Analyzing the Efficiency of Pension Reform: The Role of the Welfare Effects of Fiscal Closures

Abstract

Replacing the pay-as-you-go defined benefit (PAYG DB) system with an at least partially funded defined contribution (DC) system generates fiscal costs that need financing. The fiscal closures at hand differ by the channel and the extent of distortions. The main contribution of this paper is a thorough comparison of the welfare effects of the various fiscal closures of the pension system reform. In addition, we decompose the welfare effects to the parts attributable to changing the way pensions are financed (PAYG ⇒ prefunding) and to changing the way pensions are computed (DB ⇒ DC). We show that depending on the fiscal closure, the welfare effects differ substantially for the same pension system reform. The financing of the the pension system gap with public debt allows more intergenerational redistribution.

Reforming retirement age in DB and DC pension systems in an aging OLG economy with heterogenous agents

“…Higher welfare gains under transition to DC than under the DB system suggest a positive reinforcement between the systemic and retirement age reform. The extent of the welfare gains is slightly higher than the effects of a systemic reform, as reported for a similar calibration and economy in Makarski et al (2016 Clearly, the channels through which gains materialize differ between the DB system and the transition to a DC system (see Fig. 3).…”

“…15 Clearly, this statement does not imply that the gains are additive; the baseline scenarios differ for Makarski et al (2016) and this study. 16 In Auerbach et al (1989), contribution rates balance the pension system, which implies that cohorts just prior to retirement have to work longer and see only a small gain in lowered τ .…”

“…7 The details of this reform and modeling of the initial capital are similar to Makarski et al (2016). 8 Depending on the period over which the average is taken, it ranges from 23.1 % for 2 years before-after span and 24.1 % for a 1-year before-after span.…”

The Political (In)stability of Funded Pension Systems

“…2 A study for Poland shows that these welfare gains can be sizable, on the order of 2-3% of lifetime consumption (Makarski et al 2017). Without exception these reforms honored the pension obligations to the transition cohorts, i.e.…”

“…5 There, the key policy challenge is the appropriate timing of the introduction of funding, because the working cohorts have to finance the pensions of both their predecessors and themselves (Huang et al 1997). This double burden may be ameliorated by deploying public debt to smooth the costs of the reform across cohorts (Belan and Pestieau 1999, Song et al 2015, Makarski et al 2017. This also matters from a political perspective, because a transfer of future welfare gains helps to compensate the current losses of the transition cohorts that need to support the reform (Conesa and Garriga 2008, compare various ways to introduce a funded pillar with political support).…”