Is the retirement age increase in Poland still necessary given the 1999 reform of the pension system? EmerytGRAPE analysis with the use of OLG model answers this question.

1. Does social security reform reduce gains from higher retirement age?
Does social security reform reduce gains from higher retirement
age?
(with Joanna Tyrowicz and Krzysztof Makarski)
Karolina Goraus
PhD Candidate
University of Warsaw
EEA-ESEM Congress
28 August 2014

2. Does social security reform reduce gains from higher retirement age?
Table of contents
1 Motivation and insights from literature
2 Model setup
3 Calibration
4 Baseline and reform scenarios
5 Results
Welfare
Macroeconomic eects

3. Does social security reform reduce gains from higher retirement age?
Motivation and insights from literature
Broad picture
A scienti

4. c project at the University of Warsaw
OLG modeling of the pension system reform in Poland
Polish pension reform of 1999
the original system was a DB PAYG scheme
then introduction of a three pillar system
1 notional de

5. ned contribution (NDC) scheme ) managed by Social
Insurance Fund (SIF)
2 fully funded DC (FDC) scheme ) managed by Open Pension Funds (OPFs)
3 voluntary pension schemes

6. Does social security reform reduce gains from higher retirement age?
Motivation and insights from literature
Motivation
Current problems with pension systems:
increasing old-age dependency ratio
majority of pension systems fail to assure actuarial fairness
in most countries people tend to retire as early as legally allowed
Typical reform proposals
switching to individual accounts' systems
raising the social security contributions per worker
introducing general

7. scal contraction
increasing minimum eligibility retirement age (MERA)

8. Does social security reform reduce gains from higher retirement age?
Motivation and insights from literature
Literature review
Two streams of literature:
1 Answering the question about optimal retirement age (Gruber and Wise
(2007), Galasso (2008), Heijdra and Romp (2009))
2 Comparing dierent pensions system reforms: increasing retirement age
vs. cut in bene

9. ts/privatization of the system/... (Auerbach et al. (1989),
Hviding and Marette (1998), Fehr (2000), Boersch-Supan and Ludwig
(2010), Vogel et al. (2012))
Fehr (2000)
Macroeconomic eects of retirement age increase may depend on the existing
relation between contributions and bene

10. ts
Remaining gaps in the literature
We increase retirement age...
how the macroeconomic eects dier between various pension systems?
what happens to the welfare of dierent generations?

11. Does social security reform reduce gains from higher retirement age?
Motivation and insights from literature
Goals and expectations
Goal
Analyse macroeconomic and welfare implications of retirement age increase
under DB (de

12. ned bene

13. t), NDC (notional de

14. ned contribution), and FDC
(partially funded de

15. ned contribution) systems
Tool
OLG model with

16. rst steady state calibrated to re
ect Polish economy in 1999
Expectations
under DB: leisure #, taxes #, welfare?
under NDC: leisure #, pensions , welfare?
under FDC: leisure #, pensions , welfare?
What else makes the results less predictable? ! Labor supply adjustments,
general equilibrium eects...

17. Does social security reform reduce gains from higher retirement age?
Model setup
1 Motivation and insights from literature
2 Model setup
3 Calibration
4 Baseline and reform scenarios
5 Results
Welfare
Macroeconomic eects

18. Does social security reform reduce gains from higher retirement age?
Model setup
Model structure - consumer I
is born at age J = 20 and lives up to J = 100
optimizes lifetime utility derived from leisure and consumption:
U0 =
XJ
j=1
j1j;t1+juj (cj;t1+j ; lj;t1+j ) (1)
where is the time discounting factor and j;t denotes the unconditional
probability of a household of having survived from birth to age j at time
period t (accidental bequests are spreaded equally to all cohorts).
The instantaneous utility function:
u(c; l) = log(c) + (1 ) log(1 l ), (2)

19. Does social security reform reduce gains from higher retirement age?
Model setup
Model structure - consumer II
is paid a market clearing wage for labour supplied and receives market
clearing interest on private savings
is free to choose how much to work, but only until retirement age J
(forced to retire)
The budget constraint of agent j in period t is given by:
(1 + c;t )cj;t + sj;t + t = (1 l;t)(1
j;t )wj;t lj;t labor income (3)
+ (1 + rt(1 k;t ))sj;t1 capital income
+ (1 l;t )pj;t + bj;t pensions and bequests

20. Does social security reform reduce gains from higher retirement age?
Model setup
Model structure - producer
Firms solve the following problem:
max
(Yt ;Kt ;Lt )
Yt wtLt (r k
t + d)Kt (4)
t (ztLt )1
s.t. Yt = K
Standard

21. rm optimization implies:
t (ztLt ) (there might be
the average market wage wt = (1 )K
heterogeneity between cohorts due to age-speci

22. c productivity,
wj;t = !jwt )
interest rate r k
t (ztLt )1 d, where d stands for depreciation
t = K1

23. Does social security reform reduce gains from higher retirement age?
Model setup
Model structure - government
collects social security contributions and pays out pensions of DB and
NDC system
subsidyt =
t wtLt
XJ
j= J
pj;tj;tNtj (5)
collects taxes on earnings, interest and consumption + spends GDP

24. xed amount
of money on unproductive (but necessary) activities + services debt
Tt = l;t
(1
t )wtLt +
XJ
j= Jt
p
j;tj;tNtj
+
c;tct +k;t rt sj;t1
XJ
j=1
j;tNtj :
(6)
Gt + subsidy
t + rtDt1 = Tt + (Dt Dt1) + t
XJ
j=1
j;tNtj : (7)
wants to maintain long run debt/GDP ratio

25. xed

26. Does social security reform reduce gains from higher retirement age?
Calibration
1 Motivation and insights from literature
2 Model setup
3 Calibration
4 Baseline and reform scenarios
5 Results
Welfare
Macroeconomic eects

27. Does social security reform reduce gains from higher retirement age?
Calibration
Calibration to replicate 1999 economy
Preference for leisure () chosen to match participation rate of 56.8%
Impatience () chosen to match interest rate of 7.4%
Replacement rate () chosen to match bene

28. ts/GDP ratio of 5%
Contributions rate ( ) chosen to match SIF de

29. cit/GDP ratio of 0.8%
Labor income tax (l ) set to 11% to match PIT/GDP ratio
Consumption tax (l ) set to match VAT/GDP ratio
Capital tax set de iure = de facto

30. Does social security reform reduce gains from higher retirement age?
Calibration
Age-productivity pro

31. le -
at or ...?

32. Does social security reform reduce gains from higher retirement age?
Calibration
Final parameters
Table: Calibrated parameters
Age-productivity pro

33. le
! - D97 ! = 1
capital share 0.31 0.31
l labor tax 0.11 0.11
preference for leisure 0.578 0.526
discounting rate 0.998 0.979
d depreciation rate 0.045 0.045
total soc. security contr. 0.060 0.060
replacement rate 0.138 0.227
resulting
kt investment rate 21 21
r interest rate 7.4 7.4
Note: D97 denotes calibration with productivity pro

34. le according to Deaton
(1997) decomposition, ! = 1 denotes
at age productivity pro

35. le.

36. Does social security reform reduce gains from higher retirement age?
Calibration
Exogenous processes in the model
Demographics
Demographic projection until 2060, after that 80 years, and after that
new steady state
No of births (j=20) - from the projection, constant afterwards
Mortality rates - from the projection, constant afterwards
Productivity growth
Labor augmenting productivity parameter
Data historically, projection from AWG, after that new steady state,
1.7%

37. Does social security reform reduce gains from higher retirement age?
Calibration
No of 20-year-olds arriving in the model in each period (left) and mortality
rates across time for a selected cohort
Source: EUROSTAT demographic forecast until 2060

38. Does social security reform reduce gains from higher retirement age?
Calibration
Productivity growth

39. Does social security reform reduce gains from higher retirement age?
Baseline and reform scenarios
1 Motivation and insights from literature
2 Model setup
3 Calibration
4 Baseline and reform scenarios
5 Results
Welfare
Macroeconomic eects

40. Does social security reform reduce gains from higher retirement age?
Baseline and reform scenarios
Reform of the systems
Three experiments:
1 DB with
at retirement age ! DB with increasing retirement age
2 NDC with
at retirement age ! NDC with increasing retirement age
3 FDC with
at retirement age ! FDC with increasing retirement age
What is
at and what is increasing retirement age?
at: 60 years old increasing:

41. Does social security reform reduce gains from higher retirement age?
Baseline and reform scenarios
Pension systems
De

42. ned Bene

43. t ! constructed by imposing a mandatory exogenous
contribution rate and an exogenous replacement rate
pDB
j;t =
(
twj1;t1; for j = Jt
DB
j1;t1; for j Jt
t pDB
(8)
De

44. ned Contribution ! constructed by imposing a mandatory exogenous
contribution rate and actuarially fair individual accounts
Notional
pNDC
j;t =
8
:
P Jt1
i=1
h
i
s=1(1+r I
ti+s1)
i
NDC
Jti;ti
w Jti;ti l Jti;ti
QJ
s= Jt
s;t
; for j = Jt
j1;t1; for j Jt
DB
t pNDC
(9)
Funded
pFDC
j;t =
8
:
P Jt1
i=1
h
i
s=1(1+rti+s1)
i
FDC
Jti;ti
w Jti;ti l Jti;ti
QJ
s= Jt
s;t
; for j = Jt
j1;t1; for j Jt
(1 + rt )pFDC
(10)

45. Does social security reform reduce gains from higher retirement age?
Baseline and reform scenarios
Welfare analysis - like Nishiyama Smetters (2007)
What happens within each experiment?
1 Run the no policy change scenario ) baseline
2 Run the policy change scenario ) reform
3 For each cohort compare utility, compensate the losers from the winners
4 If net eect positive ) reform ecient

46. Does social security reform reduce gains from higher retirement age?
Results
1 Motivation and insights from literature
2 Model setup
3 Calibration
4 Baseline and reform scenarios
5 Results
Welfare
Macroeconomic eects

47. Does social security reform reduce gains from higher retirement age?
Results
Welfare
Is the reform ecient?
Net consumption equivalent from extending the retirement age:
Age-productivity pro

48. le DB transition to NDC transition to FDC
Deaton (1997) 9.88% 11.31% 11.81%
at 3.70% 4.41% 4.70%
Detailed cohort eects of extending the retirement age (age-productivity
pro

49. le according to Deaton, 1997):

50. Does social security reform reduce gains from higher retirement age?
Results
Macroeconomic eects
Aggregated labor supply (in mio of individuals)

51. Does social security reform reduce gains from higher retirement age?
Results
Macroeconomic eects
Labor supply in the

52. nal steady state
Average and aggregate changes
Labor supply Labor supply with MERA increase
(no reform) j 60 j 60 Total
Average Average Aggregate Average Aggregate
(baseline=100%) (baseline=100%)
DB 63.2% 59.6% 94.4% 71.8% 113.7%
NDC 62.0% 58.8% 94.8% 72.3% 114.7%
FDC 61.7% 59.0% 95.5% 72.2% 115.4%
Labor supply over the life cycle

53. Does social security reform reduce gains from higher retirement age?
Results
Macroeconomic eects
Capital (per eective unit of labor)

54. Does social security reform reduce gains from higher retirement age?
Results
Macroeconomic eects
Pension system de

55. cit (as % of GDP)

56. Does social security reform reduce gains from higher retirement age?
Results
Macroeconomic eects
Discounted total pension payments per retiree (stationarized)

57. Does social security reform reduce gains from higher retirement age?
Results
Macroeconomic eects
Lump-sum tax rate (extent of

58. scal adjustment for long term stable
debt/GDP ratio)

59. Does social security reform reduce gains from higher retirement age?
Results
Macroeconomic eects
Conclusions
extending the retirement age is universally welfare improving
this eect is strongly enhanced if productivity is increasing in age
agents adjust downwards the average labor supply, but the
aggregated supply increases
lower savings imply decrease in per capita capital and output

60. Does social security reform reduce gains from higher retirement age?
Results
Macroeconomic eects
Questions or suggestions?
Thank you!