Ageing and Pensions

        Lectures 5 and 6

Le Grand, Propper and Smith (2008): Chp 4
           Barr (2004): Chp 9
   ...
Outline


•Pensions and Ageing

•Efficiency and Intertemporal Allocation

•Pensioner Poverty

•Pensions and Private Market...
Pensions and Ageing

• Pensions and population ageing                 Country    Birth rates
 – Life expectancy and ↑ long...
Pensions and Govt Policy I: Efficiency

• Efficient level of pension provision: consumption smoothing
 – Provide income in...
Solving the Intertemporal Allocation Problem

• Trade-off between 2             Units                  Total    Marginal
 ...
The Intertemporal Allocation Problem Modified


•1. Consumption Variability at different life stages
 – ↑ consumption need...
Distinct Features of Pensions

•Tax treatment
•Lock-in
•Annuity
 – Reduce spending sprees
 – Efficient outcome when timing...
Pensions and Govt Policy II: Equity

•Explicit objective to reduce pensioner poverty

•Pensioner poverty defined
 – Househ...
Pensions and the Market System I: Equity

• Consumption smoothing v low lifetime incomes
 – Insufficient funds for retirem...
Pensions and the Market System II:
Efficiency
• Consumption smoothing and optimality
 …but potential market failures
• 1. ...
Govt Intervention I: Direct Provision

• 1. Means-tested benefits
 – Income and wealth eligibility criteria
 – Cost-effect...
PAYG or Funded Pensions Scheme?

• Is a funded system the solution to the ageing population?
• 1. Financing
 – Hard choice...
Pension Provision: an International
Comparison
• UK
 – First tier: basic state pension: flat-rate, minimum amount, PAYG
 –...
Govt Intervention II: Regulation

• Market failures
 – Are consumers rational, well-informed agents?
 – Complex decisions ...
Govt Intervention III: Subsidies

• Tax system treats pensions favourably
 – Income tax relief on contributions paid into ...
Summary

• Benefits of social insurance: consumption smoothing
• Costs of social insurance: moral hazard
• Govt interventi...
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Economics of Ageing and Pensions

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From a lecture in Economics of Public Issues delivered by Marie Stack of Nottingham Trent University. Shared as part of the TRUE wiki for Public-sector Economics. Download the file at http://www.economicsnetwork.ac.uk/public/lectures

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Economics of Ageing and Pensions

  1. 1. Ageing and Pensions Lectures 5 and 6 Le Grand, Propper and Smith (2008): Chp 4 Barr (2004): Chp 9 Tresch (2008): Chp 12
  2. 2. Outline •Pensions and Ageing •Efficiency and Intertemporal Allocation •Pensioner Poverty •Pensions and Private Markets •Pensions and Govt Intervention •www.thepensionservice.gov.uk Marie M Stack Economics of Public Issues 2
  3. 3. Pensions and Ageing • Pensions and population ageing Country Birth rates – Life expectancy and ↑ longevity – Ageing of the “baby boomers” Ireland 1.99 – Low and falling birth rates France 1.90 ⇒ Rising cost of pensions UK 1.74 • NB component of govt provision Germany 1.37 • What to do? –↑ Savings Spain 1.33 –↑ Taxes –↑ Retirement age Italy 1.32 –↓ incomes in retirement Greece 1.27 Marie M Stack Economics of Public Issues 3
  4. 4. Pensions and Govt Policy I: Efficiency • Efficient level of pension provision: consumption smoothing – Provide income in retirement – How to accumulate resources to finance spending in retirement – Resources available in retirement compared with working life • How to allocate resources over a lifetime? – Income variability – Retirement is anticipated • Maximise total lifetime welfare – Period 1: employed and receive earnings – Period 2: retired; no earnings – Total lifetime welfare: the sum of benefits in the 2 periods Marie M Stack Economics of Public Issues 4
  5. 5. Solving the Intertemporal Allocation Problem • Trade-off between 2 Units Total Marginal consumed benefit benefit periods: diminishing marginal benefit of 1 10 10 consumption 2 19 9 3 27 8 • Deferred utility can ↑ 4 34 7 total benefit 5 40 6 6 45 5 • Efficient outcome 7 49 4 – Current spending v 8 52 3 saving for retirement 9 54 2 10 55 1 Marie M Stack Economics of Public Issues 5
  6. 6. The Intertemporal Allocation Problem Modified •1. Consumption Variability at different life stages – ↑ consumption needs in period 1 – ↑ leisure in period 2 → spending indeterminate •2. Future consumption discounted – Heavier weighting in favour of current costs and benefits •3. Returns to Saving – Foregoing consumption today will ↑ consumption tomorrow •Deferred resources → pension Marie M Stack Economics of Public Issues 6
  7. 7. Distinct Features of Pensions •Tax treatment •Lock-in •Annuity – Reduce spending sprees – Efficient outcome when timing of death is uncertain – Risk-aversion and guaranteed level of income → Role of Pensions – A form of savings (consumption smoothing) – A form of insurance (against mortality risk) Marie M Stack Economics of Public Issues 7
  8. 8. Pensions and Govt Policy II: Equity •Explicit objective to reduce pensioner poverty •Pensioner poverty defined – Household income below 60% of the median – Equality between young and old •Policies to combat pensioner poverty entail – A redistribution of resources between generations – A redistribution of resources within generations …but no adjustment for spending needs – Index linked v a pensioner price index? – Pro-cyclical variation in pensioner poverty Marie M Stack Economics of Public Issues 8
  9. 9. Pensions and the Market System I: Equity • Consumption smoothing v low lifetime incomes – Insufficient funds for retirement • What to do? – ↑ Retirement age • Govt provision of pensions based on – Income in retirement? – Lifetime earnings? ⇒ Tension – Re-distribute to the poor based on current income – Fair treatment according to lifetime income Marie M Stack Economics of Public Issues 9
  10. 10. Pensions and the Market System II: Efficiency • Consumption smoothing and optimality …but potential market failures • 1. Information problems – Lack of information – Complicated and opaque charging structures – Financial providers ⇒ barriers to saving for retirement • Systematic under-saving v ill-health? • Automatic enrolment (opt out) v conscious enrolment (opt in) • 2. Aggregate or Social Risks – Pooling of risk v same risk – eg unexpected increases in life expectancy, inflation Marie M Stack Economics of Public Issues 10
  11. 11. Govt Intervention I: Direct Provision • 1. Means-tested benefits – Income and wealth eligibility criteria – Cost-effective in targeting limited resources on poor – Moral hazard problem • 2. Pay-as-you-go (PAYG) – Insurance based pension – Eligibility criteria: contributions into a fund for a specified nr of years – Taxes of working population pay current pensioners – Social risks are spread across generations – Under pressure by ageing populations • 3. Funded System – insurance based pension – Working population contributions invested for future retirement – Higher return, greater choice Marie M Stack Economics of Public Issues 11
  12. 12. PAYG or Funded Pensions Scheme? • Is a funded system the solution to the ageing population? • 1. Financing – Hard choices also relevant for funded systems – Transition from a PAYG to a funded system painful • 2. Rate of return (ROR) and choice – PAYG: return = rate of wage growth – Funded: historically, stock market returns > wage growth …but ↑ investment risk – Funded: > choice to invest savings in a wide range of assets …but information asymmetries • 3. Aggregate risks – PAYG: aggregate risks are spread across generations Marie M Stack Economics of Public Issues 12
  13. 13. Pension Provision: an International Comparison • UK – First tier: basic state pension: flat-rate, minimum amount, PAYG – Eligibility criteria: sufficient years of contributions – Index-linked to inflation – Second tier: S2P • Germany – Single state scheme – Earnings replacement – Roughly proportional to labour income over a lifetime – PAYG • Australia – Flat-rate means-tested: Age pension – Eligibility based on income and assets – Superannuation guarantee: additional mandatory contributions Marie M Stack Economics of Public Issues 13
  14. 14. Govt Intervention II: Regulation • Market failures – Are consumers rational, well-informed agents? – Complex decisions and opaque charging structures – Financial advisers ⇒ Govt regulation of financial market • Process regulation – Purchase and sale of financial services • Product regulation – Stakeholders pensions: individual plan above basic level of pension provision – Policy of informed choice • National Pensions Saving Scheme – Simplified, low-cost vehicle to save for retirement – Automatic enrolment – Stops short of compelling people to save Marie M Stack Economics of Public Issues 14
  15. 15. Govt Intervention III: Subsidies • Tax system treats pensions favourably – Income tax relief on contributions paid into personal private pension – Up to 25% of savings tax free ⇒ subsidy for pension saving • Tax Incentives and the ambiguous effect on savings – Tax relief → ↑ return on saving → ↑ saving – Tax relief → ↑ consumption → ↓ saving • Locked-in – Desirable from govt perspective • Regressive – Caps? – Tax relief limited to basic tax rate for everyone – Matched pension saving: National Savings Plan Marie M Stack Economics of Public Issues 15
  16. 16. Summary • Benefits of social insurance: consumption smoothing • Costs of social insurance: moral hazard • Govt intervention justified – Individuals too poor to save – Private markets cannot insure against aggregate risk – Decisions on complicated financial products • Govt provision – Means-tested benefits – System of social insurance • Social insurance – UK: minimum basic pensions and additional private saving (via subsidies or automatic enrolment) – Germany: generous system, but costly (ageing population) Marie M Stack Economics of Public Issues 16

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