Macroeconomic Aspects of Aging and Retirement
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1 CHAPTER 2 Macroeconomic Aspects of Aging and Retirement This book will focus on the role of aging and rising life expectancy in the arena of higher education in present times in particular, and on the promotion of human development/welfare in general. The researcher brings out the importance of pension as a tool of welfare promotion for all categories of workers, thus not excluding the uncovered segments in the informal sector and private companies with no pensions as jobs are largely irregular and temporary in nature. In general, the international forums led by the ILO and trade unions worldwide champion the cause of labor welfare and teachers benefits across the globe. This is important to protect the nobility of the teaching profession, particularly in nations like India where social security promoted by the welfare state is largely missing. This in turn is crucial for nurturing generations of students for aiding human development of the teacher and the taught. Thus, socialist setups were based on societal growth where education and educators have a large role to play since the times of Rousseau and Dr. Radhakrishnan, who believed that the future of the nation is built in the classrooms. Education is a classic case of a noble profession still respected both in the chosen nations and worldwide. The socio-cultural impact on the teaching profession makes the teacher a demigod figure. Contrastingly, education is also classified as a public and merit good that could be responsible for several contentious issues involved in this field. There is also a difference in the social security and pension systems across the world, especially in our chosen cases of France and India. These systems are automatic and emerge from the French socialist welfare state in The Author(s) 2017 G. Nair, Macroeconomic Aspects of Aging and Retirement of College and University Teachers, DOI / _2 7
2 8 G. Nair vogue, while there exists no social insurance system at the macrolevel, albeit some secured pension for the older generation in comparison with the less secure new pension scheme for all organized sector workers, in particular college and university teachers. The macroeconomic aspects of pensions across the world need to be briefly stated to get an overall view of various systems and procedures. In most industrialized nations, people are used to receiving public oldage pension schemes as part of their routine social safety net to the extent that they believe that no alternative system could provide the same. Nevertheless, there are differences in pension systems, modalities of pension calculations, and collection of contributions apart from the varying generosities of pensions and basic conception of the role of the state as compared to the individual in providing for citizen s financial needs in old age differing between neighboring states of the same continent. Examples of this can be cited in the pure Pay-As-You-Go systems (PAYG) in France, Germany, and Italy in contrast to the largely funded systems in Great Britain, the Netherlands, and Switzerland. On the other hand, Germany has an insurance-oriented approach, while the first pillars in the Netherlands and Switzerland provide largely flat pensions. These differences have bearings on the provision of income post-retirement in order to maintain pre-pension lifestyles to a great extent. Two more distant countries like the United States and Chile serve as forerunners of pension reforms, despite their shorter aging histories as compared to Germany that has a huge aging population. These international comparisons have their limits due to socio-cultural impacts well cited in the Chilean case that has different growth realities and yet has introduced radical pension reforms. The historical development of social security systems dates back to the late nineteenth century, with Germany as a precursor with Bismarck s social laws, followed by the Netherlands, Britain, and Switzerland between 1911 and The formal system of public old-age provision was first introduced in the United States in 1935 by President Roosevelt s New Deal, incidentally followed by Chile. All these pension systems were broadened in the 1960s and the 1970s to be cut short in the days of austerity in the 1980s during Reagenomics in the United States and Thatcherism in the United Kingdom. Social security reforms followed in the decades to come at a slower pace due to explosive sizes of the government s budgets and burgeoning debt and its servicing crisis, particularly in Germany despite
3 2 MACROECONOMIC ASPECTS OF AGING AND RETIREMENT 9 being threatened by future demographic developments vis-à-vis other countries (Wise 2009). There has been a general tendency for the lifetime working hours of men to decline in OECD countries throughout this century. This has manifested itself in several ways through an increased duration of schooling leading to delayed entry into the labor force or through reduced weekly hours of work or through an increase in holiday entitlements; and through earlier withdrawals from work in the old age. This decrease in working hours has become possible due to steady growth in hourly labor productivity and an increase in the lifetime working hours of women, many of whom have participated in paid employment and have participated for longer hours. Some women have also returned after childbirth, and many others have continued to work with growing children, thus seeking work life balances. However, the rate of productivity growth has slowed over the last two decades, compared with the rapid rates of the previous three decades. Also, the tendency to leave employment before the normal retirement age (which has itself been reduced in several countries) has increased almost universally. The proportion of older men (aged 55 64) who are working has declined over time in the past two decades. The long-term trend of early retirement from work has been stronger than the cyclical changes. The decline has persisted over times of very different rates of employment growth within countries. It becomes imperative to look forward rather than only backward. Most OECD countries face lower rates of growth if not absolute decline in the size of their labor force due to aging populations. This largely mirrors a projected slowing down in the rate of growth of population of working age. This slowdown on account of the lesser number of young people entering the labor force will eventually impact the structure of labor force, as well as its size. Assuming constant labor force participation rates, the labor force will gradually age. In the medium term, aging of the labor force can be seen as the consequences of today s substantial middle-aged cohorts becoming older and being replaced by considerably smaller young cohorts. Population aging has major implications for the ratio of people of pension age to people of working age, sometimes referred to as the support or old-age dependency ratio. In all OECD countries, it is projected that this ratio will rise, sometimes substantially, by the middle of the next century and in some countries early in that century. These have risen as a proportion of their age group and as their age group becomes
4 10 G. Nair more important within the working-age population, their absolute numbers will also rise. This will lead to an increasing support ratio further (OECD 1995). There exist three pillars of the pension system best defined by the World Bank (1994): the first pillar of the basic flat state insurance scheme; the second supplementary pillar of earnings-related defined benefit plan; and the voluntary third pillar. Apart from the first pillar of state funding, the other two can comprise of public, employer, and/or public minimum pension in Chile individual-based plans. For example, in Germany, the first one is a public pension plan, while the second is a company-based plan and the third plan is of individual measures like life insurance and other forms of private savings. The first pillar is largely homogenous for Germany, the Netherlands, Switzerland, and Great Britain, while it is constituted by social security in the United States. Orszag and Stiglitz (2001) argue that policymakers have too often interpreted the multipillar system as requiring that the second funded pillar entail private management and defined contributions. In contrast, they defend a more expansive view of the second pillar, involving public as well as private management and defined benefit as well as defined contribution funded plans. The third pillar is defined by its voluntary nature, and these plans can be monitored by the company or individual household or, theoretically, even by the state (World Bank 1994). The three pillars for six countries are demonstrated in Table 2.1. The institutions in each pillar vary widely, particularly for Britain. Two dimensions of difference are especially important: firstly, the method of financing, namely PAYG versus the fully funded; secondly, the form of contract, namely defined contributions (DC) versus defined benefits (DB). As shown in Table 2.1, these two dimensions recur throughout the three pillars. In the first pillar, PAYG financing with DB plans dominate. The third pillar is characterized principally through fully funded DC plans (for example, pension savings plans or whole life insurance) with premium paid in fixed monthly installments. Benefits then depend on contributions and the rate of return which could change in the future. The relative size of the three pillars differs widely among the six nations considered. In Germany, the first pillar dominates and almost completely displaces the other two. In Britain, Switzerland, and particularly the Netherlands, the second pillar has central importance. The third pillar is especially important in the USA. Besides the popularity of individual retirement accounts (IRA) and similar instruments, this is largely
5 2 MACROECONOMIC ASPECTS OF AGING AND RETIREMENT 11 Table 2.1 The three pillars Pillars Germany The Netherlands Switzerland Great Britain United States Chile First pillar Public retirement insurance Second pillar Firm pensions (mostly reserve accounts) Third pillar Own savings (mainly whole life insurance), other income Public basic pension Employer-related pensions (mostly DB plans) Own savings (mainly pension funds and whole insurance), other income Public base pension Employer-related pensions (BVG) Own savings (mainly whole life insurance and pension funds), other income Public base pension Public earningsrelated scheme (SERPS); firm pensions; private pensions; stakeholder pensions Own savings (mainly pension funds, supplements to firm pensions), other income Social security Public minimum pension Firm pensions (DB and DC plans); 401 (k) plans Own savings (mainly IRA and Keogh), other income Pension funds (AFP) Own savings (mainly pension funds, supplements to firm pensions), other income Source Borsch-Supan and Miegel (2001)
6 12 G. Nair due to income from work because the employment rate among people aged is much higher in the United States than in European countries (Gruber and Wise 1997). In spite of the difference in share of income in each pillar ranging from as high as 85% in the first pillar in Germany compared to 5 and 10%, respectively, in the second and third pillars to as low as 45% for the first pillar in the USA, followed by 42% in the third pillar and only 13% in the second pillar. The other cases have high first pillar contribution, followed by second and third pillars. Despite these differences, there is an astounding similarity in the overall replacement rates as high as 70 86% being highest for Germany, United States, and the Netherlands. This finding suggests a strong substitution among the three pillars that is for a strong adaptation of the private individual and employer-based old-age provision to the public pension system. One discovers that in Germany, the total contribution rate of almost 28% of gross earnings is considerably higher than the direct contribution rate to the public pension system because more than 8% of gross income is levied indirectly through general taxation. German employees pay especially higher contribution rates despite receiving the same pension levels as their Dutch colleagues. The replacement rate is nearly identical in Germany (85%), the Netherlands (86%), Switzerland (80%), and the United States (85%), but lower in Great Britain (72%). This suggests a strong substitution among the three pillars that is for a strong adaptation of the private individual and employer-based old-age provision to the public pension system. Of particular importance is the displacement effect of public pension systems on private savings. Econometric studies based on time series in Germany, the Netherlands, and the USA confirm that the PAYG pension systems have in fact reduced the need for private savings and thus the total stock of capital. With respect to contribution rates it bears noting that the international comparisons may be misleading. This is because the financing of old-age pension system varies from country to country depending in various degrees on contributions expressly devoted to the public pension system and on general tax revenues. Along with the contribution rate and the level of benefits, the retirement age is the third main system parameter. It is particularly noteworthy that employees in European countries can attain earlier retirement ages than in the USA, as the early retirement rules in Europe are especially generous and frequently present an explicit incentive to retire
7 2 MACROECONOMIC ASPECTS OF AGING AND RETIREMENT 13 earlier than in an actuarial fair pension system. There is no evidence that early retirement has freed up jobs. Generous opportunities for early retirement are also those with the highest unemployment rates. While cause and effect cannot be inferred from such simple correlations, by the same token, we do not have evidence for a causal effect from early retirement to low unemployment. The populace in Germany and the USA are most dissatisfied with their national systems, while the Swiss and the Dutch are quite content. Thus, the two relatively large PAYG systems suffer from a shrinking popular support, while workers in countries that have mixed PAYG-funded systems appear to be more content. It is interesting to know what the future holds. All the six countries covered here face a common problem aging populations, especially from 2010 onwards. Table 2.2 shows the development of dependency ratios, which is the demographic parameter for old-age pension systems. The proportion of people of retirement age of 60 and above to those in their working years of years of age has climbed dramatically in all six countries. The effects of population aging on the PAYG system have been the subject of much attention since the mid-1980s (OECD 1988; World Bank 1994). One notices that this aging process is especially marked in Germany, particularly in comparison with the USA. According to all current demographic projections, until 2040 Germany will have the highest proportion of older citizens, particularly in relation to the number of citizens of employment age. Later, from about 2050 onwards, Japan will have this dangerous distinction. The crucial question is whether the six different systems of old-age provision are similarly well equipped to deal with this problem after all, despite many demographic and political differences between the Table 2.2 Population aging: demographic dependency ratios (%) Years Germany Switzerland The Netherlands Great Britain United States Chile Source United States Bureau of Census, International Data Base
8 14 G. Nair countries, they present surprisingly similar pension income tables with roughly comparable contribution rates. This is not the case. In countries with a pronounced PAYG system (Germany being the main example), the expenditures financed by the contributions and taxes represent only expenditures for the current generation of retirees. Future expenditures will climb much more steeply than in those where pensions are partially funded because in the latter case, savings have already been accumulated to finance various members of the baby boom generation. This brings us to the perennial discussion about the pros and cons of PAYG versus fully funded pensions. In PAYG, the contributions of those currently employed are used extensively to finance the benefits of those currently drawing pensions. Thus, expenditures always equal income: neither is there a reserve built up from excess income, nor are debts incurred due to excess expenditure. Contributors Gross Earnings Contribution Rate = Retirees Pension Benefits Receipts = Expenditures. On the left side are the receipts of the PAYG system, where we combine direct and indirect contributions for simplicity in one contribution base (average gross income) and one resulting average contribution rate. To the right are the expenditures of the PAYG system, that is, average benefits per pensioner. As long as receipts equal expenditures, the contribution rate must be the product of the gross pension level and the dependency ratio: Contribution Rate = (Pensioners/Contributors) (Pension Benefits/Gross Earnings) = System Dependency Ratio Gross Pension Level. In a PAYG system, the relationship between the contribution rate and the pension level can thus in no way be freely chosen by the political process; rather it is dictated by the dependency ratio. This is determined by two developments of population aging and decreasing employment rate. Particularly, the decreasing retirement age has simultaneously decreased the proportion of population that pays contributions to the PAYG system and increased the number of beneficiaries from PAYG system, so that the system dependency ratio (pensioners by contributing workers)
9 2 MACROECONOMIC ASPECTS OF AGING AND RETIREMENT 15 has risen more steeply than the demographic dependency ratio (persons aged 60 plus by persons aged 20 59). The increase in the demographic dependency ratio as depicted in Table 2.2 therefore greatly restricts the possibilities for a political solution within the PAYG system. If one does not increase the contribution rate in proportion to the rise in the old-age burden, either pension levels must drop or employment rates must rise. Both options are politically problematic. A reduction in benefits is highly unpopular politically, while an increase in employment rates cannot be simply decreed. The only direct institutional lever is raising of the retirement age, perhaps by raising the so-called normal retirement age and/or by restricting the various early retirement and pre-retirement rules. One cannot avoid noticing that discussions in Germany and France are leading to a decrease rather than an increase in the retirement age. Also raising the retirement age corresponds to paying longer and benefitting shorter, thus for all political purposes a decrease in the value of pension benefits. The greatly restricted possibilities for a solution within the PAYG system are clearly brought out in national comparisons. Additional flexibility has been attained in several countries through pre-financing of pensions, that is, by using the only mechanisms that can spread the demographic burden over a longer term. The five countries in this study demonstrate how diverse these funding mechanisms can be. They range from an almost total state-regulated fully funded system in Chile to mixed systems, some in which the employer plays a central role like the Netherlands and Switzerland and others in which private savings contracts have become popular like the USA. In the next chapter, we shall focus on aging and retirement in France followed by the Indian case in the subsequent chapter, particularly in case of college and university teachers.
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