Political (in)stabilityof pension system reforma

Oliwia Komada (WSE and GRAPE)Krzysztof Makarski (NBP, WSE and GRAPE)Joanna Tyrowicz (IAAEU, UW, GRAPE and IZA)NBP Summer Workshop

aThe views presented herein are those of the authors and not necessairly thoseof NBP 1

Question

Is pension system privatization politically stable?

1. Reform DB → partially FDC, like Poland 19992. Possibly Hicks-Kaldor efficient,3. but with substantial costs today and gains only in the future.4. Key: Is successfully introduced reform going to be stable?5. If not one should rethink original privatization.

2

Reform DB → FDC immediate cost and delayed gains

Differences in pension system deficit in % of GDPbetween DB and FDC scenario

3

Motivation: Reform DB → FDC, welfare effect and support

The share of population gaining from introducing FDC in 1999.4

Reform DB → FDC, after transition period everybody gains

The share of population gaining from introducing FDC in 1999.5

Motivation: BUT

A number of countries reverted the privatization of the pension system:Hungary, Poland, Lithuania, Latvia, Slovakia, Czech Republic,Romania, Bulgaria (Jarrett, 2011; Schwarz et al., 2014)

6

Literature review

1. A wave of reformsHolzman and Stiglitz (2001), Bonoli and Shikinawa (2006), Gruber and Wise (2009)

2. Reform = introduce some notion of funding into the system3. Whether or not privatization is in fact welfare enhancing

Conesa and Kruger (1999), Nishiyama and Smetters (2007), Fehr (2009)

4. Despite general welfare gains...5. ... most of these reforms got reversed Jarrett (2011); Schwarz et al. (2014)

6. Some of the reversions welfare deteriorating: Hagemejer, Makarski & Tyrowicz(2015)

7. Political economy of pension systems reforms• will the reform be implemented

Cooley and Soares (1999a)• coalition between low productive workers and retirees sustain

PAYGO systems Cooley and Soares (1999)• subsequent literature reviewed by de Waque (2005) or Galasso and

Profeta (2002) 7

Goals and expectations

GoalSuppose there already is a reform, with stable gains in the long-run:does it eventually become politically stable?

Expectations

• With passing of the initially old cohorts, welfare gains becomemajoritarian

• Intend to understand/explain the reversing of reforms

8

Results - preview

1. Distribution of welfare costs and gains →abolition of funded pillar always has political support.

2. Retirees always vote for abolition.

3. No coalition low productive workers + retirees.

4. Abolition (almost) does not effect inequalities.

5. Correct assignment of property rights crucial for stability.

9

Table of contents

Model

Calibration

Voting

Results

Conclusions

10

Model

Model

• SOE deterministic heterogeneous agent OLG model• Households heterogenous in their preference and productivity• Competitive firms• Pension system reformed from DB to partially FDC• Taxes used to finance government expenditure and deficit in the

pension system

11

Households I

• Are “born” at age 20 (j = 1) and live up to 100 years (J = 80)• Belong to a type κ:

• time discounting δκ

• relative leisure preference 1− φκ

• productivity level ωκ

• Choose labor supply l endogenously• Maximize remaining lifetime utility derived from consumption c

and leisure 1− l :

Uj,κ,t =J−j∑s=0

[δsκ

πj+s,t+sπj,t

[cφκ

j+s,κ,t+s (1− lj+s,κ,t+s)1−φk]]

• Subject to the budget constraint (next slide)

12

Households II

• Subject to the budget constraint

(1 + τ ct )cj,κ,t + aj,κ,t = (1− τ l

t )(1− τ)wtωκlj,κ,t ← labor income+ (1 + (1− τκt )rt)aj−1,κ,t−1 ← capital income+ (1− τ l

t )bj,κ,t ← pension income+ beqj,κ,t ← bequests−Υt ← lump-sum tax

13

Financial markets and producers

• Small open economy• domestic interest rate linked with global interest rate r∗

t• risk premium ξ Bt

Yt(Schmitt-Grohe and Uribe (2003))

rt = r∗t + ξ

BtYt

• Perfectly competitive firms with Cobb-Douglas production function

Yt = Kαt (ztLt)1−α

14

Pension System

• Pay As You Go Defined Benefit (PAYG DB)

bJ̄,κ,t = ρ · wt−1ωκlJ̄−1,κ,t−1

• Pay As You Go Defined Contribution (PAYG DC)

bIJ̄,κ,t =

f IJ̄,κ,t

LEJ̄,t, where f I

j,t = (1 + r It )f I

j−1,t−1 + τ Iωκlj,κ,t

• both with payroll growth indexation, r I , bj,κ,t = (1 + r It )bj−1,κ,t−1

• Funded Defined Contribution (FDC)

bIIJ̄,κ,t =

f IIJ̄,κ,t

LEJ̄,t, where f II

j,t = (1 + rt)f IIj−1,t−1 + τ IIωκlj,κ,t

• with bj,κ,t = bIj,κ,t + bII

j,κ,t

15

Government

• Collects taxes τ c , τ l , τk ,Υ (sum up to T ).• Covers public good spending Gt = g · Nt · zt and• deficit of the pension system

subsidyt = τ It wtLt −

K∑κ=1

J∑j=J̄t

Nj,κ,tbIj,κ,t

• Budget constraint

Tt + Dt = (1 + rt)Dt−1 + Gt + subsidyt

• closed with the consumption tax given by the following rule

τc,t = (1− %)τfinalc + %τc,t−1 + %D( ˜(D/Y )t − (D/Y )final )

16

Calibration

Macroeconomic environment

Financial market and firms

• global interest rate r∗ = 2%• risk premium ξ = 0.03→ domestic interest rate• deprecation d → investment rate 21%• capital share in GDP α = 0.3• technological progress zt slows down from 3% to 1.5%, data + AWG projection

Taxation

• labor τl → labor income tax revenues to labor revenue• consumption τl → VAT revenues over GDP• capital τk de iure rate 19%• fiscal rule ρ i %D → smooth adjustment of debt and τc

• debt do GDP D/Y = 45%

Pension system

• contribution τ → share of benefits in GDP• replacement rate ρ → SF deficit

17

Demography

Number of 20-years old Mortality rate for60-years old

⇓ ⇓r I ↓ r II ↓

18

Heterogeneity - productivity ω

SES Eurostat 1998, Poland

Productivity ω

Result: 10 values for ω

19

Heterogeneity - leisure preference φ

SES Eurostat, 1998, Poland

Leisure preference φ

Result: 4 values for φ

20

Heterogeneity - discount factors δ

• We calibrate the central value of δ to match the investment rate• We don’t have the data on stratified mortality rates or wealth• We split the model population ad hoc into 3 groups• Their discount factors are (0.98δ, δ, 1.02δ)• In total we have 120 types within each cohort

• The resulting consumption Gini index in the initial steady stateis 25.5, consistent with Brzezinski (2011)

21

Voting

Political economy

What happens within each vote?

• Policy 0 - status quo• Policy 1 - shift of contributions: funded ⇒ PAYG

(Central and Eastern European countries)

• Policy 2 - shift of assets• Policy 3 - a combination of the two

(ex. Hungary, Poland, Bulgaria, Slovakia)

22

Pure Majority voting: the median voter

• We run these votes in subsequent years independently.• If welfare gains, subcohort is in favor.• Non strategic voting: voter vote according to their preferences.• If a policy gains majority, it is put in place.• Order of voting irrelevant (we check that). Policy 1 against status

quo, winner against Policy 2, winner against Policy 3

23

Results

Reform PAYG DB → FDC is Hicks-Kaldor efficient

Aggregate welfare gains +1% , expressed in % of permanent consumptionfrom the partial privatization scenario. 24

Reform DB → FDC, positive welfare effect and support

The share of population gaining from introducing FDC in 1999.25

Reform DB → FDC, after transition period everybody gains

The share of population gaining from introducing FDC in 1999.26

Nevertheless, rational voters want to withdraw it

Political support for each policy change against status quo.

27

Nevertheless, rational voters always want to withdraw it

Political support for each policy change against status quo.

28

Nevertheless, rational voters always want to withdraw it

Political support for each policy change against status quo.

29

Shift of contribution wins, retirees prefer both changes

Political support against winning scenario: contribution.

30

Vote for policy change, because of lower taxation...

Differences in consumption tax relative to baseline (DB→NDC)

expressed in percentage points.31

... due to conversion of explicit into implicit debt...

Differences in debt level relative to baseline (DB→NDC)

expressed in percentage points.32

...regardless of lower pension benefits...

Differences in pension benefits relative to baseline (DB→NDC)

expressed in percentage points.

33

... which are lower due to slower accumulation in PAYG pillar

34

No coalition: low productive workers + retirees

Shift of contribution, voting in 2012, consumption equivalent expressedin % of permanent consumption from the partial privatization scenario 35

Policy change slightly reduces poverty...

Relative poverty defined as percentage of population with consumption below60% of median consumption. 36

... the effect (almost) disappears when base is kept constant

Abolute poverty defined as percentage of population with consumption below60% of median consumption from the initial steady state (stationarized). 37

The short-term improvement concerns mainly retirees

Percentage of retirees with consumption below 60% of median from the initialsteady state consumption. 38

Conclusions

Conclusions

1. Distribution of welfare costs and gains →abolition of funded pillar always has political support.

2. Retirees always vote for abolition.

3. No coalition low productive workers + retirees.

4. Abolition (almost) does not effect inequalities.

5. Correct assignment of property rights crucial for stability.

39