Structure de consommation, protection sociale et revenu de retraite

Consumption Structure, welfare goods

and retirement income:

linking the ageing puzzles

Najat El Mekkaoui de Freitas

(Laboratoire d’économie de Dauphine, Université Paris-Dauphine) Joaquim Oliveira Martins

(OECD, Université Paris-Dauphine)

„ _{Some empirical facts on consumption, pension and}

saving do not fit with theory:

¾ _{First puzzle: ageing/consumption puzzle : why}

consumption decrease in old age ?

¾ _{Second puzzle: ageing/saving puzzle : Why}

individuals continue to save at old age, in particular in countries with generous PAYG and health care systems (welfare goods)?

¾ Third puzzle: saving/capitalisation puzzle : why

countries with fully funded systems have the lowest private saving rates ?

Structure of the presentation

1. Brief discussion of the three puzzles

2. A theoretical life cycle model where we consider

the main determinants of savings, inc. welfare goods, social transfers and pension replacement rates

3. The three puzzles are interconnected. Part of the

explanation relates to the interactions among the change in the structure of consumption with age, provision of welfare goods and retirement income

4. An econometric analysis of the impact of the age

structure, welfare systems on saving patterns across OECD countries.

1st _{Puzzle: The Ageing/Consumption Puzzle}

Why consumption is not smoothed throughout the life cycle ?

80.0 100.0 120.0 140.0 160.0 180.0 200.0 220.0 under 25 25-34 35-44 45-54 55-64 65-74 75 + C ons um pt ion of t h e un de r 2 5 a g e gr o up = 100

United States _{European countries}

40.0 60.0 80.0 100.0 120.0 140.0 160.0 180.0 under 30 30-44 45-59 60 + C ons um pt ion of t h e unde r 3 0 a g e gr oup (E U avera g e ) = 100 Fin Swe Deu Gbr Ita Fra

There may be cohort and time effects biasing the relationship, but some studies based on individual data suggest that these bias are relatively small

2nd _{Puzzle: The Ageing/Saving Puzzle}

3rd Puzzle: The Saving/Capitalisation puzzle Why fully-funded systems have a lower

household saving rate?

Average Household Saving rate

0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Low Funding High Funding PAYG systems Funded systems

Some interpretations of ageing/consumption puzzle:

„ _{Bernheim, Skinner and Weinberg (2001): Lack of}

forward-looking optimising behaviour to determine retirement saving;

„ Hurd and Rohwedder (2006): poor health could

explain the decline in spending;

„ Miniaci, Monfardini and Weber (2003): both shocks

to retirement wealth and leisure substitution;

„ Sarah Smith (2007): retirement is assumed to be

involuntary, largely reflecting health problems and redundancy.

Some interpretations of the ageing/saving puzzle:

„ Bloom et al. (2003) and Sheshinski (2004) : The higher life

expectancy may increase the need for additional precautionary savings.

„ Bernheim et al. (2001) : household behavior is not governed

by rational, far-sighted optimization.

„ Moore and Mitchell (1998) : households are not preparing

adequately their retirement period.

… household would need to save 20 per cent of annual

earnings to have a replacement rate=61%.

… A single woman would need to save around 32% of her

income to have a replacement ratio of 54% at age of 62

… the majority of older households will not be able to

maintain current levels of consumption into retirement without additional saving.

Some results on capitalization & savings

„ Feldstein (1974) highlighted a negative link between PAYG

pension systems and household savings.

„ Baillu and Reisen (1997): analyse the effect of funded

systems on saving (public and private) using a panel of countries 1982-93 period. They found a positive and

statistically significant impact of pension funds on saving

„ Lopez Murphy and R. Musalem (2004): considering 43

countries for the period 1960-2002, the authors found that mandatory contribution to funded pension systems increase national saving

„ Bosworth and Burtless (2004): analyse the same effect for 11

countries and during the period 1971-00 and find an impact on private saving not significant econometrically

2. What determines savings ? A simple model

„ _{In the first period, each agent splits her disposable wages}

into consumption (C_i) and saving (S_i):

Where

α

is the rate of social contributions.

„ _{In the second period, only a welfare good consumption}

(e.g. health) is considered H_i.

„ _{To finance this consumption, the agent receives a PAYG}

pension with a replacement rate

β

, the accumulated

saving accrued by the return on capital r and a given amount of social transfers T:

i i i i w r S T H =

β

. + (1 + ) ⋅ + i i i S w C + = (1−α).

„ _{Maximising the utility of each agent under the budget} constraint, we obtain :

(

)

[

]

r w r T w r H C t s H u p C u H C u E Max i i i i i i i i i + ⋅ + + + ⋅ − ≤ + + ⋅ + = 1 1 ) 1 ( 1 . . ) ( ) ( , β α

„Where p_i is the survival probability at the beginning of

and the saving rate:

Expected signs: (+) p_i, r (-) T, β, α

[

i i

]

i i i i i i i w T w r p p H r w r T w p C . ) 1 ( ) 1 ( 1 1 . 1 ) 1 ( 1 1 β α β α + + ⋅ + ⋅ − ⋅ + = ⎥⎦ ⎤ ⎢⎣ ⎡ + + + + ⋅ − ⋅ + = ⎥ ⎦ ⎤ ⎢ ⎣ ⎡ + + ⋅ + − + ⋅ − = α β i i i i i i w T r p p p w S ) 1 ( 1 1 1 1 ) 1 (

3. Proposed explanations in this paper

„ _{The three puzzles are linked together}

„ _{The interaction between consumption structure,}

provision of welfare goods and the level of retirement income can explain part of the puzzles

„ First fact: an increase of the welfare goods (health,

long-term care) at old age with a concomitant decrease in other goods & services

„ Second fact: In most countries welfare goods are

publicly provided and heavily subsidised

„ _{Third fact: Replacement ratios have increased and are}

currently higher in PAYG than in the funded systems

NB: note that PAYG are unsustainable and

replacement rates in funded systems are expected to be increase relative to PAYG

Two groups of countries considered:

„ _{Group Funded systems: Funded pension}

systems have been developed and pension replacement rate are relatively low:

…US, UK, CAN, CHE, NLD, AUS, DNK

„ _{Group PAYG: countries dominated by public}

PAYG pension systems and pension replacement rate is relatively high:

…AUT, GER, FINL, FRA, JAP, COR, NOR,

90 110 130 150 170 190 210 230 Under 25 25-34 35-44 45-54 55-64 65-74 75 and + Co n s u m p ti on o f t h e un de r 2 5 g ro u p = 100 90 110 130 150 170 190 210 230 250 270 290 Under 25 25-34 35-44 45-54 55-64 65-74 75 and + Co n s u m p ti on o f t h e un de r 2 5 g ro u p = 100 50 70 90 110 130 150 170 190 210 230 250 Under 25 25-34 35-44 45-54 55-64 65-74 75 and + C ons um pt io n o f the un de r 2 5 g roup = 10 0 0 20 40 60 80 100 120 Under 25 25-34 35-44 45-54 55-64 65-74 75 and + Co n su m pt io n o f th e u n de r 2 5 g roup = 1 00 Housing Energy Entertainments Education 90 140 190 240 290 340 390 440 490 540 590 Under 25 25-34 35-44 45-54 55-64 65-74 75 and + Co n su m pt io n o f th e u n de r 2 5 g roup = 1 00 Health 40 60 80 100 120 140 160 180 200 Under 25 25-34 35-44 45-54 55-64 65-74 75 and + C o ns u m pt io n o f th e u nde r 2 5 g ro up = 10 0 Vehicles

USA Household Panel Survey

2

st

fact: Health spending is heavily subsidised

Share of public health expenditures in total health expenditures (in %)

1970 19711972 1973 1974 1975 1976 1977 1978 1979 19801981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 19931994₁₉₉₅ 19961997 19981999 2000 20012002 50 55 60 65 70 de pp ub r 1970 1980 1990 2000 2010 styears Portugal 1970 19711972 1973 1974 1975 1976 1977 19781979 19801981 19821983 1984 1985 19861987 198819891990 1991 1992 1993 1994 199519961997 1998₁₉₉₉200020012002 36 38 40 42 44 46 de pp ub r 1970 1980 1990 2000 2010 styears USA 1970 1971₁₉₇₂ 1973 197419751976 197719781979 1980 1981 1982₁₉₈₃1984 1985₁₉₈₆ 1987 19881989 1990 1991 19921993₁₉₉₄ 19951996 199719981999 20002001 2002 84 86 88 90 92 de pp ub r 1970 1980 1990 2000 2010 styears Sweden

3

st

fact: Retirement incomes have generally

increased

average replacement rates (in %)

20 40 60 80 1980 1985 1990 1995 2000 26 RR annees Graphs by group(pays) 65 70 75 80 1980 1985 1990 1995 2000 11 RR annees Graphs by group(pays) 40 45 50 55 1980 1985 1990 1995 2000 30 RR annees Graphs by group(pays) 45 50 55 60 1980 1985 1990 1995 2000 28 RR annees Graphs by group(pays) Portugal France USA Sweden

How the links among these facts can explain the

puzzles?

„ The ageing-consumption and ageing-saving puzzles: if

old-age consumers shift their consumption structure towards goods that are heavily subsidised (higher T)

and receive increased retirement income (higher β), this could both induce a decline of total consumption and a surplus of saving at older ages.

„ But there is an explained fact: why fully-funded save

Capitalization seems to influence negatively

savings

Panel 25 OECD countries for the period 1993-2005 193 ) .40 4 -( _ _ 12 . 0 4 . 11 193 ) 72 . 4 -( 47 . 0 23 . 9 1 , 1 , = − + + ⋅ − = = − + ⋅ − = − − N t student effects Fixed Country Cap Sav N t student Cap Sav it t i it it t i it ε ε

Even in the group of fully-funded systems over

time (within) the relation is negative

aus aus ausau s au s aus _aus aus aus aus aus can can_can can cancan cancan ca n can can

che che _che che ch e che dnk dnk dnk dnk dn k dnk dnk dnk dnk dnkdn k gbr gbr gbrgbr gbr gbr gbr gbr gbr gbr gbr nld nld nl d nl d nld nl d nl d nl d nld nld nld usa usa usa

usa _usausa usa usa usa usa _usa -5 0 5 10 15 SA V 20 40 60 80 100 120 CAP

Countries High funding (in % GDP)

65 ) 55 . 4 ( _ _ 12 . 0 9 . 12 65 ) 45 . 5 ( 84 . 0 06 . 0 1 , 1 , = − − + + ⋅ − = = − + ⋅ + = − − N t student effects Fixed Country Cap Sav N t student Cap Sav it t i it it t i it ε ε

Illustration: in the USA and Canada household Saving rates have been declining over time in parallel with

increased share of pension funds in GDP

1993 1994 1995 1996 1997 1998 1999 2000 2001 20 02 20032004 2005 0 2 4 6 SA V 50 60 70 80 90 CAP 1993 1994₁₉₉₅ 1996 1997 19 98 1999 2000 2001 2002 2003 ₂₀₀₄ 2005 2 4 6 8 10 12 SA V 35 40 45 50 55 CAP USA Canada

This decline of savings within countries can be partly explained by the

increasing replacement rates, higher subsidisation of welfare goods and the increased share of old people in the population

Ricardian Equivalence also helps explaining

the capitalization/saving puzzle

PAYG Systems Funded systems

The Ricardian Equivalence is particularly strong in PAYG systems, where budget consolidation has been weaker than in fully-funded systems

aut aut aut

aut aut autautaut

aut aut bel be l bel bel bel bel bel bel deu deu de u_deudeu deu_deu deu deu de u esp esp esp esp esp esp esp esp fin fin fin fin fin finfin fin fin fin fra_frafra _frafrafrafrafrafra

ita ita itaita ita ita ita ita ita jpn jpn jpn jpn jpn jpn jpn jpn nor nor _nor norno r nor nor nor

nor prt prt prt prt prt prt sweswe swe swe swe swe swe swe swe swe 0 5 10 15 20 25 SA V -15 -10 -5 0 5 10 nlgqa aus aus aus aus aus aus _aus aus aus aus can can can can can can cancan can can chechecheche

cheche _che che dnk dnk dnk dnk dnk dnk dnk gbr gbrgbr gbr gbr gbr gbr gbr nld nl d nld nld nld nld usa usausa

usa usa usa usa usa usa usa -5 0 5 10 15 SA V -15 -10 -5 0 5 nlgqa

4. An econometric test

A reduced form approach taking into account a number of determinants of household saving rates identified in the literature:

„ (i) Short-term and macroeconomic determinants:

- GDP per capita (wealth effects) - Long term real interest rate

- Public budget balance (in % GDP), in order to test the Barro-Ricardo equivalence hypothesis (Barro, 1974)

„ (ii) Social security and welfare systems determinants:

- Average replacement rate (in public and private schemes)

- Public share on total health expenditures (proxy for the provision of welfare goods)

„ (iii) Structure of the population:

- Shares of prime (25-59) and old-age (60+) population

Panel estimates of household saving rates

Total PAYG systems Fully-Funded

systems

Public budget -0.653*** -0.664*** -0.423** (-7.35) (-7.04) (-2.31)

Real interest rate 0.269*** 0.124 0.340* (2.96) (1.27) (1.91) GDP p.c. 0.00000700*** 0.00000769*** 0.0000826 (3.40) (3.55) (1.02) Share of pop 25-59 -0.963 0.449 -0.333 (-1.43) (0.60) (-0.18) Share of pop 60-99 -3.399*** -1.947** -3.103** (-4.82) (-2.23) (-2.23)

Share of public health exp. -0.312*** -0.394*** -0.0723 (-3.45) (-3.57) (-0.49) Life expectancy at 60 -1.089 -2.318* 2.485 (-1.01) (-1.69) (1.06) Replacement rate -1.446** -0.763 -2.357 (-2.28) (-1.12) (-1.41) Replacement rate*Pop 25-59 0.0150 0.0125 0.00688 (1.15) (0.95) (0.19) Replacement rate*Pop 60-99 0.0555*** 0.0140 0.143*** (4.65) (1.07) (4.06)

Life exp. at 60*Pop 60-99 -0.0239 0.00524 -0.0968***

(-1.57) (0.34) (-3.20) Time trend 0.165 0.0321 -0.535 (0.95) (0.15) (-1.26) Constant 155.5*** 85.70* 85.51 (4.63) (1.76) (1.14) Number of observations 245 134 111 Number of countries 18 11 7

Summary & further research

„ Our empirical results show that the three puzzles are linked together.

The changing structure of consumption with age, together with a large subsidy for welfare goods and increasing replacement rates provides an explanation for both the ageing-consumption and ageing-saving puzzles

„ In line with a Ricardian equivalence effect, the level of the public

budget balance has a negative impact on savings. This explains the observed saving-capitalisation puzzle.

„ In line with standard life-cycle effects, we also showed that an

increase in the share of the old-age population has a strong negative impact on the saving rate.

„ Finally, an additional longevity-saving puzzle emerged. This would