L ↑ R/L ↑ means that q has to be increased or b (b/w) decreased: q w L = b R; q = b/w R/L Most systems are defined-benefit; → the ”burden” of ageing falls on the working generation.

The contribution rate at different combinations of b/w and R/L: 0.33* 0.40 0.50 0.60** b/w 0.50 16.5 20.0 25.0 30.0 0.60 20.0 24.0 30.0 36.0 *) corresponds to a life with 45 working years (20-64) and 15 years as a pensioner (65-80) **) close to prognoses for Italy and Spain in 2050.

The demographic dependency ratio (65+/15-64) for a selection of countries: (Source: UN, World Pop. Prospects) 2010 2050 Czech republic 22 48 France 26 47 Germany 31 59 Italy 25 62 Poland 19 52 Spain Sweden 28 41 UK 38

Ageing (+ reduction in growth prospectives): make the public pay-as-you-go systems unsustainable: Reform proposals and activities … …. easier said than done! Vested interests from politicians, pensioners’s organisations and labour unions (?)

Reform resistance: Results from economic theory as well as empirical findings show that pay-as-you-go systems expand beyond the optimal level Ageing increases the tendency of expansion The median voter becomes older!

… nevertheless: a number of reforms Major reforms, paradigm shifts (NDC): Italy, Lithuania, Poland, Sweden … Parameter changes (calculation methods, indexation, pension age): France, Germany, Hungary, Portugal …

The Swedish reform as an example From unsustainable and unfair DB payg to a NDC, financially stable without perverse redistribution Transition rules for those born between 1938 and 1953. Demographic strain reduced by work incentives and life expectancy in the benefit formula.

1980s: A parliamentary commission + social partners: good investigation; no changes! 1990s: Small working group of politicians from all parties. No social partners. Awareness of the system’s unsustainability. Economic crises.

Reform options Path dependency … Honouring the social contract … (even it the contract means taxing still not born?) Transition rules. Incentives? Delayed retirement, increased working hours? Fairness (redistribution?).

Fairness within a generation; outcome for men and women; socio- economic groups: Benefit level Replacement rate Rate of return

Fairness between generations? Indexing with growth / wages means that co-living generations share the fruits of good years and the burden of lean years But – of course – reduced labour supply reduces the growth rate ….