Do Individual Accounts Postpone Retirement? Evidence from Chile Alejandra C. Edwards and Estelle James

2 Work disincentives in old Chilean system Like other DB countries--Gruber & Wise Early pension easy & not decreased on actuarial basis so taking pension at first eligible age max PV of lifetime benefits Public sector--pensioners couldn’t work Private sector—could work but incremental benefit small (50%,1%,70%)

3 Chilean reform of 1981 Replaced DB with DC—contributions go into individual accounts, pension depends on accumulation, on actuarial basis Cut payroll tax, especially for pensioners Raised retirement age and made it more difficult to retire early Most workers under 50 (born>1931) switched We expect this to raise lfpr of older workers through 2 channels: –Postponed pensioning, so liquidity constrained workers must work –Increased work propensities among pensioners

4 1) Postponed pensioning required=> raises lfpr through liquid income effect Normal pension set at age 65 and 60 for men and women respectively Early pension not permitted until 1987 Tighter conditions for early pension—pension must be 50% of own-wage and 110% of minimum pension guarantee If pension is postponed, it increases on actuarial basis (50% in 5 years because larger accumulation, fewer retirement years) Therefore we expect postponed pensioning, which should increase work propensities of credit-constrained workers--liquidity effect

5 2) Reduced work disincentives, espec. for pensioners (substitution effect) Payroll tax fell from 23-25% to 12.5% so net wage rises Pensioners exempt from pension payroll tax No penalty for work after pension These positive effects should be greater for workers who were younger on date of reform and should be phased in over time as more older workers in new system

6 Data set from Greater Santiago Area Household Surveys Individual level data on –Labor force participation –Demographic characteristics –Labor and pension income We link to o fficial macroeconomic data Shortcomings: –Not longitudinal, no retrospective data –We don’t know retirement age or type pension, new or old system affiliates or no affiliation –This leads us to underestimate impact of reform on new system affiliates

7 Aggregate trends are consistent with our hypotheses. We observe: a decrease in pensioning after mid-80’s an increase in labor force participation of 50+ after mid-eighties1981 higher participation rates among cohorts born after 1931 these effects are stronger for pensioners Our strategy: do these trends pre and post reform remain after adding individual and macro-economic variables? Answer: they do

8 Pension probabilities were rising, but fell after reform

9 Male 50+ lfp rates were falling, go up after the reform

10 Changes in lfp are more dramatic for pensioners

11 We use probit analysis to see if these results hold after controlling for other variables, : 2 dependent variables: probability of being pensioned, probability of being in labor force Individual characteristics: age, education, real hh income, marital status, # children, spousal age, etc. Macro-economic variables: unemployment rate, real annual GDP growth, deviations from trend GDP Pension status and amount 3 reform indicators

12 We model impact of reform in 3 alternative ways: 1) Change in time trends of pension rates and lfpr rates for 50+ and 65+ groups pre- and post-reform (reform effects start in 1987) 2) Change in cohort trends pre- and post-reform (1931 birth cohort is the first exposed to reform) Time and cohort trends are interacted with pension status to allow for differences in trends 3) Dummies for groups of individuals exposed to post- reform incentives. We expect an increasing fraction of 50+ individuals to respond to the new system’s incentives each year, starting in 1987

13 The data set: men 30+ Series of 40 annual cross-sections from 1960 to 2002 ( missing). Sample representative of Greater Santiago (most urban 1/3 of country’s population) –95,000 individual cases organized by year of observation –93,000 individual cases organized by birth cohort starting in 1900

14 Trends in other variables

15 Explanatory power increases when co-variates are added, but reform effect remains Pension prob higher and work prob lower for more educated workers over 50 –this increases gap explained by reform Pension prob rise and lfp falls with UnE –there is a full cycle after 1987 Adding pensioner status into lfp equation raises R 2, cuts pure age effect, and reduces negative impact of macro effects Virtually entire downward trend in lfp before reform and upward trend after reform is due to pensioners

16 Main reform effects, after controlling for co-variates: Pension probability, age – fell 15 percentage points, cut in half by 2002 –shift to non-pensioner status increased aggregate work, since lfpr > for non-pensioners LFP among pensioners, age –rose >2% per year, >30 percentage points by 2002, compared to pre-reform trend line –more than doubled mid-1980’s to 2002 –Smaller effects for older groups, age 65+ These effects are increasing for retirees who were younger on date of reform All 3 reform indicators give consistent results

17 Estimated per year change in lfp (percentage points) at means non-pensionerspensioners Age Before reform After reform Net change Age 65+ Before reform After reform Net change

18 Estimated per year change in lfp (percentage points) non-pensionerspensioners Age 60 in 1990 Before reform After reform Net change Age 66 in 1990 Before reform After reform Net change

19 Policy implications and future research Incentives from shift to DC system have had positive effects on supply of older workers Which is more important—actuarial fairness or system constraints and taxes? –Larger drop in pension prob before 65 suggests that early retirement constraints play major role –Larger lfpr effect among pensioners suggests that exemption from payroll tax plays key role Future research using new longitudinal data: –Do workers take pension as soon as eligible? –Has lfpr also increased among old system and no- system affiliates (or does lfpr of those in new system increase more when we identify them)?