Slides accompanying a wonderful talk given by Oliwia Komada at International Pension Workshop 2019 in Paris.

1. Political (In)Stability of Social Security
Oliwia Komada (GRAPE, and WSE)
Krzysztof Makarski (GRAPE, WSE, and NBP)
Joanna Tyrowicz (GRAPE, IAAEU, UW, and IZA)
International Pension Workshop
Paris, 2019
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2. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and
Galasso 2005, Kelley 2014, Parlevliet 2017
Conclusion: social security is politically feasible → becomes politically stable.
cohort denies to contribute to PS → no future cohort pays for its pension.
But: true for PAYG scheme,
This paper: political (in)stability of funded pillar
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3. Motivation

4. The rise and fall of the funded pillar
• Many countries introduced at least partial funding.
see Holzman and Stiglitz 2001, Bonoli and Shinkawa 2006, Gruber and Wise 2009
• Reform: DB PAYG → FDC:
• immediate cost and delayed gains,
• welfare improving. eg. Makarski et al. 2017
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5. Reform DB → FDC: r > g thus funded pillar increase welfare
Welfare gains from introducing FDC in 1999. Consumption equivalent expressed in
% of permanent consumption from the partial funding scenario.
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6. Literature review - continued
• Despite general welfare gains...
• ... most of these reforms got reversed.
Jarrett (2011); Schwarz et al. (2014)
• (At least) Some of the reversings welfare deteriorating.
Hagemejer et al. (2015)
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7. Our contribution:
• Understand/explain the reversing of reforms in Central and
Eastern European countries
• Analyzing political economy of funded pillar.
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8. What we do: consider political stability of the funded pillar
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Receive political support when introduced.
Key question:
Does it eventually become politically stable?
Expectation: With passing of the initial cohorts, welfare gains become dominant.
If not one should rethink original funding.
Tool:
Overlapping generations model with intra-cohort heterogeneity
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9. Results - preview
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions
• low productive workers + retirees,
• patient + workers close to retirement .
3. Abolition (almost) does not effect inequalities.
4. If voters are altruistic, abolition is less probable.
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10. Table of contents
Motivation
Model
Calibration
Voting
Results
Conclusions
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11. Model

12. Model: Overlapping Generations
• Households heterogeneous in their preference and productivity.
• Small open economy: premium risk (Schmitt-Grohe and Uribe (2003)) .
• Firms: perfectly competitive with Cobb Douglas production.
• Pension system: DB → FDC.
• Government: uses taxes to finance deficit in the pension system,
public good and services debt.
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13. Households
• Are “born” at age 21 (j = 1) and live up to 100 years (J = 80)
• Face cohort and time specific survival probability πj,t
• 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
Vj,κ,t(aj,κ,t) = uκ(cj,κ,t+j−1, lj,κ,t+j−1)+δκπj,t+1Vj+1,κ,t+1(aj+1,κ,t+1),
where uκ(cj,κ,t, lj,κ,t) = ln cj,κ,t + φκ ln(1 − lj,κ,t)
• Pay taxes (labor, consumption, capital gains) & contribute to
pensions
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14. Pension system
Initial steady state: defined benefit
• Exogenous contribution rate τ and an exogenous replacement rate ρ
bDB
¯J,κ,t = ρw¯J−1,t−1ωκl¯J−1,κ,t−1
indexed by payroll growth rate
Reform: partially funded defined contribution
• Exogenous contribution rate τ = τPAYG
+ τFF
and actuarially fair individual
accounts
bDC
¯J,κ,t =
accumulated sum of contributions¯J,κ,t
expected remaining lifetime¯J,t
• Contributions and pensions are indexed by:
• payroll growth rate in PAYG,
• tax free interest rate in funded part.
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15. Government
• Collects taxes τc, τl , τk (sum up to T).
• Covers public good spending
• Covers pension system’s deficit
• Budget closed with τc
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16. Calibration

17. Macroeconomic environment: Polish economy in 1998
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
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18. Macroeconomic environment: Polish economy in 1998
Demography
• Eurostat forecast
• longevity ↑
• fertility ↓
Heterogeneity
• productivity ωκ 10 values based on Structure of Earnings Survey Eurostat
• leisure φκ 4 values based on Structure of Earnings Survey Eurostat
• discount factor δκ 3 values to match wealth Gini and interest rate
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19. Voting

20. 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)
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21. Pure Majority voting
• 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.
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22. Results

23. Voting results: funding is not stable.
Political support for each policy change against status quo.
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24. Rational voters always want to withdraw it.
Political support for each policy change against status quo.
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25. Vote for policy change
Policy 3: both shifts, voting in 2012, consumption equivalent under the veil of ignorance
expressed in % of permanent consumption from the partial funding scenario
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26. Vote for policy change, because of lower taxation...
Decomposition of consumption equivalent via partial equilibrium.
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27. ...regardless of lower pension benefits.
Decomposition of consumption equivalent via partial equilibrium.
tax pensions
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28. No coalition: low productive workers + retirees.
Policy 3: both shifts, voting in 2012, consumption equivalent expressed
in % of permanent consumption from the partial funding scenario
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29. No coalition: patient + workers close to retirement.
Policy 3: both shifts, voting in 2012, consumption equivalent expressed
in % of permanent consumption from the partial funding scenario
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30. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
3. The effect almost disappears when the base is kept constant.
Percentage of population with consumption below 60% of median consumption from the initial ss.
4. The effect almost disappears in the long run.
5. The short run improvement concerns mainly retires.
poverty
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31. Funding more stable if voters care about their children
Support for reducing funded pillar as a function of altruism: voting in 2012,
0 → standard voting,
0.5 → parents care about children’s utility half as much as about their own. 26

32. Conclusions

33. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions
• low productive workers + retirees,
• patient + workers close to retirement .
3. Abolition (almost) does not effect inequalities.
4. If voters are altruistic, funding is more stable.
5. Correct assignment of property rights crucial for stability.
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34. Questions or suggestions?
Thank you!
w: grape.org.pl
t: grape org
f: grape.org
e: o.komada@grape.org.pl
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35. Vote for policy change, because of lower taxation...
Differences in consumption tax relative to baseline (DB→NDC)
expressed in percentage points.
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36. ... due to conversion of explicit into implicit debt...
Differences in debt level relative to baseline (DB→NDC)
expressed in percentage points.
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37. ...regardless of lower pension benefits...
Differences in pension benefits relative to baseline (DB→NDC)
expressed in percentage points.
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38. ... which are lower due to slower accumulation in PAYG pillar
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39. Policy change slightly reduces poverty...
Relative poverty defined as percentage of population with consumption below
60% of median consumption. 33

40. ... the effect (almost) disappears when base is kept constant
Abolute poverty defined as percentage of population with consumption below
60% of median consumption from the initial steady state (stationarized). 34

41. The short-term improvement concerns mainly retirees
Percentage of retirees with consumption below 60% of median from the initial
steady state consumption. 35

42. Demography
Number of 20-years old Mortality rate for
60-years old
⇓ ⇓
rI ↓ rII ↓
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43. Heterogeneity - productivity ω
SES Eurostat 1998, Poland
Productivity ω
Result: 10 values for ω
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44. Heterogeneity - leisure preference φ
SES Eurostat, 1998, Poland
Leisure preference φ
Result: 4 values for φ
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45. 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 state
is 25.5, consistent with Brzezinski (2011)
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46. Reform DB → FDC, immediate cost and delayed gains
Differences in pension system deficit in % of GDP
between DB and FDC scenario
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47. Reform DB → FDC, welfare effect and support
The share of population gaining from introducing FDC in 1999.
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48. Reform DB → FDC, after transition period everybody gains
The share of population gaining from introducing FDC in 1999.
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