We analyze the political stability of social security reforms that involve a funded pillar (a.k.a.privatizations of social security). We employ an overlapping generations model with intracohort heterogeneity. The (partial) privatization of social security is efficient in Kaldor-Hickssense and has political support. Subsequently, agents vote on abolishing the funded pillar, capturing the accumulated pension assets, and replacing it with the pay-as-you-go scheme,i.e. \unprivatizing" the pension system. We show that even if such reform reduces welfare in the long run, the distribution of benefits across cohorts along the transition path implies that \unprivatizing" social security is always politically preferred. We conclude that the correct assignment of property rights over retirement assets may be of crucial importance for determining the stability of pensions systems with a funded pillar.

1. Political (in)stability
of pension system reforma
Oliwia Komada (WSE and GRAPE)
Krzysztof Makarski (NBP, WSE and GRAPE)
Joanna Tyrowicz (IAAEU, UW, GRAPE and IZA)
NBP Summer Workshop
a
The views presented herein are those of the authors and not necessairly those
of NBP 1

2. Question
Is pension system privatization politically stable?
1. Reform DB → partially FDC, like Poland 1999
2. Possibly Hicks-Kaldor efficient,
3. but with substantial costs today and gains only in the future.
4. Key: Is successfully introduced reform going to be stable?
5. If not one should rethink original privatization.
2

3. Reform DB → FDC immediate cost and delayed gains
Differences in pension system deficit in % of GDP
between DB and FDC scenario
3

4. Motivation: Reform DB → FDC, welfare effect and support
The share of population gaining from introducing FDC in 1999.
4

5. Reform DB → FDC, after transition period everybody gains
The share of population gaining from introducing FDC in 1999.
5

6. Motivation: BUT
A number of countries reverted the privatization of the pension system:
Hungary, Poland, Lithuania, Latvia, Slovakia, Czech Republic,
Romania, Bulgaria (Jarrett, 2011; Schwarz et al., 2014)
6

7. Literature review
1. A wave of reforms
Holzman and Stiglitz (2001), Bonoli and Shikinawa (2006), Gruber and Wise (2009)
2. Reform = introduce some notion of funding into the system
3. Whether or not privatization is in fact welfare enhancing
Conesa and Kruger (1999), Nishiyama and Smetters (2007), Fehr (2009)
4. Despite general welfare gains...
5. ... most of these reforms got reversed Jarrett (2011); Schwarz et al. (2014)
6. Some of the reversions welfare deteriorating: Hagemejer, Makarski & Tyrowicz
(2015)
7. Political economy of pension systems reforms
• will the reform be implemented
Cooley and Soares (1999a)
• coalition between low productive workers and retirees sustain
PAYGO systems Cooley and Soares (1999)
• subsequent literature reviewed by de Waque (2005) or Galasso and
Profeta (2002) 7

8. Goals and expectations
Goal
Suppose there already is a reform, with stable gains in the long-run:
does it eventually become politically stable?
Expectations
• With passing of the initially old cohorts, welfare gains become
majoritarian
• Intend to understand/explain the reversing of reforms
8

9. Results - preview
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. Retirees always vote for abolition.
3. No coalition low productive workers + retirees.
4. Abolition (almost) does not effect inequalities.
5. Correct assignment of property rights crucial for stability.
9

10. Table of contents
Model
Calibration
Voting
Results
Conclusions
10

11. Model

12. Model
• SOE deterministic heterogeneous agent OLG model
• Households heterogenous in their preference and productivity
• Competitive firms
• Pension system reformed from DB to partially FDC
• Taxes used to finance government expenditure and deficit in the
pension system
11

13. Households I
• Are “born” at age 20 (j = 1) and live up to 100 years (J = 80)
• 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:
Uj,κ,t =
J−j
s=0
δs
κ
πj+s,t+s
πj,t
cφκ
j+s,κ,t+s (1 − lj+s,κ,t+s)1−φk
• Subject to the budget constraint (next slide)
12

14. Households II
• Subject to the budget constraint
(1 + τc
t )cj,κ,t + aj,κ,t = (1 − τl
t )(1 − τ)wtωκlj,κ,t ← labor income
+ (1 + (1 − τκ
t )rt)aj−1,κ,t−1 ← capital income
+ (1 − τl
t )bj,κ,t ← pension income
+ beqj,κ,t ← bequests
− Υt ← lump-sum tax
13

15. Financial markets and producers
• Small open economy
• domestic interest rate linked with global interest rate r∗
t
• risk premium ξ Bt
Yt
(Schmitt-Grohe and Uribe (2003))
rt = r∗
t + ξ
Bt
Yt
• Perfectly competitive firms with Cobb-Douglas production function
Yt = Kα
t (ztLt)1−α
14

16. Pension System
• Pay As You Go Defined Benefit (PAYG DB)
b¯J,κ,t = ρ · wt−1ωκl¯J−1,κ,t−1
• Pay As You Go Defined Contribution (PAYG DC)
bI
¯J,κ,t
=
f I
¯J,κ,t
LE¯J,t
, where f I
j,t = (1 + rI
t )f I
j−1,t−1 + τI
ωκlj,κ,t
• both with payroll growth indexation, rI, bj,κ,t = (1 + rI
t )bj−1,κ,t−1
• Funded Defined Contribution (FDC)
bII
¯J,κ,t
=
f II
¯J,κ,t
LE¯J,t
, where f II
j,t = (1 + rt)f II
j−1,t−1 + τII
ωκlj,κ,t
• with bj,κ,t = bI
j,κ,t + bII
j,κ,t
15

17. Government
• Collects taxes τc, τl , τk, Υ (sum up to T).
• Covers public good spending Gt = g · Nt · zt and
• deficit of the pension system
subsidyt = τI
t wtLt −
K
κ=1
J
j=¯Jt
Nj,κ,tbI
j,κ,t
• Budget constraint
Tt + Dt = (1 + rt)Dt−1 + Gt + subsidyt
• closed with the consumption tax given by the following rule
τc,t = (1 − )τfinal
c + τc,t−1 + D( ˜(D/Y )t − (D/Y )final
)
16

18. Calibration

19. Macroeconomic environment
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
17

20. Demography
Number of 20-years old Mortality rate for
60-years old
⇓ ⇓
rI ↓ rII ↓
18

21. Heterogeneity - productivity ω
SES Eurostat 1998, Poland
Productivity ω
Result: 10 values for ω
19

22. Heterogeneity - leisure preference φ
SES Eurostat, 1998, Poland
Leisure preference φ
Result: 4 values for φ
20

23. 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)
21

24. Voting

25. Political economy
What happens within each vote?
• Policy 0 - status quo
• 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)
22

26. Pure Majority voting: the median voter
• We run these votes in subsequent years independently.
• If welfare gains, subcohort is in favor.
• Non strategic voting: voter 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
23

27. Results

28. Reform PAYG DB → FDC is Hicks-Kaldor efficient
Aggregate welfare gains +1% , expressed in % of permanent consumption
from the partial privatization scenario. 24

29. Reform DB → FDC, positive welfare effect and support
The share of population gaining from introducing FDC in 1999.
25

30. Reform DB → FDC, after transition period everybody gains
The share of population gaining from introducing FDC in 1999.
26

31. Nevertheless, rational voters want to withdraw it
Political support for each policy change against status quo.
27

32. Nevertheless, rational voters always want to withdraw it
Political support for each policy change against status quo.
28

33. Nevertheless, rational voters always want to withdraw it
Political support for each policy change against status quo.
29

34. Shift of contribution wins, retirees prefer both changes
Political support against winning scenario: contribution.
30

35. Vote for policy change, because of lower taxation...
Differences in consumption tax relative to baseline (DB→NDC)
expressed in percentage points.
31

36. ... due to conversion of explicit into implicit debt...
Differences in debt level relative to baseline (DB→NDC)
expressed in percentage points.
32

37. ...regardless of lower pension benefits...
Differences in pension benefits relative to baseline (DB→NDC)
expressed in percentage points.
33

38. ... which are lower due to slower accumulation in PAYG pillar
34

39. No coalition: low productive workers + retirees
Shift of contribution, voting in 2012, consumption equivalent expressed
in % of permanent consumption from the partial privatization scenario 35

40. Policy change slightly reduces poverty...
Relative poverty defined as percentage of population with consumption below
60% of median consumption. 36

41. ... 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). 37

42. The short-term improvement concerns mainly retirees
Percentage of retirees with consumption below 60% of median from the initial
steady state consumption. 38

43. Conclusions

44. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. Retirees always vote for abolition.
3. No coalition low productive workers + retirees.
4. Abolition (almost) does not effect inequalities.
5. Correct assignment of property rights crucial for stability.
39