Pension Systems in a World with Stagnant Population and Market Inefficiencies: A Comparison

• Název práce v češtině: Penzijní systémy ve světě se stagnující populací a tržními nedokonalostmi: srovnání
• Název v anglickém jazyce: Pension Systems and Economic Growth: the Case of Additional Costs
• Klíčová slova: penze, OLG, simulace
• Klíčová slova anglicky: pension, OLG, simulation
• Akademický rok vypsání: 2012/2013
• Typ práce: diplomová práce
• Jazyk práce: angličtina
• Ústav: Institut ekonomických studií (23-IES)
• Vedoucí / školitel: PhDr. Jaromír Baxa, Ph.D.
• Řešitel: skrytý - zadáno vedoucím/školitelem
• Datum přihlášení: 18.06.2013
• Datum zadání: 18.06.2013
• Datum a čas obhajoby: 25.06.2014 00:00
• Místo konání obhajoby: ies
• Datum odevzdání elektronické podoby: 15.05.2014
• Datum proběhlé obhajoby: 25.06.2014
• Oponenti: PhDr. Natálie Švarcová, Ph.D.

Zásady pro vypracování

1. Introduction
2. Literature Overview
3. Fully funded and pay-as-you-go system description
4. Administrative and other costs related to pension systems
5. Creation of theoretical models
6. Computer Analysis
7. Discussion of the Results
8. Conclusions

Methodology
I plan on using a comprehensive general equilibrium model, perhaps an overlapping generations (OLG) model of endogenous growth, assuming flat-rate tax rate on wage income of contemporary workers to finance pay-as-you-go system and forced regular savings with tax benefits for workers to save for old age in the fully funded pension system. Further, I would include the assumption of volatile capital market returns and low-probability events with excessive impacts on level of returns, administrative and other costs related to private saving via individual accounts and possible substitutes to such approach, individual displeasure from being a part of fully funded scheme (in case certain percentage of people prefers immediate consumption), and possibly other real-world deviations from the assumptions shown in the literature. To obtain simulation results, I would utilize computer programs (e.g. Matlab, Gauss, etc.). Additionally, I would include several different realizations of funded systems and a sensitivity/scenario analysis to see which model would offer the best results. Finally, I would like to propose improvements to both systems that would make people better-off than under the current conditions.

Seznam odborné literatury

Arrau P., Schmidt-Hebbel K. (1993) “Macroeconomic and Intergenerational Welfare Effects of a Transition from Pay-As-You-Goto Fully-Funded Pension Systems", The World Bank
Auerbach A. L.. Kotlikoff L. (1987) “Dynamic Fiscal Policy”. Cambridge University Press.
Corsetti G., Schmidt-Hebbel K. (1995) “Pension reform and growth” World Bank Publications
Marek D. (2007) “Penzijní reforma v České republice: model důchodového systému s kombinovaným financováním”. Disertation Thesis, Charles University in Prague.
Miles D., Cerny A. (2006) “Risk, Return and Portfolio Allocation under Alternative Pension Systems with Incomplete and Imperfect Financial Markets” The Economic Journal 116(511):529-557, Wiley Online Library
Murthi M., Orszag J. M., Orszag P. R. (1999) “Administrative costs under a decentralized approach to individual accounts: lessons from the United Kingdom” conference on “New Ideas about Old Age Security,” World Bank, Citeseer
Modigliani F., Muralidhar A. (2004) “Rethinking pension reform” Cambridge University Press
Sinn H. (2000) “Why a funded pension system is needed and why it is not needed” International Tax and Public Finance 7(4):389-410, Springer

Předběžná náplň práce

The topic of pension system reform has become particularly important lately in Central-East Europe as most of the countries there currently cover their pension expenses from contemporary worker’s taxes and contributions (so called unfunded or pay-as-you-go system). As the average human’s life has been increasing, population size stagnates and the financial crisis has taken its toll, there is a dire need of either substantial change in current system’s parameters or transformation of the pension system into a new better-fitting one because there is simply not enough money from current taxpayers to suffice the retirement expenses. Blake and Mayhew (2006) demonstrate the issue on the example of UK pension system that will, even in case of the most optimistic version of population and economic growth, fail to deliver the current level of pensions by 2030.

It is often argued that substituting state-run pay-as-you-go pension systems by private fully-funded schemes (where people continuously invest throughout their lives to save up money for their own retirement) could raise saving and eliminate factor market distortions, increasing long-term growth and welfare levels. Generally, such reform enables economic agents to transfer resources from formal, i.e. taxed and regulated, to unregulated informal sector while usually offering substantive tax benefits at the same time (Corsetti and Schmidt-Hebbel 1995). The advantages of a funded system against an unfunded system largely depend on its parameters, particularly on the level of state regulation and facilities offered by the financial sector.

The studies of e.g. Arrau and Schmidt-Hebbel (1993) and Auerbach and Kotlikoff (1987) suggest a funded system to increase both output and social welfare in comparison to an unfunded system, with differences growing larger depending on tax or debt financing of the transition period between systems. Corsetti and Schmidt-Hebbel (1995) find that the increase is even larger when assuming endogenous rather than exogenous long-term growth in the economic model. Supporting the previous findings, Marek (2007) shows that even accounting for the transformation costs, the long-term analysis of funded systems offer better results than any parametrical changes in unfunded systems. This is shown also in the work of Miles and Cerny (2006) who analyze the recent pension reform in Japan.

Funded systems have several drawbacks, though, which are often fully or partially omitted in the studies; first, people are heterogeneous with different degrees of myopia – while some of them understand the necessity of contributing for their own pensions, many people would prefer present over future consumption at any time. Second, effectiveness of funded pensions systems relies on stability and returnability of financial sector, primarily capital markets. The recent years have shown us that an assumption of long-term bull markets is questionable at least, and so is the efficiency of lifetime savings into them. Finally, as Murthi et al. (1999) point out, there are substantive costs connected with decentralized approach to individual accounts (i.e. individual contributions into state-run funded pension system); up to 25 percent of the contributions is lost on simple management and administrative costs, depending on the level of state regulation, 15 percent of the total wealth is lost due to individual inability to regularly save a constant amount of money, and up to 10 percent is lost by converting the amount saved into a lifetime annuity upon retirement.

Economic models of pension systems must take these and several other downsides into account to provide correct results, mainly when considering the microeconomic impact of funded systems on private and social welfare. In my thesis, I would compare the fully funded pension system with the pay-as-you-go pension system, while including the additional costs and imperfections in the analysis, unlike the preceding authors, to obtain a more precise information about their impacts on the social welfare and economic performance. I currently plan on including data from the Czech Republic and possibly from other European countries.

Předběžná náplň práce v anglickém jazyce

Research questions:

1. Under the additional assumptions, would fully funded scheme improve social and particularly individual welfare over a pay-as-you-go scheme in the long term, as opposite to the previous findings?

2. Under the additional assumptions, would fully funded scheme improve social and particularly individual welfare over a pay-as-you-go scheme in the long term in case there are no or little parametrical changes in the PAYGO system? (i.e. if it stays in its current state)

3. Would debt financing of the transition between pay-as-you-go and fully funded system result in better economic performance of the country in the long run when compared to tax financing?