We analyze political stability of social security that involves funding. We employ an overlapping generations model with intra-cohort heterogeneity. In this setup we introduce funding, which is efficient in Kaldor-Hicks sense and has majority political support. Subsequently, agents vote on capturing the accumulated pension assets, and replacing it with a pay-as-you-go scheme. We show that even if capturing assets reduces welfare in the long run, the distribution of benefits across cohorts living at the time of voting always yields sufficient political support for capturing assets i.e. unfunding pensions. We explain the mechanisms which yield this counter-intuitive result.

1. Political (In)Stability of Social Security
Oliwia Komada (GRAPE, and WSE)
Krzysztof Makarski (GRAPE, WSE, and NBP)
Joanna Tyrowicz (GRAPE, IAAEU, UW, and IZA)
18th Journ´ees LAGV
Aix-en-Provence, 2019
1

2. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and
Galasso 2005, Kelley 2014, Parlevliet 2017
2

3. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and
Galasso 2005, Kelley 2014, Parlevliet 2017
Conclusion: social security is politically feasible → becomes politically stable.
2

4. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and
Galasso 2005, Kelley 2014, Parlevliet 2017
Conclusion: social security is politically feasible → becomes politically stable.
cohort denies to contribute to PS → no future cohort pays for its pension.
2

5. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and
Galasso 2005, Kelley 2014, Parlevliet 2017
Conclusion: social security is politically feasible → becomes politically stable.
cohort denies to contribute to PS → no future cohort pays for its pension.
But: true for PAYG scheme,
This paper: political (in)stability of funded pillar
2

6. Motivation

7. The rise and fall of the funded pillar
• Many countries introduced at least partial funding.
see Holzman and Stiglitz 2001, Bonoli and Shinkawa 2006, Gruber and Wise 2009
• Reform: DB PAYG → FDC:
• immediate cost and delayed gains,
• welfare improving. eg. Makarski et al. 2017
3

8. Reform DB → FDC: r > g thus funded pillar increase welfare
Welfare gains from introducing FDC in 1999. Consumption equivalent expressed in
% of permanent consumption from the partial funding scenario.
4

9. Literature review - continued
• Despite general welfare gains...
• ... most of these reforms got reversed.
Jarrett (2011); Schwarz et al. (2014)
• (At least) Some of the reversings welfare deteriorating.
Hagemejer et al. (2015)
5

10. Our contribution:
• Understand/explain the reversing of reforms in Central and
Eastern European countries
• Analyzing political economy of funded pillar.
6

11. What we do: consider political stability of the funded pillar
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Receive political support when introduced.
7

12. What we do: consider political stability of the funded pillar
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Receive political support when introduced.
Key question:
Does it eventually become politically stable?
7

13. What we do: consider political stability of the funded pillar
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Receive political support when introduced.
Key question:
Does it eventually become politically stable?
Expectation: With passing of the initial cohorts, welfare gains become dominant.
7

14. What we do: consider political stability of the funded pillar
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Receive political support when introduced.
Key question:
Does it eventually become politically stable?
Expectation: With passing of the initial cohorts, welfare gains become dominant.
If not one should rethink original funding.
7

15. What we do: consider political stability of the funded pillar
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Receive political support when introduced.
Key question:
Does it eventually become politically stable?
Expectation: With passing of the initial cohorts, welfare gains become dominant.
If not one should rethink original funding.
Tool:
Overlapping generations model with intra-cohort heterogeneity
7

16. Results - preview
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
8

17. Results - preview
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
8

18. Results - preview
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
3. Abolition (almost) does not effect inequalities.
8

19. Results - preview
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
3. Abolition (almost) does not effect inequalities.
4. If voters are altruistic, abolition is less probable.
8

20. Table of contents
Motivation
Model
Calibration
Voting
Results
Conclusions
9

21. Model

22. Model: Overlapping Generations
• Households heterogeneous in their preference and productivity.
• Firms: perfectly competitive with Cobb Douglas production.
• Government: uses taxes to finance deficit in the pension system,
public good and services debt.
10

23. Model: Overlapping Generations
• Households heterogeneous in their preference and productivity.
• Firms: perfectly competitive with Cobb Douglas production.
• Government: uses taxes to finance deficit in the pension system,
public good and services debt.
• Pension system: DB → FDC.
• Small open economy: premium risk (Schmitt-Grohe and Uribe (2003)) .
10

24. Households
• Are “born” at age 21 (j = 1) and live up to 100 years (J = 80)
• Face cohort and time specific survival probability πj,t
• Belong to a type κ:
• time discounting δκ
• relative leisure preference 1 − φκ
• productivity level ωκ
• Choose labor supply l endogenously
• Maximize remaining lifetime utility derived from consumption c
and leisure 1 − l
Vj,κ,t(aj,κ,t) = uκ(cj,κ,t+j−1, lj,κ,t+j−1)+δκπj,t+1Vj+1,κ,t+1(aj+1,κ,t+1),
where uκ(cj,κ,t, lj,κ,t) = ln cj,κ,t + φκ ln(1 − lj,κ,t)
• Pay taxes (labor, consumption, capital gains) & contribute to
pensions
11

25. Pension system
Initial steady state: defined benefit
• Exogenous contribution rate τ and an exogenous replacement rate ρ
bDB
¯J,κ,t = ρw¯J−1,t−1ωκl¯J−1,κ,t−1
indexed by payroll growth rate
12

26. Pension system
Initial steady state: defined benefit
• Exogenous contribution rate τ and an exogenous replacement rate ρ
bDB
¯J,κ,t = ρw¯J−1,t−1ωκl¯J−1,κ,t−1
indexed by payroll growth rate
Reform: partially funded defined contribution
• Exogenous contribution rate τ = τPAYG
+ τFF
and actuarially fair individual
accounts
bDC
¯J,κ,t =
”savings”PAYG
¯J,κ,t
+ savingsFF
¯J,κ,t
expected remaining lifetime¯J,t
• Contributions and pensions are indexed by:
• payroll growth rate in PAYG,
• tax free interest rate in funded part.
12

27. Calibration

28. Macroeconomic environment: Polish economy in 1998
Financial market and firms
• global interest rate r∗ = 2%
• risk premium ξ = 0.03 → domestic interest rate
• deprecation d → investment rate 21%
• capital share in GDP α = 0.3
• technological progress zt slows down from 3% to 1.5%, data + AWG projection
Taxation
• labor τl → labor income tax revenues to labor revenue
• consumption τl → VAT revenues over GDP
• capital τk de iure rate 19%
• fiscal rule ρ i D → smooth adjustment of debt and τc
• debt do GDP D/Y = 45%
Pension system
• contribution τ → share of benefits in GDP
• replacement rate ρ → SF deficit
13

29. Macroeconomic environment: Polish economy in 1998
Demography
• Eurostat forecast
• longevity ↑
• fertility ↓
Heterogeneity
• productivity ωκ 10 values based on Structure of Earnings Survey Eurostat
• leisure φκ 4 values based on Structure of Earnings Survey Eurostat
• discount factor δκ 3 values to match wealth Gini and interest rate
14

30. Voting

31. Political economy
What happens within each vote?
• Policy 0 - status quo keep funded pillar as it is
15

32. Political economy
What happens within each vote?
• Policy 0 - status quo keep funded pillar as it is
• Policy 1 - shift of contributions: funded ⇒ PAYG
(Central and Eastern European countries)
15

33. Political economy
What happens within each vote?
• Policy 0 - status quo keep funded pillar as it is
• Policy 1 - shift of contributions: funded ⇒ PAYG
(Central and Eastern European countries)
• Policy 2 - shift of assets
15

34. Political economy
What happens within each vote?
• Policy 0 - status quo keep funded pillar as it is
• Policy 1 - shift of contributions: funded ⇒ PAYG
(Central and Eastern European countries)
• Policy 2 - shift of assets
• Policy 3 - a combination of the two
(ex. Hungary, Poland, Bulgaria, Slovakia)
15

35. Pure Majority voting
• We run these votes in subsequent years independently.
16

36. Pure Majority voting
• We run these votes in subsequent years independently.
• If welfare gains, subcohort is in favor.
16

37. Pure Majority voting
• We run these votes in subsequent years independently.
• If welfare gains, subcohort is in favor.
• Non strategic voting: voters vote according to their preferences.
16

38. Pure Majority voting
• We run these votes in subsequent years independently.
• If welfare gains, subcohort is in favor.
• Non strategic voting: voters vote according to their preferences.
• If a policy gains majority, it is put in place.
16

39. Pure Majority voting
• We run these votes in subsequent years independently.
• If welfare gains, subcohort is in favor.
• Non strategic voting: voters vote according to their preferences.
• If a policy gains majority, it is put in place.
• Order of voting irrelevant (we check that).
Policy 1 against status quo, winner against Policy 2, winner against Policy 3.
16

40. Results

41. Voting results: funding is not stable.
Political support for each policy change against status quo.
17

42. Rational voters always want to withdraw it.
Political support for each policy change against status quo.
18

43. Vote for policy change
Policy 3: both shifts, voting in 2012, consumption equivalent under the veil of ignorance
expressed in % of permanent consumption from the partial funding scenario
19

44. Vote for policy change, because of lower taxation...
Decomposition of consumption equivalent via partial equilibrium.
20

45. ...regardless of lower pension benefits.
Decomposition of consumption equivalent via partial equilibrium.
tax pensions
21

46. No coalition: almost all voters support abolition
Policy 3: both shifts, voting in 2012, consumption equivalent expressed
in % of permanent consumption from the partial funding scenario
22

47. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
poverty
23

48. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
poverty
23

49. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
3. The effect almost disappears when the base is kept constant.
Percentage of population with consumption below 60% of median consumption from the initial ss.
poverty
23

50. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
3. The effect almost disappears when the base is kept constant.
Percentage of population with consumption below 60% of median consumption from the initial ss.
4. The effect almost disappears in the long run.
poverty
23

51. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
3. The effect almost disappears when the base is kept constant.
Percentage of population with consumption below 60% of median consumption from the initial ss.
4. The effect almost disappears in the long run.
5. The short run improvement concerns mainly retires.
poverty
23

52. Funding more stable if voters care about their children
Support for reducing funded pillar as a function of altruism: voting in 2012,
0 → standard voting,
0.5 → parents care about children’s utility half as much as about their own. 24

53. Conclusions

54. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
25

55. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
25

56. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
3. Abolition (almost) does not effect inequalities.
25

57. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
3. Abolition (almost) does not effect inequalities.
4. If voters are altruistic, funding is more stable.
25

58. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
3. Abolition (almost) does not effect inequalities.
4. If voters are altruistic, funding is more stable.
5. Correct assignment of property rights crucial for stability.
25

59. Questions or suggestions?
Thank you!
w: grape.org.pl
t: grape org
f: grape.org
e: o.komada@grape.org.pl
26

60. Vote for policy change, because of lower taxation...
Differences in consumption tax relative to baseline (DB→NDC)
expressed in percentage points.
27

61. ... due to conversion of explicit into implicit debt...
Differences in debt level relative to baseline (DB→NDC)
expressed in percentage points.
28

62. ...regardless of lower pension benefits...
Differences in pension benefits relative to baseline (DB→NDC)
expressed in percentage points.
29

63. ... which are lower due to slower accumulation in PAYG pillar
30

64. Policy change slightly reduces poverty...
Relative poverty defined as percentage of population with consumption below
60% of median consumption. 31

65. ... the effect (almost) disappears when base is kept constant
Abolute poverty defined as percentage of population with consumption below
60% of median consumption from the initial steady state (stationarized). 32

66. The short-term improvement concerns mainly retirees
Percentage of retirees with consumption below 60% of median from the initial
steady state consumption. 33

67. Demography
Number of 20-years old Mortality rate for
60-years old
34

68. Demography
Number of 20-years old Mortality rate for
60-years old
⇓ ⇓
rI ↓ rII ↓
34

69. Heterogeneity - productivity ω
SES Eurostat 1998, Poland
Productivity ω
Result: 10 values for ω
35

70. Heterogeneity - leisure preference φ
SES Eurostat, 1998, Poland
Leisure preference φ
Result: 4 values for φ
36

71. Heterogeneity - discount factors δ
• We calibrate the central value of δ to match the investment rate
• We don’t have the data on stratified mortality rates or wealth
• We split the model population ad hoc into 3 groups
• Their discount factors are (0.98δ, δ, 1.02δ)
• In total we have 120 types within each cohort
• The resulting consumption Gini index in the initial steady state
is 25.5, consistent with Brzezinski (2011)
37

72. Reform DB → FDC, immediate cost and delayed gains
Differences in pension system deficit in % of GDP
between DB and FDC scenario
38

73. Reform DB → FDC, welfare effect and support
The share of population gaining from introducing FDC in 1999.
39

74. Reform DB → FDC, after transition period everybody gains
The share of population gaining from introducing FDC in 1999.
40