Pension Reform, Retirement Ages, and Labour Supply in the United States and the European Union (EU15) 1950-2060

Christian Toft, Edward Whitehouse, and Gary Burtless

Beijing Normal University, China, Wednesday 22 May 2013

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Outline

1: Introduction 2: Reform and trends in normal and early

pension eligibility age provisions

3: Pre- and post-reform incentives to retire4: Reform and trends in labour market

participation5: Reform and future labour supply6: Conclusion and discussion

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Abstract / Summary Taking a long 60 year look at trends in pensionable age policy this chapter

places current policy initiatives in a broader context and considers how the different policies in the U.S. and EU15 countries have impacted on labour supply and participation of older people and how recent policies currently being phased-in are projected to impact during the next 50 years.

We argue that the substantial gap between the participation rates on the two continents developing until the mid 1990s can largely be explained by differences in retirement age policy and that the much stronger increase in participation in EU15 vis-à-vis the U.S. during the past 15 years is one of the fruits of the new policies that have been adopted.

Indeed, projections of the impact of retirement age reform discussed in the chapter indicates that in future we can expect EU15 countries to have higher participation rates for older people than the United States, thereby turning the pattern of the past forty years on its head.

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Socio-economic context of pension reformSocio-demographic trends People live longer and get fewer children Changing labour markets Men retire earlier and enter the labour market later Increase in women’s labour market participation converging

towards the male pattern Changing family structures New family structures with more single person households Increase in women’s paid work implying less time for caring

(elderly & children) New social demands due to increase in number of lone parents Child poverty

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Received comparisons: US – EU

European welfare states: innovative & advanced

US welfare state: laggard & under-developed

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Pension policy traditions ‘Bismarck’-style public pension plans: Earnings-related

contributions and benefits emphasising fiscal equivalence between contributions and benefits. Limited private provision of retirement benefits

‘Beveridge’-style public pension plans: Provision of basic, flat-rated pension with little or no emphasis on fiscal equivalence between contributions and benefits. Significant provision of private retirement benefits

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U.S. – EU15 comparison of pension policy traditions

‚Bismarck’-style public pension plan

‚Bismarck’-Lite ‚Beveridge’-style public pension plan

Austria Italy Canada Australia (Switzerland)Belgium Luxembourg United States Denmark United KingdomFinland (Norway) IrelandFrance Portugal JapanGermany Spain The Netherlands

Greece Sweden New Zealand

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Factors shaping retirement patterns

Pull factors: These primarily consist of financial incentives which are “pulling” older workers into retirement.

Push factors: These consist mainly of factors which restrict the available set of attractive job opportunities open to older workers and thus “push” them into retirement.

Comparative literature mid 1990s

Blöndal and Scarpetta OECD Project

Gruber and Wise NBER Project

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Table: Population and ageing trends - mid 2000s to 2050

United States EU 15

Working age (25-54) 20 % increase 12 % decline

Elderly (65 and over) 133 % increase 75 % increase

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Figure: Populations of working age (20-64) by age group in Germany in 2010 and 2030

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Figure: The last remaining German - On the road to the gray republic

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US – EU Reforms

Last major US pension reform: Reagan 1983

Europe: Permanent state of reform

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Table: Overview of country cases

Countries Presentation Countries Presentation

Denmark Greece (limited info)Finland Focus Italy FocusSweden Portugal (limited info)

Spain Focus Austria Belgium (limited info) Ireland France United Kingdom Germany FocusLuxembourg Omitted United States FocusNetherlands Focus EU15 averages Focus

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Outline1: Introduction 2: Reform and trends in normal and early pension

eligibility age provisions3: Pre- and post-reform incentives to retire4: Reform and trends in labour market participation5: Reform and future labour supply6: Conclusion and discussion

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Summary:

We extend and expand the recent work by Turner (2007) and Chomik and Whitehouse (2010) on pension eligibility ages 1950-2050 by emphasizing more clearly the difference between normal and early eligibility ages, and by including the most recent reforms as well as the early retirement options implicit in unemployment compensation and disability schemes.

Summary of issues:

Normal pension eligibility ages

Early eligibility ages and actuarial benefit adjustments

Pre-retirement options (unemployment – disability)

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Normal pension eligibility ages

My definitionThe normal pension eligibility age is that age at which pension scheme members, independent of contribution record can first draw full benefits without reduction for early retirement.

Alternative definition (Whitehouse)The age at which a full career worker can first draw full benefits without reduction for early retirement. A full career worker is defined as an individual starting work at age 20 and contributing in every year from that time.

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The U.S. benchmark

Normal age (since 1937): 65 years of age Early eligibility age (since 1956/61): 62 years of age Deductions for early retirement since 1956 No introduction of special rules for older workers in

unemployment compensation Disability

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Normal pension eligibility ages reform1950-2000 versus 2000 onwards

Few alterations in normal eligibility ages 1950-2000 but we see a wave of reform after the turn of the century

U.S. Reagan reform 1983 – phased in from 2002 onwards All major EU15 countries are now following the American

lead and example Germany in 2007 followed by France in 2010, and Italy and

Spain 2011 New EU innovation – eligibility age dependent on life

expectancy: Denmark, Italy, and Greece

 

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Figure: Reforming early and normal retirement age provisions, 2002 and 2011

80604020020406080

6765656565

6767

6567

6567

65676868

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626261

62626263

60

6063

5563

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Denmark

FinlandSwedenAustriaBelgium

FranceGermany

LuxembourgNetherlands

GreeceItaly

PortugalSpain

Ireland

United Kingdom

United States

early Age 2002

Early Age Normal Age

2010:

Early eligibility ages and actuarial benefit adjustmentsU.S. pioneer versus the European norm

United States has been a pioneer in introducing early retirement options, instituting an early eligibility age at 62 years of age for women in 1956 and for men in 1961 but with an annual actuarial decrement of 6.67 per cent

In Europe, only France and Sweden had a similar rule at the time. Spain also introduced an early age option with actuarial deductions in 1967

With these exceptions and until recent reforms, the European norm has been to include early eligibility age provisions without actuarial decrements

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Early eligibility ages and actuarial benefit adjustmentsEarly reforms: 1950s onwards

Special early eligibility age for women: Austria, Belgium, Germany, Greece, Italy, and the UK Special early eligibility age for the long-term unemployed: Germany, Austria, and France

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Early eligibility ages and actuarial benefit adjustmentsSecond generation reforms: 1970s onwards

Only in the 1970s were universal early retirement provisions introduced on a wide scale in Europe

Germany, Belgium, France, and Finland Netherlands, Denmark

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Example: Italy Seniority Pensions & Baby Pensioners 1956 seniority pensions (pensione di anzianità) were

introduced for public sector employees, allowing them to retire with a full pension after twenty five years of service (twenty years for women) without any age restrictions

From 1965 onwards private sector workers could retire at any age after 35 years of service and in 1973 contribution requirements for public sector workers were reduced to 20 years of service (fifteen for women). In Italian discourse these people were often referred to as “baby pensioners” because of their young ages

An age restriction (and actuarial reductions) was only introduced in 1993 when a minimum age of 52 years was introduced. Increased during the 1990s

Early eligibility ages and actuarial benefit adjustments Reforms since the mid 1990s

First, spurred on by EU legislation relating to gender equality, special early eligibility ages for women are being phased out

Second, countries such as Germany, Finland, and Austria have abolished special provisions for the unemployed. On a broader front, concurrent with the increase in the normal eligibility age, during 2002-2012 the early eligibility ages have been set up in many countries (see figure)

Third, beginning with Finland in 1986, countries that did not already have it (e.g. France, Sweden, Spain) have implemented actuarial reductions for early retirement, and the required numbers of contribution years have also been increased in a several countries

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Figure: Reforming early and normal retirement age provisions, 2002 and 2011

80604020020406080

6765656565

6767

6567

6567

65676868

67

626261

62626263

60

6063

5563

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Denmark

FinlandSwedenAustriaBelgium

FranceGermany

LuxembourgNetherlands

GreeceItaly

PortugalSpain

Ireland

United Kingdom

United States

early Age 2002

Early Age Normal Age

2010:

Pre-retirement options: U.S. versus EU In addition to pension policy, development of early retirement

options during the 1970s onwards involved unemployment compensation and disability policy. (Italy exception)

U.S. unemployment compensation has limited duration and in contrast to Europe, no special rules for older workers were introduced 1970-1990

By contrast, EU15 countries introduced i) special pre-retirement schemes for older workers (Belgium, France, Denmark, Finland) ii) relaxed job-search rules for older workers, and iii) extended insurance benefit duration

 

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Pre-retirement options: French caseThe Mitterrand reform

In the case of France, Guillemard (1991) argues that the introduction of a full career option in 1982/83, allowing people with 37.5 years of contribution to retire at the age of 60, was in fact part of a cost-cutting exercise aiming to move claimants from generous unemployment compensation to the less generous pension schemeTechnically speaking, the Mitterrand reform removed the early retirement penalty for long service employees in the age interval 60-65 (Bozio 2006)

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EU pre-retirement options – example FinlandThe “unemployment pipeline”

Finnish developments conveniently illustrate in a simplified manner the essential features of a broader European trend. What has become known as the “unemployment pipeline to retirement” consists of one sequence of schemes that applies to all localities, all industries, and both sexes In institutional terms, Finland is the polar case to Italy. While in Italy almost all early withdrawal options have been a result of general rules embedded in the regular pension scheme, in Finland almost all withdrawal options have been based on special provisions in pension, unemployment compensation, and disability legislation

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EU pre-retirement options – example Finland Ordinary unemployment insurance Extended unemployment insurance (for people over a

certain age) Unemployment pension, with benefits related to

pension provision (in contrast to unemployment insurance – i.e. the Danish approach)

Normal retirement age

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Figure: Pre-retirement policy in Finland 1971 onwards

Pre-retirement options: Disability policyPolicy traditions

Under most programs, provisions for disability benefits for persons who are permanently disabled as the result of non-occupational causes are very similar to those for the aged. The same basic formula usually applies for total disability as for old age—a cash amount usually expressed as a percent age of average earnings. Partial disability benefits, if payable, are usually reduced, according to a fixed scale. The system may also provide rehabilitation and training.

Source: US Social Security Administration: Social Security Programs Throughout the World Europe 2010 Page 7

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Disability: Policy issues

Medical criteria Labour market criteria (unemployment insurance) Permanent or temporary awards - rehabilitation

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Disability: Policy trends until the mid1990s

Given the importance of disability benefits as an income support for persons leaving the labour market before the pensionable age, entitlement conditions for this type of benefits are particularly relevant for the retirement decision. In any case, there are strong indications that entitlement conditions have been de facto eased in disability benefit systems throughout OECD countries. The easing of eligibility requirements has been most notable in countries which have introduced an explicit labour-market criterion in granting disability pensions. Source: Blöndal and Scarpetta (1999 Page 23)

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Disability: Policy reform since mid1990sExample: The Netherlands

Disability Insurance in the Netherlands has been rigorously reformed. Crucial elements of the reforms were stronger incentives for employers and employees to prevent sickness and disability, obligations regarding reintegration, and a strong financial incentive for benefit recipients to continue working when possible. The reform had its effect: chapter 3 of this study argues that disability insurance is no longer used as an early exit route into retirement. In the Netherlands, the inflow of hidden unemployment (retirement) in DI seems to have halted. …. One may however ask whether older workers are sufficiently insured by DI. The admittance to DI benefits for ‘fully disabled’ has become very strict. Source: Euwals et al 2009 Rethinking Retirement pages 25 & 75

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Outline

1: Introduction 2: Reform and trends in normal and early pension

eligibility age provisions3: Pre- and post-reform incentives to retire4: Reform and trends in labour market participation5: Reform and future labour supply6: Conclusion and discussion

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Generosity indicators

Replacement rates

Pension wealth

Change in pension wealth from working an additional year

Effects of working a year longer In contributory pension schemes, a longer working period may

imply an extra year’s contribution which usually brings some extra pension entitlement.

A longer work period implies a shorter duration of retirement The final elements of the pension incentive to retire reflect

further costs to the worker of delaying the pension claim. The worker might die during the year, and so receive nothing from the pension system. Different workers might also have different time preferences, with some having particularly strong preferences for current rather than future consumption.

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Table: Implicit tax and “subsidy” rates on continued work embedded in public pension schemes, 1967, 1995, and prospective rates

1967 1995 Prospective

Finland 0 22 -12

Germany 4 14 -14

Netherlands 9 13 -24

Italy 30 79 11

Spain 18 -9

United States 8 12 1

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Table: Implicit tax and “subsidy” rates on continued work embedded in benefits for the elderly, 1995

Old–agepensions

Unemployment related benefits

Disability benefits

Special early-retirement

Finland 22 42 71

Germany 14 37 46

Netherlands 13 57 41

Italy 79

Spain 18 33 53

United States 12

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Conclusion: Pension incentive analysis

We see an overall return to incentive neutrality similar to the 1960s and a “rank-reversal” vis-à-vis our United States and EU15 comparison in that most EU15 coun-tries will have lower implicit tax rates and therefore better incentives than the United States once all reform induced changes have been phased in. On this measure, only Southern Europe (except Spain) has worse incentives than the US. However, incentive problems in unemployment and disability benefit systems may remain

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Outline1: Introduction 2: Reform and trends in normal and early pension

eligibility age provisions3: Pre- and post-reform incentives to retire4: Reform and trends in labour market participation5: Reform and future labour supply

6: Conclusion and discussion

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Data In contrast to the United States, Europe does not have a long time series providing estimates of age and sex specific participation rates on a consistent basis. Our dataset draws on three sources.

A: 1950, 1960, 1970. Data for these years are from ILO (2004) whereby the primary sources in most instances appear to have been population censuses.

B: 1970-1983. The estimates for these years are based on a number of different sources.

C: 1984-2010. Our estimates for these years have as a starting point been taken from the ILO dataset “Labour Force Participation Rates 1980 to 2009” (obtained 10 June 2010). Most of the data are from the EU Labour Force Survey. For those years where there are no Eurostat data, ILO appears to have estimated rates based on conventional national surveys, but linking these rates with the Eurostat data.

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Figure: Trends in Labour Force Participation Rates, EU15 and US, 1950-2010, Men

0

10

20

30

40

50

60

70

80

90

100

Participation Rates

45-49 USA 50-55 USA 55-59 USA 60-64 USA 65+ USA

45-49 EU15 50-55 EU15 55-59 EU15 60-64 EU15 65+ EU15

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Figure: Trends in Labour Force Participation Rates, EU15 and US, 1950-2010, Women

0

10

20

30

40

50

60

70

80

90

100

Participation Rates

45-49 USA 50-55 USA 55-59 USA 60-64 USA 65+ USA

45-49 EU15 50-55 EU15 55-59 EU15 60-64 EU15 65+ EU15

Changes in participation rates 1970 to 1982

Base year: First year with labour force survey data

(mostly either 1970 or 1974)1982: Between 1982 and 1984 many

countries revised their data – introduction of EU survey

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Annex Table 1A: Changes in participation rates, men, 1970 to 1982

Age Group 55-59 Age Group 60-64

Base YearRate in

base yearChange 70-82

Change 74-82

Rate in base year

Change 70-82

Change 74-82

Finland 1970 80,2 -11,6 -10,0 67,0 -23,5 -15,5Germany 1970 88,5 -6,5 -3,7 71,9 -28,1 -19,5Netherlands 1971 91,5 -16,8 -12,6 73,7 -36,1 -28,6Italy 1970 75,1 -2,5 -2,4 48,2 -11,4 -6,0Spain 1972 90,4 -7,1 -4,6 77,7 -16,4 -13,2United States 1970 89,5 -7,6 -3,7 75,0 -17,8 -10,6EU15 1970 85,1 -6,9 -4,9 69,0 -19,5 -14,2

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Annex Table 1B: Changes in participation rates, women, 1970 to 1982

Age Group 55-59 Age Group 60-64

Base YearRate in

base yearChange 70-82

Change74-82

Rate in base year

Change70-82

Change74-82

Finland 1970 58,3 3,0 1,9 31,3 -0,8 1,6Germany 1970 36,4 4,3 2,8 20,4 -7,8 -4,3Netherlands 1971 17,7 0,3 0,0 11,8 -4,1 -3,5Italy 1970 16,4 3,4 2,4 10,6 3,6 5,2Spain 1972 24,8 -2,7 -4,0 19,1 -1,8 -4,9United States 1970 49,0 0,6 2,2 36,1 -2,7 0,0EU15 1970 33,9 3,0 1,4 21,7 -1,8 -1,7

Changes in participation rates 1984-2010

Identification of “year of minimum” for men Change from 1984 to “year of minimum” Change from “year of minimum” to 2010

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Changes in participation rates 1984-2010

Men:Trends in the US and EU15 are similar but much more pronounced in Europe For the age group 60-64, Finland, Germany, and the Netherlands have experienced an increase in participation between 22 and 30 percentage points By contrast, the US increase was a little more than 7 percentage points

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Changes in participation rates 1984-2010

Women:US pension policy literature mainly concerned with men because of the female cohort effect Yet, using the male minimum as a means of periodization, we see clear parallels between the genders in EuropeFor the age group 60-64, female participation dropped when male participation dropped and increased together with male participation

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Annex Table 2A: Changes in participation rates, men, 1984 to 2010

Age Group 55-59 Age Group 60-64

Year of Minimum 1984 1984 to

minimumMinimum

to 2010Year of

Minimum 1984 1984 to minimum

Minimum to 2010

Finland 1996 65,1 -7,0 17,9 1995 38,0 -16,3 22,7

Germany 1993 79,4 -8,6 14,0 1994 35,1 -6,8 25,4

Netherlands 1996 65,8 -5,7 24,9 1996 29,3 -9,1 29,5

Italy 2001 70,2 -17,9 16,1 2005 37,7 -8,9 1,8

Spain 1995 79,3 -7,9 8,2 1999 57,0 -17,4 7,0

United States 1994 80,2 -3,3 1,6 1994 56,1 -3,3 7,2

EU15 Av 74,8 -8,4 10,7 44,8 -11,8 11,8

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Annex Table 2B: Changes in participation rates, women, 1984 to 2010

Age Group 55-59 Age Group 60-64

1984

1984 to year with male

"minimum"

Year with "minimum" to

2010 1984

1984 to year with male"minimum"

Year with "minimum" to 2010

Finland 61,0 -4,6 23,5 32,6 -14,7 24,1Germany 39,6 1,9 28,8 11,5 -2,5 26,5Netherlands 21,4 9,2 30,6 7,7 1,7 18,4Italy 19,8 4,5 17,5 10,6 -1,2 2,9Spain 22,3 2,3 24,4 16,5 -1,3 12,1USA 49,8 9,4 9,2 33,4 4,4 12,9EU15 Average 37,2 3,0 20,0 19,1 -0,9 11,1

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Outline

1: Introduction 2: Reform and trends in normal and early pension

eligibility age provisions3: Pre- and post-reform incentives to retire4: Reform and trends in labour market participation5: Reform and future labour supply6: Conclusion and discussion

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Projection methodology Projection methodology has so far often been based on

assumptions of constant future participation rates. Projected changes in aggregate participation rates then result only from a shift in the population age structure.

The idea of the OECD/EC “cohort component methodology” is to extrapolate into the future the observed recent shifts in the level of participation and recent changes in rates of entry into and exit from the labour market

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Projection methodology: Pension reform

Pension reform: The modelling strategy is to consider the likely impact of different reform aspects on the probability of withdrawing from the labour market – as measured by the exit rates. From this basis the impact of reform on labour market participation can be calculated.

Projected participation rate changes 2007 to 2060in EU15, men & women - age group 55-64

Two projections

Overall projected percentage point change in participation Percentage point change due to pension reform

If pension reform change is greater than the overall change, we would project a drop in the absence of reform

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Projected participation rate changes 2007 to 2060in EU15, men and women - age group 55-64

EU15Overall change: 17 percentage pointsReform induced: 13 percentage points

The “surplus” is due to the female cohort effect. Looking only at men, there would be a projected decline in participation in the absence of reform

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US – EU15 comparison2007US: 63.8 per centEU15: 48.6 per cent 2060US: 63.4 per centEU15: 65.6 per cent

In the absence of reform, only southern Europe (Italy, Spain, Portugal) would see an increase due to increasing female participation (cohort effect)

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EU15 countries: Large reform induced changes 2007 to 2060 Finland – 12.1 percentage points Austria – 17.1 percentage points Germany – 17.7 percentage points Italy – 22.2 percentage points Spain – 11.5 percentage points United Kingdom – 12.0 percentage points

We do not have estimates for all countries.

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Figure: Participation rates in 2007, projected changes in overall partici-pation rates and estimated impact of pension reform, 2020 & 2060. Age Group 55-64

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Outline1: Introduction 2: Reform and trends in normal and early pension

eligibility age provisions3: Pre- and post-reform incentives to retire4: Reform and trends in labour market participation5: Reform and future labour supply6: Conclusion and discussion

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Ageing in the U.S. and EU15 Europe and the United States are facing different ageing prospects

providing different contexts for pension policy. Even though the U.S. will see a substantially stronger increase in the number of people of retirement age (65 plus), EU15 have and will continue to have a higher dependency ratio due to a different trend in the size of the population of working age.

Over the next few years EU15 will see a slightly increasing population of working age whereupon decline will set in. In 2050 EU15 will have 16 million fewer people of working age while the U.S. is projected to have close to 50 million more.

Relations between the countries within EU15 will change in that the largest decline will be concentrated in Germany and Southern Europe while high fertility France and the United Kingdom will have stable or perhaps even growing populations.

An ageing working population in EU15 Overall we will see a substantial change in the age composition of

the population with a strong decline in the “prime age working population” (25-54) and a strong increase in the “older population of working age” (55-64).

Until 2020 we see an increase in both places leading to a certain convergence so that there will be a little more than 33 “old” working age persons for every 100 “prime aged” persons in EU15 and the U.S.

From 2020 onwards the U.S. is projected to experience a certain rejuvenation of the working age population but in EU15 a process of accelerated obsolescence sets in. By the mid 2020s EU15 is projected to have 37 “old” persons for every 100 prime aged with Germany and Italy leading the way with a ratio of 44 and 40, respectively.

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Ageing and European pension reform The age group 55-64 is of course exactly the group that European

policy makers in the past have strongly encouraged to leave the work force.

Allowing a fraction of the older working population to withdraw from the labour market may have been feasible at a time when there were 100 prime aged workers for a limited number of old workers but is no longer sustainable.

Pension reform has been doing a great deal to address this issue and the effect seems to be that in the countries that have most rigorously reformed past policies, labour force participation has increased the most.

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