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2021Dec
Extending Pension Policy in Emerging Asia: An Overlapping-Generations Model Analysis for Indonesia

George Kudrna, John Piggott and Phitawat Poonpolkul

Abstract: This paper examines the economy-wide effects of government policies to extend public pensions in emerging Asia - particularly pertinent given the region’s large informal sector and rapid population ageing. We first document stylized facts about Indonesia’s labour force, drawing on the Indonesian Family Life Survey (IFLS). This household survey is then used to calibrate micro behaviours in a stochastic, overlapping-generations (OLG) model with formal and informal labour. The benchmark model is calibrated to the Indonesian economy (2000-2019), fitted to Indonesian demographic, household survey, macroeconomic and fiscal data. The model is applied to simulate pension policy extensions targeted to formal labour (contributory pension extensions to all formal workers with formal retirement age increased from 55 to 65), as well as to informal labour (introduction of non-contributory social pensions to informal 65+). First, abstracting from population ageing, we show that: (i) the first set of pension policy extensions (that have already been legislated and are being implemented in Indonesia) have positive effects on consumption, labour supply and welfare (of formal workers) (due largely to the formal retirement age extension); (ii) the introduction of social pensions targeted to informal workers at older age generates large welfare gains for currently living informal elderly; and (iii) the overall pension reform leads to higher welfare across the employment-skill distribution of households. We then extend the model to account for demographic transition, finding that the overall pension reform makes the contributory pension system more sustainable but the fiscal cost of non-contributory social pensions more than triples to 1.7% of GDP in the long run. As an alternative, we examine application of a means-tested social pension system within the overall pension reform. We show that this counterfactual reduces the fiscal cost (of social pensions) and further increases the welfare for both current and future generations.

Keywords: Informal Labour, Population Ageing, Social Security, Taxation, Re- distribution, Stochastic General Equilibrium.

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2021Dec
Macro-Demographics and Ageing in Emerging Asia: The Case of Indonesia

George Kudrna, Trang Le and John Piggott

Abstract: We document the economic and social circumstances of older people in Indonesia, a low-income country with a population of 273 million, in the context of rapid demographic transition. We find that, in common with a number of other emerging economies in East and South East Asia, most older people in Indonesia are experiencing significant hardship, with nearly half either in poverty or vulnerable to poverty. Economic growth per se does not seem to lead to an improvement in the circumstances of these cohorts. Ongoing societal ageing suggests that this situation will become more critical in the next couple of decades. A major effort in developing effective and sustainable social protection structures to provide support to the future elderly in Indonesia is required. Constructing an informed macro-demographic profile of an emerging economy can be a daunting challenge, but is an essential pre-cursor to evidence based social policy development focused on older cohorts. This paper draws on demographic and household survey data in Indonesia to craft a profile of older cohorts in Indonesia, within a context of changing education and labour force participation. This work has been undertaken to provide context and data for a major research effort around the development of a detailed macroeconomic model to analyse and assess appropriate social protection applications. But it has generated insights into the circumstances of older cohorts, and associated changes through time, which have value in their own right.

We report that:

  • Indonesia will undergo pronounced population ageing driven by a reduction in total fertility rate. For example, the aged dependency ratio (65+/15-64) is projected to increase from less than 10% (in 2020) to over 46% in 2100. This is also attributed to an increasing life expectancy, particularly at older ages. For those at age 65, life expectancy is projected to increase by almost 20 years in 2100 (which is almost double the expected lifespan in the middle of the 20th century). Indonesia’s total population has also quadrupled to 273 million (in 2020) since 1950 and is projected to increase to 320 million in 2100. However, the annual population growth rate will become negative, reaching -0.3% in 2100 due to population ageing.
  • Importantly, drawing on IFLS household survey data, this demographic transition is occurring in an economy where the large majority of the labour force operates in informal employment, not covered by a formal retirement income policy or, currently, a social pension.
  • At older ages, people continue to derive their income mainly from employment, along with private transfers from their adult children and these two income sources will be impacted by fewer adult children (to provide private transfers) and longer lifespans (affecting the labour supply of older people).
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2021Oct
Motivated saving: The impact of projections on retirement contributions

George Smyrnis, Hazel Bateman, Loretti Dobrescu, Ben R. Newell and Susan Thorp

Abstract: Can projections of retirement wealth and income motivate pension plan participants to save more? Results of field and online experiments show that participants who see both retirement balance and income projections increase voluntary savings. In the field study, conducted by a large Australian pension plan in 2013-14, participants of the treatment group received current balance, projected retirement balance and projected retirement income information, while participants of the control received only current balance information. Within one year of the treatment, the frequency, and average amount, of voluntary savings by treated plan participants rose significantly, as did the rate of participants interactions with the plan. In the related online experiment conducted in 2017, we tested the relative effect of information on (i) current balance; (ii) current balance and projected retirement balance; (iii) current balance and projected retirement income; and (iv) current balance, projected retirement balance and projected retirement income. Consistent with the field trial, the combination of retirement balance and income projections motivates a significantly higher retirement savings accumulation, after a sequence of ten savings decisions, than current balance information alone. Together our results strongly endorse recent changes to retirement plan benefit statement guidelines initiated by pension regulators globally.

Keywords: pensions, field experiment, benefit projections

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2021Sep
Mature workers
Work Less but Stay Longer

Erik Hernaes, Zhiyang Jia, John Piggott and Trond Christian Vigtel

Abstract: Many consider that reducing the eligibility age for pension benefits will discourage labor supply by mature workers. This paper analyzes a recent Norwegian pension reform which effectively lowered the eligibility age of retirement from 67 to 62 for a group of workers. For the individuals we study, the expected present value of benefits was held constant by introducing flexible claiming and actuarially adjusting the periodic pension payment. This neutralized the income effect of decreasing the access age, while the abolition of any earnings test ensured constant present value of the pension, independent of the age when it is claimed. This provides us with a unique opportunity to study the isolated impact of increased flexibility. We employ a particular difference-in-difference approach, which allows us to study the effect on the distribution of labor supply behavior (represented by earnings) instead of just the mean. Older workers are found to stay longer in the labor market but with reduced intensity, implying a higher incidence of gradual exit. On average the reform leads to small and statistically insignificant increases in aggregate earnings over ages 62 to 66. The fiscal effect was negligible, due to actuarial adjustments of pensions and small changes in aggregate earnings. We do however find a reduced inflow to disability, which may add to any positive fiscal effect. Our findings thus suggest that increased pension flexibility could promote gradual exit from the labor market, allowing improved individual choice and positive welfare effects. It could also be an important component of a broader pension reform.

Keywords: Retirement, Pension, Flexibility

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2021Sep
Warwick McKibbin
Mitigating Climate Change: Growth-Friendly Policies to Achieve Net Zero Emissions by 2050

Florence Jaumotte, Weifeng Liu and Warwick J. McKibbin

Abstract: The paper examines climate mitigation strategies to reach net-zero emissions by mid-century, focusing on smoothing macroeconomic costs in the short- to medium-term—the horizon relevant for policymakers. It explores a comprehensive policy package, which complements carbon pricing with an initial green fiscal stimulus, consisting of green public investment and subsidies to renewables production. Model simulations show that thanks to the green public spending, the policy package boosts global output relative to the baseline for the first 15 years of the low-carbon transition. Subsequent transitional output costs resulting from further increases in carbon prices are moderate of the order of 1 percent of baseline global GDP by 2050. The findings suggest that upfront green fiscal packages could help smooth the transition to a low-carbon economy. In the current context of the Covid-19 economic crisis, they would help support the recovery from the crisis and put the global economy on a greener, more sustainable path.

Keywords: Climate Change, Net-Zero Emissions, Green Infrastructure, Macroeconomics, DSGE, CGE, G-Cubed

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2021Sep
Global Demographic Change and International Capital Flows: Theory and Empirics

Weifeng Liu

Abstract: While population has been aging globally, regions and countries are significantly asymmetric in the timing and speed of the demographic transitions, especially between developed and developing regions. This paper explores the impacts of asymmetric demographic change on international capital flows with two contributions. First, the paper introduces demographic structure and pension systems into a theoretical overlapping generation model of a small open economy, and derives an analytical solution which links a large set of factors to the current account. This framework enables tractable analysis of the effects of various demographic shocks on external balances, and also of the interaction between demographic shocks and producvity growth and pension systems. Second, the paper provides a comprehensive literature review of both modeling and empirical studies. There are several qualitative implications. First, the patterns of capital flows depend on the nature of demographic shocks (permanent or transitory; fertility or mortality) and also on the stage of demographic shocks. Second, less generous pension systems tend to increase national saving and drive capital outflows. Third, financial frictions such as borrowing constraints of young people tend to increase national saving and drive capital outflows. Fourth, production and trade specialization in labor-intensive sectors tends to decrease investment and drive capital outflows in the face of fertility growth. Fifth, the magnitude of the demographic effects depends on the extent of cross-border mobility of capital, labor and goods. There are also several quantitative implications. First, demographics alone can explain a significant fraction of historical current account dynamics among advanced economies, especially low-frequency movements. Second, institutional and financial frictions need to be incorporated to reconcile the demographic effects with historical capital flows from emerging to advanced economies. Third, production structure and trade specialization also play an important role in demographics-driven capital outflows from emerging economies. On the other hand, empirical studies strongly support that the demographic change since the second half of last century has statistically significant effects on the current account balance. The current account tends to decrease in the dependency ratio, and increase in the working-age population share. This paper also points out the potential research direction.

Keywords: Global demographic change; fertility and mortality; international capital flows; current account balances; overlapping generation model; pension systems; factor mobility; financial frictions; structural change

 

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2021Aug
cepar award
Robust Inference for the Frisch Labor Supply Elasticity

Michael Keane and Timothy Neal

Abstract: There is a long standing controversy over the magnitude of the Frisch labor supply elasticity. Macro economists using DSGE models often calibrate it to be large, while many micro data studies find it is small. Several papers attempt to reconcile the micro and macro results. We offer a new and simple explanation: Most micro studies estimate the Frisch using a 2SLS regression of hours changes on income changes. But available instruments are typically “weak.” In that case, we show it is an inherent property of 2SLS that estimates of the Frisch will (spuriously) appear more precise when they are more shifted in the direction of the OLS bias, which is negative. As a result, Frisch elasticities near zero will (spuriously) appear to be precisely estimated, while large estimates will appear to be imprecise. This pattern makes it difficult for a 2SLS t-test to detect a true positive Frisch elasticity. We show how the use of a weak instrument robust hypothesis test, the Anderson-Rubin (AR) test, leads us to conclude the Frisch elasticity is large and significant in the NLSY97 data. In contrast, a conventional 2SLS t-test would lead us to conclude it is not significantly different from zero. Our application illustrates a fundamental problem with 2SLS t-tests that arises quite generally, even with strong instruments. Thus, we argue the AR test should be widely adopted in lieu of the t-test.

Keywords: Frisch elasticity, labor supply, weak instruments, 2SLS, Anderson-Rubin test

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2021Aug
A Practical Guide to Weak Instruments

Michael Keane and Timothy Neal

Abstract: We provide a simple survey of the literature on weak instruments, aimed at giving practical advice to applied researchers. It is well-known that 2SLS has poor properties if instruments are exogenous but “weak.” We clarify these properties, explain weak instrument tests, and examine how behavior of 2SLS depends on instrument strength. A common standard for “strong” instruments is a first-stage F -statistic of at least 10. But 2SLS has some poor properties in that context: It has low power, and the 2SLS standard error estimate tends to be artificially small in samples where the 2SLS parameter estimate is most contaminated by the OLS bias. This causes t-tests to give very misleading results. Surprisingly, this problem persists even if the first-stage F is in the thousands. Robust tests like Anderson-Rubin greatly alleviate these problems, and should be used in lieu of the t-test even with strong instruments. In many realistic settings a first-stage F well above 10 may be necessary to give high confidence that 2SLS will outperform OLS. For example, in the archetypal application of estimating returns to education, we argue one needs F of at least 50.

Keywords: Instrumental variables, weak instruments, 2SLS, endogeneity, F-test, size distortion, Anderson-Rubin test, conditional t-test, conditional LR test, Fuller, JIVE

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2021Aug
Pensions, Income Taxes and Homeownership: A Cross-country Analysis

Hans Fehr, Maurice Hofmann and George Kudrna 

Abstract: This paper studies the role of pensions and income taxes in determining homeownership and household wealth. It provides a cross-country analysis, using tax and pension policy designs in Germany, the US and Australia. These developed nations have similar incomes per capita but very different homeownership rates, with the US and Australia having much higher homeownership compared to Germany. The question is to what extent the observed differences in homeownership are induced by national tax and transfer policies. To that end, we develop a stochastic, overlapping generations (OLG) model with tenure choice. The model is calibrated to Germany featuring German statutory public pension and dual income tax systems, and then applied to study the effects of alternative income tax and pension policy structures. Our simulation results indicate that the US and Australian policy designs have a dramatic impact on homeownership, explaining more than half of the observed differentials. We also show significant macroeconomic effects due to differences in tax and pension policies.

Keywords: Housing demand, social security, income taxation, stochastic general equilibrium

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