the privatization of retirement income? variation and trends in the income packages of old age...

Introduction

Over the last decades there has been growingawareness in the academic literature that theoutcome of welfare policies cannot be prop-erly understood without giving proper atten-tion to the role that private institutions play incomplementing, and sometimes substitutingfor, public provision (see Rein and Rainwater,1986 for a seminal contribution).

This general insight applies with particularforce to the area of pensions and incomesecurity in old age. Although public pensionsystems of different types and generosity havebeen developed in all advanced economies,public pension benefits have never been andnever will be the only source of income forpensioners. In all advanced economies we findthat occupational pension schemes, individualsavings arrangements and the general capital

The privatization of retirement income? Variation and trendsin the income packages of old age pensioners

Axel West Pedersen*, NOVA – Norwegian Social Research, Oslo, Norway

Article

Journal of European Social Policy 0958-9287; Vol 14(1): 05–23; 039782 Copyright © 2004 SAGE Publications, London,Thousand Oaks and New Delhi, DOI: 10.117/0958928704039782

Summary The aim of this article is to investi-gate the changing balance between public andprivate components in the income packages ofold age pensioners in a selection of nineOECD countries. Four waves of data from theLuxembourg Income Study databank are usedto analyse variation across countries andacross time in the public/private mix of retire-ment income. The article seeks to address twomain questions: (a) Is there a general trendtowards a stronger reliance on private incomeprovision and, perhaps, a trend towards con-vergence in the balance between public andprivate income components? (b) Is there evi-dence of a tendency for substitution/crowdingout between public and private income com-ponents, and hence a tendency for cross-national convergence in the relative incomeposition enjoyed by old age pensioners –despite variation in the generosity of nationalpension systems?

Key words income packaging, pension systems,retirement

Résumé L’objectif de cet article est d’analyserla modification de l’équilibre entre les com-posants publics et privés dans les revenus despensionnés pour neuf pays de l’OCDE. Quatregroupes de données de la banque de donnéesde Luxembourg sur les revenus ont été utiliséspour analyser les variations entre les pays etdans le temps en ce qui concerne l’équilibreentre la part privée et publique dans lespensions. Cet article aborde deux questionsprincipales: (a) Y a-t-il une tendance généralevers une plus grande dépendance aux revenusprivés et éventuellement une tendance conver-gente dans l’équilibre des composants publicset privés du revenu? (b) Y a-t-il une preuved’une tendance de substitution entre les com-posants publics et privés des revenus des pensionnés et ainsi une tendance d’une con-vergence entre États de la position relative desrevenus dont bénéficient les pensionnés malgréune variation dans la générosité des systèmesde pension nationale?

* Author to whom correspondence should be sent: Axel West Pedersen, NOVA – Norwegian SocialResearch, PO Box 3223 Elisenberg, 0208 Oslo, Norway. [email: [email protected]]

www.sagepublications.com

market make significant contributions to the‘income package’ of pensioners – although toa varying degree in different countries andacross time.1

In recent years, the potential role of privateinstitutions as providers of income security inold age has also been high on the politicalagenda, spurred on by the demographics ofageing and the severe financial problems thatare projected for national pension systems inthe coming decades. In an influential reportfrom 1994, the World Bank recommendedthat the traditional pay-as-you-go socialinsurance should be replaced with a system ofmandated individual savings accounts as auniversal strategy to avert the ‘old age crisis’(World Bank, 1994). Although none of theadvanced capitalist economies can be said tohave followed the radical prescriptions of theWorld Bank so far, some form of privatizationis being pursued in many OECD countries.

In some countries deliberate attempts aremade to shift the burden of retirement provi-sion from the public to the private sphere. Inother countries, occupational pension schemesand individual savings arrangements appear togrow more or less spontaneously presumablyas the result of an increasing gap between thequality of public provision and the demandfor income replacement in old age amongbroad segments of the population. We cantalk of a ‘silent transition’ towards a more pri-vatized (and prefunded) system of retirementprovision (Börsch-Supan and Reil-Held,1998).

In this article I shall use data from theLuxembourg Income Study (LIS) databank toinvestigate the interplay between public andprivate components in the income packages ofpensioners in a selection of OECD countries.Nine countries with very different traditionsof public pension provision are included in thestudy: Australia, Canada, Denmark, Germany,the Netherlands, Norway, Sweden, the UKand the US. In addition to the analysis ofcross-national differences, I also look at devel-opments over time in each of the countriescovered. For all countries except one

(Denmark), four waves of cross-sectionalmicro-data are available spanning the periodfrom around 1980 to the mid-1990s.

More specifically, I address three sets ofissues:

• What is the scope of cross-national differ-ences in the composition of retirementincome packages?

• Is it possible to identify a general trendover time towards an increasing share ofprivate income components, and, perhaps,a trend towards convergence in thebalance between public and privateincome components?

• Is there evidence of a tendency for substi-tution/crowding out between public andprivate income components, and hence atendency for cross-national convergence inthe relative income position enjoyed bypensioners – despite variation in the gen-erosity of public pensions?

While the first two sets of issues are mainlydescriptive in orientation, the third is moreanalytical and focused on general theoreticalquestions about the interplay between publicand private pensions.

It is necessary at this point to specify what Imean by public versus private sources ofretirement provision. Clearly the ordinarycapital market and the housing market belongto the fold of private vehicles of retirementprovision, but the distinction between publicand private pension systems is inherently diffi-cult to make both in theory and practice.While attempts to stimulate and regulateprivate occupational pension systems shouldbe recognized as an important part of theoverall policy package dealing with theproblem of income provision in old age, itdoes not follow that the affected pensionschemes themselves should be considered partof the public pension system. According to theapproach taken here, a pension system is con-sidered to belong to the public fold if it is leg-islated and covers the whole population or atleast all wage earners. To qualify as private,the coverage and benefit structure of a

6 Pedersen

Journal of European Social Policy 2004 14 (1)

pension scheme must reflect discretionarydecisions on the part of private agents, eitherthe beneficiaries themselves (individual pen-sions) or their employers/unions (occupationalpensions). The real ambiguity arises in thecases where the state has made employer-financed pension schemes obligatory for spe-cific industries, sectors, or for the entirelabour market. My solution is to include suchmandated schemes in the public fold, if, andonly if, the associated regulation is so tightand complete as to leave no real choice forindividuals, companies or unions regardingthe terms of pension coverage. (The secondtier of the Finnish pension system is a case inpoint.) I treat special pension schemes forpublic employees as an instance of (private)occupational welfare even if they are techni-cally arranged through legislation (see Rein,1983). The main motivation for this is thatthey are selective welfare arrangements em-bedded in labour management and labourrelations in much the same way as occupa-tional schemes in the private sector.

Before embarking on the presentation of theempirical analysis of LIS data, I shall brieflyreview some of the theoretical issues andexisting research on the interplay betweenpublic and private pensions. I shall also offer asketch of the institutional differences in publicpension provision needed to interpret theempirical results.

Theoretical perspectives and previousresearch

In the social policy literature, opinions differover the nature of public and private systemsof retirement provision and their implicationsfor social outcomes. Some analysts tend to seeprivate pensions and savings as a simple func-tional equivalent to public provision, andhence it is argued that cross-national variationin the institutional mix between the two onlymasks an essential convergence among advan-ced capitalist economies (Rein, 1983; Roseand Shiratori, 1986). This perspective also

seems to pervade a recent OECD report aboutthe financial resources of pensioners in a selec-tion of OECD countries:

The strategies that underlie the systems inthe different countries are fundamentallydifferent in the role they assign to publicpension schemes, the space they leave foradditional occupational or personal pensionprovision, the incentives they provide forearly retirement and in approaches to taxa-tion. Nevertheless the outcomes are similar,at least in terms of replacement income ofolder people . . . (OECD, 2001: 9)

Other social policy analysts maintain a clearlydualistic view of the two types of welfare pro-vision. Richard Titmuss was an early expo-nent of the dualistic view. In a famous essayfrom the 1950s he contrasted three types ofwelfare provision: social welfare, occupationalwelfare, and fiscal welfare, arguing that thetwo latter, ‘private’ types of welfare entail adistributive logic that contrasts sharply withthe egalitarian ethos of social welfare(Titmuss, 1958). This dualistic conception ofpublic and private welfare is also prevalent inmore contemporary writings on social policyand the welfare state. In the influential worksof Gøsta Esping-Andersen, cross-national dif-ferences in the balance between public andprivate provision of pensions and retirementincome are seen as a key symptom of welfarestate variation (Esping-Andersen, 1987; 1990;see also Korpi and Palme, 1998). As I shallexplain in more detail below, the dualisticview does not necessarily entail a denial thatpublic and private pension arrangements aresubstitutes in quantitative terms. Quite to thecontrary, authors in this tradition oftenassume the existence of a self-reinforcing, neg-ative dynamic between public and private pro-vision, which over time should be expected toproduce rather dramatic differences in theoverall mixture of public and private pensionsbetween different countries.

Hence, both these contrasting theoreticalperspectives seem to share the assumption that

The privatization of retirement income? 7


public and private pensions are substitutes inquantitative terms. Individuals and collectiveactors, like employers and trade unions, con-sider public and private pensions as alterna-tive means to achieve ‘adequate’ income levelsafter retirement. This expectation about asimple and mechanical pattern of substitutionand crowding out between public and privatepensions is consistent with the so-called life-cycle hypothesis of savings behaviour, knownfrom the economics literature. The life-cyclemodel holds that individuals save in order touphold a preferred consumption standard inretirement, and it predicts that they will relaxtheir efforts to save by themselves if con-fronted with a generous public pension system(Modigliani and Brumberg, 1954; Feldstein,1974).

However, the assumption about a clear-cutsubstitution/crowding out between public andprivate pensions has been called into questionby a number of authors. Some argue that therelationship can, at least occasionally, work incompletely the opposite direction: that theexpansion of public pensions might be a causefor growth in private pensions (Hannah,1992; Dobbin and Boychuck, 1996). Onepossible mechanism behind such a comple-mentary relationship concerns preference for-mation and could be termed ‘the recognitioneffect’ (Barro and MacDonald, 1979). Asmany scholars have pointed out, retirement isby and large a social invention of the 20thcentury (Hannah, 1986; Myles, 1989), whichsuggests that the need for retirement income issocially constructed rather than being anatural constant. It is therefore not unreason-able to assume that the introduction andimprovement of public pension benefits could,in specific historical circumstances, help toboost expectations about what constitutes an‘adequate’ income level after retirement, andtherefore stimulate increased demand forprivate supplements.

Existing empirical studies convey a mixed ifnot contradictory picture. Many scholars havepointed to the simple and undeniable fact thatin most developed countries, public and

private pension systems have grown in tandemthroughout the postwar era (van Gunsterenand Rein, 1985; Hannah, 1992). Moreover,the notion of complementarity has found sup-port in historical case-studies. Dobbin andBoychuck (1996) argue that coverage withoccupational pensions increased in the US as aconsequence of the introduction of socialsecurity pensions in the New Deal reforms ofthe late 1930s.

Other studies have found evidence in favourof substitution. On the basis of time-seriesdata for the US, Munnell (1982) found astrong substitution effect between public andoccupational pension accrual among membersof the workforce. It is interesting to note thatwhile she found almost a one-to-one substitu-tion between public and occupational pen-sions, individual savings behaviour appearedto be unaffected by changes in public pen-sions. Also, some tentative studies of cross-national data have pointed to a negativerelationship between the scope of public andprivate pensions (Esping-Andersen, 1987;1990; Kangas and Palme, 1992; Pedersen,1997). To this list we can add the recentOECD report mentioned above, according towhich the relative income position of retiredhouseholds is virtually identical in a sample ofmember countries despite wide differences inthe generosity of public pension systems(OECD, 2001).

These latter attempts to draw causal infer-ences from a snapshot of cross-national datasuffer from a set of notorious problemsamong which the limited number of cases isthe most serious (‘the small-N problem’; seeLieberson, 1992; Goldthorpe, 1997). Thepresent study seeks to overcome at least someof these problems by using an analytical strat-egy that exploits cross-national variation incombination with time-series data for each ofthe country cases involved. By pooling cross-national and time-series data, the analysisrests on a richer data source than is usuallyavailable in cross-national research and, in par-ticular, it allows for a more effective controlfor country-specific idiosyncrasies, including

8 Pedersen


https://www.researchgate.net/publication/227388904_Inventing_Retirement?el=1_x_8&enrichId=rgreq-10f4d507-a082-4629-8135-cbb87e4cb311&enrichSource=Y292ZXJQYWdlOzIzODQyOTExNztBUzoxMTg4MTM2NzY4MDYxNTFAMTQwNTMzODc5NjYyNg==

https://www.researchgate.net/publication/30941640_Old_Age_in_the_Welfare_State_The_Political_Economy_of_Public_Pensions?el=1_x_8&enrichId=rgreq-10f4d507-a082-4629-8135-cbb87e4cb311&enrichSource=Y292ZXJQYWdlOzIzODQyOTExNztBUzoxMTg4MTM2NzY4MDYxNTFAMTQwNTMzODc5NjYyNg==

country-specific measurement errors (Janoskiand Hicks, 1994).

Having said this, I must hasten to add thatwe are a far cry from having the ideal dataand the perfect analytical design to test thehypothesis about substitution/crowding outbetween public and private retirement pro-vision. Ideally one would want observationsover a much longer time-span for eachcountry than has been available for this study.The addition of a set of diachronic obser-vations for each country only adds trueanalytical leverage, as compared to the cross-sectional snapshot, if there has been signifi-cant variation in the relevant institutionalvariables during the period covered, and thiscondition is not generally fulfilled in our data.A longer time-span is particularly importantwith respect to studies of pension policy out-comes since there is likely to be a considerabletime-lag between institutional changes inpension systems and their observable out-comes in terms of a realized income packageamong a generation of retirees. It takes a life-time for a pension system to mature, and thefinal consequences of a specific public pensionsystem – including the effect of behaviouralresponses – can only be observed when thecohorts who have been exposed to the systemfor their entire active life-course finally retire.What is more, public and private pensionsystems might mature with a different speedand, hence, one should be prepared to observeeffects with a varying time-lag. If there are anyareas in the social sciences where universaland final answers to important empiricalquestions can be found, clearly this is not oneof them.

The institutional context

Before presenting the analysis of micro-data itis necessary to briefly introduce the institu-tional context to which contemporary genera-tions of pensioners are exposed in thedifferent countries. It can be argued that thepension systems in the advanced economies

have developed out of two very differenttraditions (Baldwin, 1990). One is the Con-tinental European social insurance tradition,first made operational in Bismarck’s Germany.Among its main characteristics were a stronginsurance analogy with an exclusive emphasison redistribution over the lifecycle, a closecorrespondence between earnings/contribu-tion records and expected benefits and (atleast in its historical origins) a strong segmen-tation among systems for different socio-economic groups. Historically, this traditionbecame dominant in Central and SouthernEurope. A modified version of the socialinsurance approach was also adopted in theUS, when a public pension system was finallyintroduced with the New Deal reforms in thelate 1930s.

The other main tradition is the ‘Beveridge’model, with its emphasis on providing acertain level of minimum protection in old agethrough means-tested and/or flat-rate benefits.The 1891 Danish Act for relief for the agedwas the earliest expression of this approach(Baldwin, 1990; Petersen, 1990), which can beseen to characterize later developments in theNordic countries, the Netherlands, the BritishIsles, and Commonwealth countries such asCanada, Australia and New Zealand. How-ever, fairly strong differences among thesecountries (both historically and presently) inbenefit levels, the role and type of means-testing, eligibility rules and the mode offinancing must qualify the degree to which wecan speak of a common tradition.

During the first three postwar decades thedifferences between these two traditionstended to wane. The addition of a second tierof earnings-related public pensions in the UK,Canada and the Nordic countries (except forDenmark), and the establishment of a systemof mandated occupational schemes in theNetherlands and Australia is evidence of sig-nificant modifications of many of the systemsoriginating from the ‘Beveridge’ model.Important modifications also took place in thesocial insurance schemes of the ContinentalEuropean countries. The previous strong seg-



https://www.researchgate.net/publication/231945724_The_Danish_1891_Act_on_Old_Age_Relief_A_Response_to_Agrarian_Demand_and_Pressure?el=1_x_8&enrichId=rgreq-10f4d507-a082-4629-8135-cbb87e4cb311&enrichSource=Y292ZXJQYWdlOzIzODQyOTExNztBUzoxMTg4MTM2NzY4MDYxNTFAMTQwNTMzODc5NjYyNg==

mentation of pension schemes for differentcategories of the workforce was in manycountries reduced through decisions to stan-dardize benefit formulas, and the increasingrole of general revenue financing allowed forcross-subsidization between socio-economicgroups. Furthermore, means-tested ‘socialpensions’ or categorical social assistanceschemes with special provisions for the elderlywere set up in almost all countries, securing acertain minimum protection as a complementto the earnings-related schemes.

Table 1 summarizes the main features of thepension systems found in the nine countrycases covered in the following analysis ofmicro-data.2 The category of means-testedbenefits is here taken to include schemes thatoperate with broad income and asset-testing,as in Australia, and schemes that employ amore narrow income test, as in Canada. Thecategory does not include systems that providea minimum pension guarantee in conjunctionwith an earnings-related pension system (i.e.the pension tests employed in Sweden, Finlandand Norway) and it does not include varioussorts of ‘earnings or employment testing’.

In four of the countries with a historicaltradition of minimum protection (Canada,Norway, Sweden and the UK), a second tierof earnings-related pension was added tothe public pension system some time duringthe 1960s and 1970s.3 In Australia and the

Netherlands, coverage with mandated occupa-tional pensions has become virtually universalamong wage earners. In the Dutch case thepractice of mandating has been developedin a close interplay with the diffusion ofpension schemes through collective bargaining(Lutjens, 1996).

Within the group of countries sharing a‘Beveridge’ legacy, there are also importantdifferences concerning the nature of theminimum protection. Australia is the onlycountry where public pension provision isbased exclusively on means-tested benefits.The pension systems in Denmark and Canadaprovide a combination of universal flat-rateand means-tested benefits, while Norway andthe Netherlands are the only countries wheremeans-testing plays no significant role at all.Sweden and the UK cannot be unambiguouslyclassified on this dimension. In Sweden, ameans-tested housing allowance for pension-ers has continued to play an important role inthe overall system of income protection, andin the UK means-tested social assistance bene-fits (so-called ‘Income Support’) have formeda significant part of the income transferstowards the elderly. Similarly, the ambiguousclassification of Germany on the issue ofmeans-testing reflects the fact that means-tested minimum protection for the elderly isavailable outside the pension system proper, inthe form of social assistance benefits.

10 Pedersen


Table 1 Main features of national pension systems in the mid-1990s

Contemporary public systemsHistorical Universal Means-tested Earnings- Mandated

legacy flat-rate benefits related occupationalbenefits benefits pensions

Australia MP No Yes No YesCanada MP Yes Yes Yes NoDenmark MP Yes Yes No NoThe Netherlands MP Yes No No YesNorway MP Yes No Yes NoSweden MP Yes No (Yes) Yes NoUK MP Yes No (Yes) Yes NoGermany SI No No (Yes) Yes NoUS SI No Yes Yes No

Notes: MP = Minimum protection. SI = Earnings-related social insurance.

Different worlds of income packaging?

The concept of income packaging was elabo-rated by Rainwater et al. (1986) to capturethe idea that claims to economic resources canbe acquired in different arenas and from dif-ferent sources, with politics (political rights),markets (exchange) and the family (care,altruism) being the most clearly distinguish-able arenas. Here I shall use the concept in arather pragmatic sense, as a lead-in to describ-ing variation in the interplay between differentincome sources in the provision for retirementin the nine country cases.

The LIS databank offers the researcher awide range of choices, and here follows a briefdescription of the most important choicesmade for the following analyses. The popula-tion of ‘pensioners’ selected for the followinganalysis is defined as individuals belonging tohouseholds in which the household head hasreached 65 and for which earnings (wages,salaries and self-employment income) consti-tute less than one-third of total householdincome.4 The primary motive for this addi-tional criterion is to clean out the effect ofdifferent effective retirement ages in therespective country cases. I have also excludedthe very old; i.e. households where the headhas reached the age of 80 years or more. Theunit of analysis is individuals, and theirincome is always measured and evaluated interms of the total household income, dividedby a factor (an equivalence scale) to adjust fordifferent household sizes.5 The adjustment isin this case achieved by dividing the totalhousehold income by the square root of thehousehold size.6

In most of the following analysis I shall usea rough distinction between public and privateincome components, but I start by presentinga finer breakdown of total disposable incomeinto four components of gross income minusincome taxes paid by the pensioner house-holds as shown in Table 2.

One should note that the income conceptused here takes no account of the economic

value associated with accumulated housingwealth. This is problematic since the rate ofhome ownership among the elderly variesacross the nine countries. Australia is oftenpointed out as a country where the prevalenceof home ownership among the elderly is veryhigh, and where the accumulation of housingwealth plays a particularly important role as avehicle for allocating economic resourcestowards the retirement phase (see for instanceWhiteford and Kennedy, 1995; Ritakallio,2003). Other countries with comparativelyhigh rates of home ownership among theelderly are Norway, Canada and the US. It islikely that the picture of the relative economicwell-being among the elderly would have beenmore favourable, and that the assessment ofboth the absolute and relative contribution byprivate sources of retirement provision wouldhave been higher for these countries, if thissource of retirement provision had been appro-priately accounted for (Ritakallio, 2003).

As can be seen from Figure 1, public pen-sions (including means-tested benefits) are thesingle most important income sources in allthe nine countries. Public pensions take up atleast 50 percent of gross income in all ofthe nine countries and at both time-points.Canada and the US around 1980, and the USand the UK around 1995, are the only casesshowing a rough balance between the share ofpublic and private income components.

Nevertheless, Figure 1 does demonstrate asignificant degree of cross-national variationin the share taken up by public transfers – atboth time-points. However, a couple of prob-



Table 2 A breakdown of total disposableincome

Public transfers+ Occupational pensions+ Earnings+ Income from capital= Gross income– Income tax and social security

contributions= Disposable income

https://www.researchgate.net/publication/228288325_The_Importance_of_Housing_Costs_in_Cross-National_Comparisons_of_Welfare_State_Outcomes?el=1_x_8&enrichId=rgreq-10f4d507-a082-4629-8135-cbb87e4cb311&enrichSource=Y292ZXJQYWdlOzIzODQyOTExNztBUzoxMTg4MTM2NzY4MDYxNTFAMTQwNTMzODc5NjYyNg==

lems with measurement should be noted atthis point. In the Swedish data from the firstwave, occupational benefits are recordedtogether with public transfers. In actual fact,Sweden did at the time have a very extensivecoverage with occupational pension schemes,and according to figures presented by Kohl(1992), occupational pension schemes shouldin the period around 1980 be responsible forabout one-fifth of the total expenditure onpensions in Sweden.7 Adjusting for this sourceof bias would probably show that the trueshare taken up by public transfers was in therange of 75–80 percent in Sweden around1980. In the fourth wave of Swedish LIS data,this problem has been removed for the firsttime. The German figures, however, can besaid to underestimate the role of public pen-sions. The problem is that a core group of civilservants (‘Beamten’) are fully served by a sep-arate pillar of public sector occupational pen-sions. To count all income received from thisseparate scheme as occupational pensions pro-duces an inflated picture of the role of occupa-tional pensions (and a deflated picture of therole of public pensions) in comparison withcountries where similar schemes work as sup-plements to a general public pension system.A similar problem arises in the UK for thoseemployees who were contracted out of SERPS,but here the bias is likely to be much smaller.

With these qualifications in mind, we canconclude that the share taken up by publictransfers varied between more than 80 percentin Germany to just below 50 percent inCanada in the period around 1980. In themid-1990s the range of variation is almost thesame, although some of the countries showinga high degree of public dominance in 1980have seen a decline in the share taken up bypublic transfers. In 1995 Germany stands outas the country with the highest share of publictransfers – 76 percent of all gross incomereceived by pensioners. The role of earnings isfairly modest and shows little variation acrosscountries and across time – partly, of course,due to the criteria used in the selection of eachcountry sample, according to which the share

of earnings in total income was not allowed toexceed 33 percent.

The two main private income sources areoccupational pensions and income fromcapital/financial assets (the latter will in somecountries include income from individualannuities). Around 1980, occupational pen-sions accounted for no less than 34 percent ofthe total income received by pensioners in theNetherlands, and somewhere between 15percent and 20 percent in the UK andDenmark, Canada and the US. Occupationalpensions appeared to take up a relativelymodest share in Norway and Australia – 11percent and 8 percent respectively. In the caseof Australia, one should note that mostprivate sector occupational pension plans payout lump sums rather than annuities (Olsberg,1995; Bateman and Piggot, 1997), and lump-sum payments are not recorded in the LISdata. It is worth mentioning that the prefer-ence for schemes with lump-sum payments inAustralia should probably be seen in light ofthe fact that public pension benefits areincome tested. Lump-sum payments will onlymake themselves felt indirectly in the data ifthe money is invested in financial assets (orconverted into a private annuity). Therefore,the LIS data will tend to strongly underesti-mate the role played by occupational pensionsin the Australian retirement system, a fact thatis supported by the relative modesty of thereported share taken up by occupational pen-sions even in 1995 – about 15 percent.

In the mid-1990s the share taken up byoccupational pensions has increased quite sig-nificantly in a number of countries. It is par-ticularly interesting to note the significance ofoccupational pensions in two Scandinavianwelfare states, Norway and Sweden, where ithas often been claimed that public provision isvirtually dominant. In Norway, the sharetaken up by occupational pensions has almostdoubled from about 11 percent to about 20percent. The corresponding Swedish figurewas 17 percent in 1995.

According to the figures presented here, therelative significance of income from capital/

12 Pedersen




Panel A: Wave I around 1980

0

10

20

30

40

50

60

70

80

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100

Swed

en

Ger

man

y

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way U

K

Den

mar

k

Net

herla

nds

Aus

tralia

USA

Can

ada

Capital income

Earnings

Occ. pensions

Public transfers

Tax

Panel B: Wave VI around 1995

0

10

20

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Swed

en

Ger

man

y

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way U

K

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Aus

tralia

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ada

Capital income

Earnings

Occ. pensions

Public transfers

Tax

* Denmark is not represented in the first wave of LIS data, and I have therefore included information

taken from the Danish 1987 data-set in the top panel of the graph. Note also that the country cases are

ordered according to the share taken up by public transfers in the first wave of data, referring to the

period around 1980.

Figure 1 The share of different income components in the aggregate income package (grossincome) of old age pensionersa



Note: a Denmark is not represented in the first wave of LIS data, and I have therefore includedinformation taken from the Danish 1987 data-set in the top panel of the graph. Note also that thecountry cases are ordered according to the share taken up by public transfers in the first wave of data,referring to the period around 1980.

financial assets shows very strong variationboth across countries and across time.8 In thefirst wave of data that refers to the periodaround 1980, income from capital appears tobe particularly important in Canada andAustralia, accounting for about 30 percent ofthe gross incomes of pensioners. By contrast,the share was particularly low in Germany (3percent) and the Netherlands (4 percent). Inthe mid-1990s the share taken up by capitalincome was still below 10 percent inGermany, Sweden and Denmark, while thehighest shares – about 20 percent – are foundin Australia and the US. In Canada the sharetaken up by capital income has decreased bymore than 50 percent – from 32 percent in1981 to 14 percent in 1994.

Finally, Figure 1 illustrates how the level oftaxation among pensioners shows very strongcross-national variation. Denmark, Swedenand the Netherlands tax pensioners relativelyheavily. In other countries – Germany, in par-ticular – pensioners hardly pay any incometax at all.

A casual inspection of Panel A could indi-cate that there exists a widespread, if notalways very dramatic, tendency in the direc-tion of de facto privatization of income provi-sion in old age. I shall look somewhat moreclosely at this issue in the following section.

A general trend towards privatization?

During the period covered by the present study(1980–95), few countries experienced dramaticand conscious attempts to privatize the systemof income protection in retirement. The mostrelevant examples are the measures taken inAustralia and the Netherlands to mandateoccupational pension schemes for the entirelabour market. However, these measures willnot have taken full effect for the pensionercohorts that we are studying here. Further-more, few if any countries made dramatic cutsin public pension systems that might have hada direct effect on the composition of the

income packages of retired households. On thecontrary, some of the countries covered herehave fairly young earnings-related pensionschemes that were still in the process of matu-ration during the period studied. Norway andCanada are cases in point.

Hence, the question is whether we can iden-tify a more gradual and partly spontaneoustendency to rely more heavily on privateincome sources in this sample of countries.

Figure 2 does not convey a neat and consis-tent pattern of growth in the share taken upby private income components across the ninecountry cases. Three countries exhibit a fairlyconsistent pattern of growth in private incomesources (and a corresponding decline in theshare taken up by public transfers): the UK,the Netherlands and Norway. The most dra-matic change has taken place in the UK wherethe share taken up by private income compo-nents increased from about one-third to aboutone-half during the 1980s. The developmentin Norway is almost equally impressive,although it started from a much lower level.Germany, too, appears to have experienced afairly strong growth in the share taken up byprivate income components during the 1980s,but it should be kept in mind that the Germandata tend to exaggerate the role played byoccupational pensions vis-a-vis the remainingcountries. The apparent drop in the share ofprivate income after 1989 can probably beexplained, at least partly, as a consequence ofreunification, since the relative scope ofprivate income sources in retirement is likelyto be more modest in the eastern Länder.

Other countries appear to have experienceda different development. In particular oneshould notice a rather consistent decline in theprivate share that can be observed for Canadaover this 15-year period. The continued matu-ration of the second tier of earnings-relatedpublic pensions (The Canada and QuebecPension Plans) is probably a key explanationfor this development (Myles, 2000; Osberg,2001). In the Netherlands, the US, Denmarkand Australia, there does not appear to havebeen a general trend in either direction.

14 Pedersen


The widespread tendency for a decline inthe share taken up by private income sourcessince the early 1990s can probably beexplained as being a result of the transition tolow inflation economies experienced by mostOECD countries in this period. With lowerinflation rates follow lower nominal interestrates and therefore a decline in the incomeshare stemming from financial capital.

It is interesting, therefore, to look especiallyat the share taken up by occupational pensionsas depicted in Figure 3. When concentratingon the relative significance of occupationalpensions, there emerges a more consistentpicture of ‘privatization’ in this sample ofcountries. Occupational pensions take up anincreasing share in most countries, with theNetherlands and Australia as two exceptions.In the Netherlands the share of occupationalpension is very high throughout the period.

With respect to the Australian figures onemust recall that lump-sum payments are notcaptured by the LIS data.

However, one should not immediately jumpto conclusions about the causes of theobserved growth in occupational pensions. Itmight be driven by an increasing gap betweenthe demand for economic security in retire-ment and the quality of public pension systems,but it could also – at least partly – be theresult of historical changes in the compositionof the labour force and the related maturationof occupational pension schemes. At least inthe Scandinavian countries it is likely that partof the growth in occupation pension expendi-ture is simply a delayed effect of the vastincrease in public sector employment thattook place in the 1960s and 1970s.



10

20

30

40

50

60

Wave I Around 1980 Wave II Around 1985 Wave III Around 1990 Wave IV Around 1995

% o

f g

ross in

co

me

USA

UK

Netherlands

Canada

Australia

Norway

Denmark

Sweden

Germany

* The time series are incomplete for Denmark, Germany and Sweden. As already mentioned the

Swedish data did not adequately classify occupational pensions until 1995, and therefore it is

impossible to tell anything about the trend over time. A similar problem exists in the second wave of

German date (1984) and therefore the development between the first and the third waves has been

linearly intrapolated.

Figure 2 The share of private income components in total gross income. Nine country cases and(up to) four time periodsa

Wave I around 1980 Wave II around 1985 Wave III around 1990 Wave IV around 1995

Note: a The time series are incomplete for Denmark, Germany and Sweden. As already mentioned, theSwedish data did not adequately classify occupational pensions until 1995, and therefore it is impossible totell anything about the trend over time. A similar problem exists in the second wave of German data (1984)and therfore the development between the first and the third waves has been linearly intrapolated.

Substitution or complementarity?

Let us now finally turn to the more analyticalquestions: Does the pattern of cross-nationalvariation in the scope of private retirementincome help support, or refute, the competinghypotheses about substitution or complemen-tarity between public and private incometransfers towards the elderly?

In the previous section we saw that thebalance between public transfers and privateincome components shows considerable varia-tion both across countries and over time. Still,the material presented so far does not give anyanswer to the pertinent question of whetherhigh average levels of public pensions gotogether with low levels of private provisionand vice-versa. Any variation in the generosityof public pension benefits would of courseaffect the relative shares of public and privatecomponents even if the absolute amount ofprivate income were completely unaffected.

In order to address the questions aboutcrowding out or substitution, the size of eachincome component must be measured inabsolute terms or according to some external,

country-specific standard. The choice madehere is to use mean disposable (equivalent)income among non-pensioners as the commonyardstick for measuring the scope of publicand private income components, and also forevaluating the total level of disposable incomeenjoyed by pensioners. I have calculated netfigures for the public and private incomereceived by each individual pensioner, usingthe average tax-rate observed for this individ-ual (for the use and justification of thisapproach, see Rainwater, 1993: 7).9

This procedure has been applied to thefigures presented in Figure 4. Here the totaldisposable income received by pensioners isbroken down into public and private compo-nents and measured as a percentage of themean equivalent income among the non-retired. As could be expected, there is consid-erable variation across the nine countries inthe mean value of (net) public transfersreceived by pensioners, both around 1980 andaround 1995. In Wave I, net public transfersamounted to at least 60 percent of the meanequivalent income among the non-retired inSweden, Germany and the Netherlands. At the

16 Pedersen


5

10

15

20

25

30

35

40

Wave I Around 1980 Wave II Around 1985 Wave III Around 1990 Wave IV Around 1995

% o

f g

ross in

co

me

Netherlands

UK

Canada

USA

Denmark

Norway

Sweden

Germany

Australia

Wave I around 1980 Wave II around 1985 Wave III around 1990 Wave IV around 1995

Figure 3 The share of occupational pensions in total gross income. Nine country cases and (upto) four time periods




0,0

10,0

20,0

30,0

40,0

50,0

60,0

70,0

80,0

90,0

100,0

Sweden Germany Netherlands Norway USA UK Australia Denmark Canada

Net public transfers Net private income


0,0

10,0

20,0

30,0

40,0

50,0

60,0

70,0

80,0

90,0

100,0

Sweden Germany Netherlands Norway USA UK Australia Denmark Canada

Net public transfers Net private income

Figure 4 Net amount of public transfers and net income from private sources received by old agepensioners, measured in % of average disposable income among the non-retired



other end of the continuum we find the UK,Australia, Denmark and Canada, where theaverage net amount of public transfersreceived by pensioners was just below 40percent in Wave I. Around 1995, variation inthe scope of public transfers was even larger,ranging from almost 70 percent in Germanyand Sweden to below 40 percent in the UKand Australia. The standard deviation ofcountry scores on net public transfers is 10.4in 1980 and 11.6 in 1995.

According to the hypothesis about substitu-tion, we should expect that private incomeswould tend to compensate for the low level ofpublic pension benefits offered in some coun-tries, and hence that the cross-national varia-tion in total (net) disposable income amongthe retired would be much more modest.However, Figure 4 does not reveal a strongand consistent pattern of substitution betweenpublic and private income components. Al-though there is a negative correlation betweenthe scope of public and private income sourcesat both time-points, it is fairly weak andinconsistent. Variation in the scope of privateincome components does not produce any-thing like a perfect levelling of cross-nationaldifferences in terms of total disposable incomereceived by the retired. The standard deviationof country scores on total disposable incomeis about the same in absolute terms – 11.1around 1980 and 11.2 around 1995 – as thevariation in scores on public transfers takenalone.

In Wave IV, Australia stands out as a strongoutlier. Australia is recorded with the lowestlevel of public transfers and one of the lowestlevels of private income across the entiresample. One could argue, however, that theAustralian figures are not really comparablesince the LIS data fail to pick up occupationalpensions paid out as lump sums. Also it isarguably particularly problematic with respectto the Australian case, in that the economicvalue of home ownership and accumulatedhousing wealth is not included in the incomeconcept. If Australia is excluded from thesample in the mid-1990s, a much more consis-

tent negative correlation between the scope ofpublic and private incomes appears across theremaining eight countries. The range of varia-tion in total disposable income is significantlyreduced (to between 70 percent and 90 per-cent of the net equivalent income among thenon-retired) and the standard deviation incountry scores drops to 7.2. In other words,when Australia is excluded from the sample,the pattern of cross-national variation in themid-1990s becomes significantly more consis-tent with the hypothesis of substitution.

These relationships are explored more sys-tematically in Table 3 using information fromall four waves of LIS data. Here a number oflinear regression models have been estimatedbased on the 31 country/time-specific observa-tions that are available.10 The first threecolumns of Table 3 show results for modelsthat aim to explain variation in the scope ofnet private income. When net private transfersare regressed on net public transfers using theentire pooled time series data-set, we obtain anegative but rather small coefficient. The esti-mated coefficient implies that for every per-centage point increase in the scope of publictransfers, the scope of private transfers isreduced by 0.24 percentage points. The coeffi-cient is not statistically significant, however.

As already indicated, the fact that theAustralian data are likely to seriously underes-timate the scope of private incomes might helpto explain this rather weak and indeterminateresult. Therefore a second model has beenestimated, where a dummy variable forAustralia is included to clean out the effect ofspecial measurement problems in the Aus-tralian case (on the assumption that the meas-urement problem is constant over time). Inthis model the negative relationship betweenpublic and private income components comesout somewhat stronger and achieves statisticalsignificance at the 5 percent level.

It could be argued, however, that cross-national differences are a poor source of infor-mation on a possible true causal relationship,and that it would be preferable to use onlyvariation across time in each country case for

18 Pedersen


the estimation of the relationship between thedependent and independent variables. This isachieved in the last of the three models byincluding dummy variables for each of thecountry cases (except one) in the regressionequation.

The result does not give strong support tothe hypothesis about substitution, althoughthe coefficient is negative as expected. Vari-ation over time in the generosity of publictransfers towards the elderly in these ninecountry cases does not do a good job inexplaining variation over time in the scope ofprivate income received by the elderly, and theobserved negative relationship is not statisti-cally significant. It needs to be pointed out, ofcourse, that there is even less support for thecompeting hypothesis about a complementaryrelationship between public and private meansof retirement provision. To the extent that wedo find a pattern of correlation in this mate-rial, the sign is consistently negative.

Turning finally to the relationship betweenthe average amount of public transfers and thetotal disposable income enjoyed by pension-ers, we find fairly strong and significant co-efficients linking the generosity of publictransfers and total disposable income in eachof the three models.

The income position of pensioners tends to

be more favourable when public pensions arerelatively generous, as could be expected. Thisresult holds even when we attempt to controlfor special measurement problems in theAustralian case. It also holds when we controlaway all country-specific effects and concen-trate the analysis on variation over time ineach of the country cases, as shown in the lastcolumn of Table 3. This result holds up even ifone simultaneously controls for all period-specific effects. Changes over time in the gene-rosity of public transfers towards the elderlycan to a large degree explain changes over timein the relative economic well-being of pension-ers. The estimated coefficient suggests that forevery percentage point increase (decrease) inthe relative generosity of public transfers, therelative income position of pensioners im-proves (deteriorates) by 0.78 percentagepoints. In other words, variation in the gen-erosity of public pension does appear to makea systematic imprint on the average level ofrelative economic well-being found amongpensioners.

Conclusions

In all the nine country cases covered in thisstudy, pensioners rely on a mixture of public



Table 3 Regression analysis with net private transfers and total disposable income received bypensioners as dependent variables. Regression coefficients (t-statistics) for the effect of net publictransfers

Dependent Net private transfers Total disposable incomevariable

Pooled Pooled Pooled Pooled Pooled Pooledsample sample sample sample sample sample

including controlling including controllingdummy for all dummy for all

variable for country- variable for country-Australia specific effects Australia specific effects

Independent –0.241 –0.364 –0.177 0.664 0.541 0.784variable: net (–1.686) (–2.553) (–0.911) (4.832) (3.973) (3.801)public transfersN 31 31 31 31 31 31

Note: Bold typeface signals statistical significance at the 5% level.

and private income components. The balancebetween public and private provision showsconsiderable variation, however. Private in-come sources tend to be relatively importantin the countries where the public pensionsystem is largely concentrated on the provi-sion of flat-rate benefits, such as the Nether-lands, Denmark and increasingly the UK. Theshare taken up by private income is surpris-ingly low in Australia, however, but here theextensive use of means-testing might explainwhy private provision is taking forms that aredifficult to capture in ordinary income surveys– as occupational pensions offering lump-sumpayments and as the accumulation and subse-quent consumption of housing wealth. Incountries with very generous earnings-relatedpublic pension systems, such as Germany andSweden, the share taken up by private incomecomponents is more modest. But even inSweden – a country that has often beendescribed as featuring complete state domi-nance in the provision of welfare – the sharetaken up by private income sources is far fromtrivial. We have seen that the share taken upby private income components appears to berising in many countries, although variationover time in nominal interest rates can be sus-pected to have contributed to break an other-wise more consistent and linear development.

An almost universal tendency towards pri-vatization comes out more clearly if we lookespecially at the share taken up by occupa-tional pensions. It is possible to imagine thatthis development is – at least partly – theresult of an increasing gap between prefer-ences and expectations about income securityin retirement and the benefit levels promisedby public pension systems. However, oneshould also be aware that structural changesin the labour market are likely to play a role.At least as far as the Scandinavian countriesare concerned, part of the explanation lieswith the postwar growth in public sectoremployment. Coverage with generous occupa-tional pension schemes is a traditionalprivilege of public sector employees, and theexpansion of the service-providing welfare

state is therefore an important cause of therelative growth of occupational pensions.

The attempts made in this article to investi-gate the relationship between public andprivate income provision in retirement havefailed to produce very clear-cut results. Thesupport found for the hypothesis about substi-tution between income components is weakand inconsistent at best. It is certainly notconsistent and strong enough to produce any-thing like perfect levelling of the relativeincome position enjoyed by pensioners in dif-ferent countries.

One plausible explanation for the lack of astrong and clear crowding out effect is thatthe expansion of public pensions has helped toboost expectations and preferences for retire-ment income so that the demand for privatesupplements has not decreased to the degreeone would have expected according to thehypothesis of substitution.

Here one should be aware that the empiri-cal evidence we have on this subject mainlyrefers to processes of expansion: some coun-tries have increased the generosity of publicpension benefits more than others. So far wehave less – if any – experience about the con-sequences of significant reductions in the gen-erosity of public pension benefits.

Even though I do not have any clear evi-dence on this, I suspect that the phenomenonof preference adjustment is less likely to mate-rialize when the process is reversed. Whilethere is reason to believe that people haveincreased their taste for pensions as the publicsystems expanded in the golden postwarperiod, it does not follow that people will nec-essarily downgrade their expectations in tunewith present or future cut-backs. As pointedout by Lieberson (1985), we cannot take forgranted that all causal relationships work inthe same way for upward and downwardchanges in the treatment variable. Althoughthe expansion of public pension systems hasnot consistently ‘crowded out’ private provi-sion, it could very well be the case that futurereductions in public provision will effectivelytrigger an expansion of private provision.

20 Pedersen


Even if this is the case, it does not followthat changes in the balance between publicand private provision are neutral and withoutsocial repercussions. According to the dualis-tic view of public and private welfare provi-sion mentioned at the beginning of this article,changes to the balance between public andprivate provision will have profound repercus-sions for the distributive logic of the entiresystem, and therefore substitution does not byany means imply equivalence. Research ondata from the LIS seems to support this view.Several studies have shown that private pen-sions are everywhere a very strong source ofinequality in the income package of retiredhouseholds (Pestieau, 1992; Pedersen, 1999;Behrendt, 2000). It is doubtful, however,whether a blunt distinction between ‘public’and ‘private’ welfare will continue to behelpful in characterizing the wide range ofnew forms of retirement provision that arecurrently being implemented in many OECDcountries. In some newly implemented statu-tory schemes for retirement saving, individualsare more directly exposed to the risks of thecapital market than are the members of manytraditional private occupational pensionschemes. It remains to be seen whether distrib-utive outcomes will continue to follow a dual-istic pattern.

Acknowledgements

I am indebted to Ann-Helén Bay, Johan JeroenDe Deken, Christian Toft, Einar Øverbye, andtwo anonymous referees for helpful commentsto earlier drafts of this article.

Notes

1 Historically, intra-family transfers have also beenan important source of economic support for theelderly, but today this type of transfer appears tohave lost its significance in many of the devel-oped economies (Quadagno, 1990).

2 The table refers to the situation before the latestwave of pension reforms that have brought signif-icant changes, particularly in Sweden. The pen-

sioner generations that are studied here will ofcourse have been exposed to the old system only.

3 In Denmark a very modest second tier ofemployment-related pension benefits was alsoadded in the early 1960s. However, in thisscheme both contributions and benefits are flat-rate and unrelated to the level of earnings.

4 In LIS the household head is taken to be the(eldest) adult male if present, and in the absenceof an adult male, the (eldest) adult female.

5 Technically, this is achieved by using household-level information while weighting each house-hold according to the number of householdmembers.

6 This has become a conventional choice in com-parative income distribution research (seeAtkinson et al., 1995). The implication is that amarried couple will need 1.4 times the income ofa person living alone in order to achieve thesame equivalent income, and a family of fourwill need 2 times the income of a person livingalone.

7 This point has passed unnoticed in a number ofstudies based on the LIS data, and hence thedominance of public pensions in Sweden hastended to be grossly overstated, with Kohl(1992) as a notable exception.

8 These income sources are likely to suffer fromserious problems of under-reporting – problemsthat can even be expected to vary in degreebetween different countries. Furthermore, thescope of income from capital is likely to fluctu-ate strongly with changes in nominal interestrates and hence with changes in inflation rates.Therefore the variation across time and space infigures on these income sources should betreated with caution.

9 This procedure is not ideal for all purposes. It islikely to underestimate the after-tax value ofpublic pension benefits (had they been the onlysource of income) and to overestimate the mar-ginal increase in total disposable income result-ing from private income sources.

10 The pooled sample of observations for the ninecountry cases only contains 31 data pointsbecause three observations for Sweden and oneobservation for Germany have been treated asmissing. In addition we lack a Danish data-setfrom Wave I.

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