Ph.D. Dissertation (2003)
Summary
In most industrialised countries, old-age security is predominantly organised as unfunded or pay-as-you-go pension systems. Members of the young generation pay contributions which finance the pension benefits of the retirees. Because of this intergenerational dependency, the ratio of young to old is of particular importance.
Two developments are expected to put particular pressure on unfunded pension systems as they both alter this ratio: ageing of the population and labour mobility. Ageing as projected for most industrialised countries influences the ratio of contributors to retirees in a twofold way. On the one hand, fertility rates are low. On the other hand, life expectancies are high and even increasing. This leads to a smaller number of young individuals who face a growing number of old individuals. Labour migration intensifies this development if the young react to this growing imbalance by migrating.
In this thesis, these two developments – ageing and migration – are discussed and their consequences for publicly provided, unfunded pension systems are analysed.
In contrast to funded systems, unfunded pension systems are based on redistribution across generations. The introductory generations benefit at the expense of later generations. The pension benefits which the first generations receive without having ever (much) contributed constitute an implicit debt. The following generations must service this debt with an implicit tax, i.e. only one part of their contributions can be regarded as savings whereas the other part is lost from the point of view of the contributors. But despite the therefore lower internal rate of return compared to the market rate of return, unfunded pension systems are not inefficient. They do not waste resources. This implies that a partial or complete transition towards a funded system does not lead to any efficiency gains which could be used to compensate the transitory generations. The implicit debt is given by the introductory gains and must be services with implicit or explicit taxes.
Questions arise with respect to the optimal allocation of this burden across the life cycle of individuals and across generations with respect to efficiency and distribution. In this thesis, these questions are taken up for different cases of political power distribution and different mobility scenarios.
The starting point is whether there are still efficiency increasing reforms which affect individuals, not generations. Even though the implicit taxes which a member of a generation has to pay are given, the taxes might not be optimally distributed over the individual life cycle, thus leading to distortions of the labour-leisure decision. In order to evaluate the optimality, the path of implicit taxes is related to the path of labour supply elasticities. It can be shown for Germany that it is possible to improve efficiency by differentiating implicit taxes across age groups on the basis of labour elasticities, thus reducing the distortions of the labour supply. From an intrapersonal perspective, there are thus ways for a Pareto improvement.
For all reform proposals, feasibility considerations have to be taken into account. In a majoritarian voting system, a reform is feasible if the majority of voters incurs no loss in terms of utility. If a reform makes no voter of any generation worse off, the majority is ensured. A reform like to the one just discussed, which does not change the intergenerational distribution of implicit taxes, but increases efficiency intrapersonally, is therefore feasible. If, however, a reform involves a change of the intergenerational distribution of implicit taxes benefiting some generations and hurting others, feasibility is no longer guaranteed.
In order to be able to draw conclusions about the feasibility of reforms which initiate a partial transition to a funded system, it is appropriate to identify the winners and losers. For this, a specific reform is considered which results in the reduction of contributions and pension benefits in a way that respects the budget constraint of the unfunded pension system. The implicit taxes are thus lowered for the young, who still have to contribute for many years before receiving benefits, while they are increased for those, who are close to retirement or already retired. The young will thus be in favour of the reform and the old against. Ageing of the population affects the numbers of the supporters and the opponents. The question is whether the decisive (median) voter belongs to the supporters of the reform and, if yes, for how long, given the development of society towards a gerontocracy. In Germany, the young will have the majority until 2012, while France becomes a gerontocracy in 2014 and Italy in 2006.
The analysis thus focuses on the case where the young cannot react in any way – except by voting. We thus exclude any form of exit option. If the young have lost the majority and no constitutional safeguards have been established, the unfunded pension system might then expand uncontrollably. This strict assumption allows us to determine the chance for success of reforms against the background of gerontocracy alone and to identify the point in time when reforms are no longer feasible. In the following, we abandon this assumption and explicitly allow for the possibility that the young can react by emigrating. The young have then either a conditional or an unconditional exit option, even after they have lost the majority.
Conditional mobility is the case where the (potential) mobility of the young can be controlled by the old. The young are thus mobile conditional on the old granting them mobility. The old do this strategically in order to commit to a certain level of redistributive taxation. The young invest in human capital only if they are able to react to deviations from this level by emigrating which induces the old to choose the degree of mobility optimally. Even though no one emigrates in equilibrium, the exit option prevents the young generation from being exploited. By balancing exit option and gerontocratic power, an intergenerationally redistributive system need then neither strongly expand nor completely erode.
If mobility is however unconditional, i.e. independent from actions of the old generation, mobility of the young might endanger the sustainability of national unfunded pension systems. Reactions of the systems must therefore be expected as an attempt to hold back domestic contributors and to attract foreign contributors. Growing integration of the Member States of the European Union can be expected to intensify this competition.
In order to analyse this case in more detail, different mobility scenarios within the European Union and the consequences for nationally organised pension systems are looked at. It is straightforward to conclude that mobility of the young might result in an erosion of unfunded pension systems. The question which must be addressed concerns the optimal allocation of responsibilities and the optimal degree of harmonisation of old-age security to avoid this potential “race to the bottom” while ensuring an efficient allocation of labour. If pension systems are not sufficiently harmonised, the principle of free movement of labour threatens intergenerationally redistributive activities while at the same time the taxes implicit in unfunded pension systems potentially distorts the allocation of labour. It can be shown that in order to prevent this from happening, a uniform European pension system is not necessary. All that is needed for the relevant mobility scenarios are co-ordinated or equalised contribution rates. The European Union must then guarantee the binding nature of the harmonisation rules agreed upon by the Member States. At present, however, the Member States are far from conceding such fundamental responsibilities to the European level.
To sum up, the thesis analyses the consequences of the demographic development for unfunded pension systems. If the status quo is maintained, old-age security will face a crisis in the next few decades. But neither a large expansion nor a complete erosion is inevitable. In order to mitigate the crisis, fundamental reforms must be initiated which loosen the intergenerational dependencies and guarantee a fair sharing of the burden. This would reduce the pressure on unfunded pension systems stemming from ageing and migration.
Contact
Silke
Uebelmesser
University of Munich, Department of Economics, CES,
Schackstr. 4, 80539 Munich, Germany,
eMail: uebelmesser@lmu.de
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