Political (In)Stability of Social Security Reform

Motivation Model Results

Political (In)Stability of Social Security Reformwith Krzysztof Makarski

Joanna Tyrowicz

Faculty of Economics, University of WarsawEconomic Institute, National Bank of Poland

NIESR - 2015 - London

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Motivation

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Literature review

A wave of reforms: Holzman and Stiglitz (2001), Bonoli and Shikinawa (2006),Gruber and Wise (2009)Most of these reforms somehow reversed: Jarrett (2011)(At least) Some of the reversings welfare deteriorating: Hagemejer et al (2015)

Political economy of pension systems: will the reform be implementedCooley and Soares (1999), Galasso and Profeta (2002), subsequent literaturereviewed by de Waque (2005)extant literature on whether or not privatization is in fact welfare enhancing:Conesa and Kruger (1999), Nishiyama and Smetters (2007), Fehr (2009)

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Literature review

A wave of reforms: Holzman and Stiglitz (2001), Bonoli and Shikinawa (2006),Gruber and Wise (2009)Most of these reforms somehow reversed: Jarrett (2011)(At least) Some of the reversings welfare deteriorating: Hagemejer et al (2015)Political economy of pension systems: will the reform be implemented

Cooley and Soares (1999), Galasso and Profeta (2002), subsequent literaturereviewed by de Waque (2005)extant literature on whether or not privatization is in fact welfare enhancing:Conesa and Kruger (1999), Nishiyama and Smetters (2007), Fehr (2009)

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Goals and expectations

GoalSuppose there already is a reform, with stable long-term gains, but delayed: does iteventually become politically stable?

Expectations

With passing of the initially old cohorts, welfare gains become majoritarianIntend to understand/explain the reversing of reforms

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Outline

1 Motivation

2 Model

3 Results

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Agents

”born” at age 20 (j = 1) and live up to 100 years (J = 80)subject to time and cohort dependent survival probability πchoose labor supply l endogenously until exogenous retirement age J̄ (forced toretire)

optimize remaining lifetime utility derived from leisure 1− l and consumption c

Uj,t =J−j∑s=0

[δsπj+s,t+sπj,t

u(cj+s,t+s, lj+s,t+s)]

with

u(c, l) = log(cφ(1− l)1−φ)

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Agents

receive market clearing wage for laborreceive market clearing interest rate on private savingsreceive pension income + unintentional bequestspay taxes

Subject to the budget constraint

(1 + τ ct )cj,t + sj,t = (1− τ lt )(1− τ ι)wj,tlj,t ← labor income

+ (1 + (1− τkt )rt)sj−1,t−1 ← capital income

+ (1− τ lt )pιj,t ← pension income+ bj,t ← bequests−Υt ← lump-sum tax

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Firms

Perfectly competitive representative firmStandard Cobb-Douglas production function

Yt = Kαt (ztLt)1−α

Profit maximization implies

wt = zt(1− α)kαtrt = αkα−1

t − d

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Government

collects taxes on earnings, interest and consumption (sum up to T )spends GDP fixed share of GDP on government consumption Gcollects social security contributions and pays out pensionsof DB and NDC system

subsidyt = τ ιJ̄−1∑j=1

wj,tlj,t −J∑j=J̄

pj,tNj,t

services debt D and maintains debt/GDP ratio fixedlump-sum taxes Υ adjust to satisfy the govt budget constraint

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

J∑j=1

Nj,t

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Pension system

Initial steady state: defined benefit

Exogenous contribution rate τ and an exogenous replacement rate ρ

pDBJ̄,t = ρwJ̄−1,t−1lJ̄−1,t−1

indexed by 25% of total payroll growth

Reform: partially funded defined contribution

Exogenous contribution rate τ and actuarially fair individual accounts

pDCJ̄,t =accumulated sum of contributionsJ̄,t

expected remaining lifetimeJ̄,t

In PAYG: Contributions and pensions are indexed by 25% of total payroll growthIn funded part: return on capital, tax free

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Political economy

What happens within each vote?

Policy 1 - shift of contributions: funded ⇒ PAYGPolicy 2 - shift of pensions: annuity ⇒ benefitPolicy 3 - a combination of the two

We run these votes in subsequent yearsIf consumption equivalent positive, a cohort is in favorIf a policy gains majority, it is put in placeOrder of voting: Policy 1 vs status quo → winner vs Policy 2 → winner vsPolicy 3(tested for transitivity of preferences, holds)

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Voting results

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Why are reforms never stable?

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Pension benefits (year 14 and year 44)

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Debt share (year 14 and year 44)

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Taxes (year 14 and year 44)

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Shift of pensions becomes unviable quite fast

Winning scenarios

Voting year Winning scenario2014 32024 32034 12044 12054 12064 12074 12084 12154 1

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Conclusions

We allow subsequent votes of pension system reform reversion to seek when dothey become politicall stableThe votes concern scenarios with long-run welfare deteriorating policiesWe find that

funded is never preferred to PAYGannuity becomes preferred to benefit

Our model has no political risk, business cycle, etc.Pension reform reversion is preferred always if it reduces taxes for the livingcohorts

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Thank you for your attention!

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Political (In)Stability of Social Security Reform

Economy & Finance

Transcript of Political (In)Stability of Social Security Reform