Effects of population ageing on the pension system in Belarus

Lisenkova, Katerina; Bornukova, Kateryna Article Effects of population ageing on the pension system in Belarus Baltic Journal of Economics Provided in Cooperation with: Baltic International Centre for Economic Policy Studies (BICEPS), Riga Suggested Citation: Lisenkova, Katerina; Bornukova, Kateryna (2017) : Effects of population ageing on the pension system in Belarus, Baltic Journal of Economics, ISSN 2334-4385, Taylor & Francis, London, Vol. 17, Iss. 2, pp. 103-118, https://doi.org/10.1080/1406099X.2017.1318000 This Version is available at: https://hdl.handle.net/10419/180102 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Full Terms & Conditions of access and use can be found at http://www.tandfonline.com/action/journalInformation?journalCode=rbec20 Baltic Journal of Economics ISSN: 1406-099X (Print) 2334-4385 (Online) Journal homepage: http://www.tandfonline.com/loi/rbec20 Effects of population ageing on the pension system in Belarus Katerina Lisenkova & Kateryna Bornukova To cite this article: Katerina Lisenkova & Kateryna Bornukova (2017) Effects of population ageing on the pension system in Belarus, Baltic Journal of Economics, 17:2, 103-118, DOI: 10.1080/1406099X.2017.1318000 To link to this article: https://doi.org/10.1080/1406099X.2017.1318000 © 2017 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group Published online: 04 May 2017. Submit your article to this journal Article views: 925 View related articles View Crossmark data Effects of population ageing on the pension system in Belarus* Katerina Lisenkova a and Kateryna Bornukova b a Fraser of Allander Institute, University of Strathclyde, Glasgow, UK; b Belarusian Economic Research and Outreach Center (BEROC), Minsk, Belarus ABSTRACT Belarus currently has a relatively generous pay-as-you-go pension system, but population aging coupled with recent problems with economic growth will soon make it unsustainable. We build a rich overlapping generation model of Belarusian economy, which shows that without reform the Pension Fund will run into persistent and growing deficit, which will reach 9% of GDP by 2055. We also compute the fiscal projections of several parametric pension reforms, including the reform which will start in 2017. To avoid a deficit without reform, pension benefits would have to be substantially reduced. The increase of retirement age to 65 for both genders has a strong positive effect on sustainability of the pension system and keeps the deficit below 2% of GDP. ARTICLE HISTORY Received 27 January 2016 Accepted 21 March 2017 KEYWORDS Belarus; pension system; demography; retirement age; pension reform JEL CLASSIFICATION C68; H55; J26 1. Introduction After the dissolution of the USSR, the majority of former Soviet Union states experienced increases in mortality (Brainerd & Cutler, 2005;Ellman,1994) and sharp drops in birth rates (Adsera, 2004;Perelli-Harris,2008). Belarus was not an exception, although the increase in mortality was less pronounced than in other newly independent states, as the socio-economic changes were less drastic (Grigoriev et al., 2010; Shakhotska, 2007). The health crisis of the 1990s contributed to the decline in the life expectancy, especially among males (Cockerham, 1997; Shakhotska, 2006). In 1999 the male life expectancy at birth was only 62.2 years (World Development Indicators, World Bank, 2015), the lowest for the past 50 years. In 2000s, economic growth in Belarus picked up. It was pro-poor (Haiduk & Chubrik, 2007), and living standards improved rapidly. As economic uncertainty subdued and incomes grew, both life expectancy and fertility increased. The government also introduced maternity and child benefits, and these policies contributed to an increase in fertility (Amialchuk, Lisenkova, Salnykov, & Yemelyanau, 2014). But these positive developments were not enough to reverse the negative trend in population growth. According to the World Bank, the Belarusian population decreased from 10.2 million in © 2017 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group This is an Open Access article distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/ licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. CONTACT Kateryna Bornukova [email protected] * BEROC Working Paper Series, WP no. 28. BALTIC JOURNAL OF ECONOMICS, 2017 VOL. 17, NO. 2, 103–118 https://doi.org/10.1080/1406099X.2017.1318000 1991 to 9.5 million people in 2014. According to the UN population projections, it is expected to contract to 8.1 million people by 2050. More importantly for the pension system, the old-age dependency ratio (number of persons of retirement age per 100 workers) will almost double from 43 in 2015 to 82 in 2050 (see Figure 1). The current pension system in Belarus is a standard one-pillar pay-as-you-go scheme. The retirement age in Belarus is among the lowest in the region: in 2016 it was 55 years for females and 60 for males. The contribution rate of 29%, on the other hand, is among the highest in Eastern Europe (Zviniene & Biletsky, 2011). In 2015 the average pension benefit exceeded the poverty level 2.37 times, and constituted 42% of an average wage (Belstat, 2016). Low post-war birth rates implied that in the 2000s the cohorts entering retirement were relatively small. This favourable demographic environment allowed for a surplus in the Pension Fund. As old-age dependency worsened, 2013 became the first year with registered Pension Fund deficit. UN population projections suggest that age dependency will continue worsening until 2050 when it stabilizes, and Pension Fund deficits might become unsustainable. Belarus is currently reforming the pension system: starting from 2017 the retirement age both for males and females will increase half a year each year, until it reaches 58 years for females and 63 for males in 2022. This paper models both the reform, as the pre-reform (55/60 retirement age) scenario. Since none of the scenarios deliver the balanced Pension Fund, as a third scenario we also consider a possible more radical retirement age increase to 65 for both sexes. Many developed countries face similar challenges as their populations are ageing. A growing body of literature is analysing public pension systems with general equilibrium overlapping generation (OLG) models. De Nardi, Imrohoroglu, and Sargent (1999), for instance, study social security reform in the U.S. economy; Diaz-Gimenez and Diaz-Saave- dra (2009) study the effects of an increase in retirement age in Spain. Figure 1. Old-age dependency ratio. Source: 2010-based UN population projections (medium scenario). 104 K. LISENKOVA AND K. BORNUKOVA Zviniene and Biletsky (2011) build fiscal projections for the pension system ofBelarus using the World Bank pension reform options simulation toolkit accounting model (PROST). To the best of our knowledge, this paper is the first attempt to model the Belarusian pension system in an OLG framework, taking into account general equilibrium effects of possible reforms and macroeconomic consequences of decreasing working-age population. We find that under the current arrangements of the public pension scheme with the current replacement rate (average pensions at around 40% of average wage) the Pension Fund deficits increase up to the year 2050. The ongoing reform –the increase of the retirement age to 58/63 –will slow down the build-up of the deficit but will not solve the problem. We also show that it will be necessary to either decrease the replacement rate or increase contributions to keep the Pension Fund afloat. Delaying retirement, in particular for women, is another option, which not only improves the sustainability of the Pension Fund, but also benefits GDP growth by increasing the labour supply. The rest of the paper is structured as follows. In Section 2 we give an overview of the pension system in Belarus. In Section 3 we briefly describe the model. In Section 4 we describe the calibration of the model to Belarusian macro and micro data. Simulation results and possible reform projections are described in Section 5. Section 6 concludes. 2. The pension system in Belarus today The current pension system in Belarus was inherited from the Soviet Union. The pension system is redistributive or pay-as-you-go (current generations of workers pay contributions, which are used in the same period to pay pensions to the current retirees). The retirement age as of 2016 was 60 years for men and 55 years for women. These are among the lowest pension ages in Europe, comparable only to those in Russia and some Central Asian counties (see Table 1 for details). The only reforms of the pension system before 2017 in Belarus were the restrictions of access to work pensions, which are now paid only for those who contributed to the Pension Fund for at least 15.5 years (still very low). The minimum length of contributions is currently under further increase, with the aim to reach 20 years of contributions by 2020. In 2017 the major pension reform started. Each year starting with 2017 the retirement age would be increased half a year, until it reaches 58 years for females and 63 years for males by 2022. If the person does not meet this threshold, she/he is only entitled to the social pension, paid after the age 65 for men and 60 for women. As most developed countries have moved towards the same pension age for both sexes, Belarus remains among the group of transition countries which still have earlier retirement age for women. The social security contributions are paid to the Fund of the Social Protection of the Population (here the Pension Fund). Total pension contributions are 29% of gross wages, of which only 1% is paid directly by the employee, while the employer pays the rest. The Pension Fund is a separate and independent from the government’s budget, and there are mechanisms allowing the Pension Fund surpluses to be directed into the government budget, or for the government budget to finance the deficits of the Pension Fund. In 2015, the total amount of pensions paid out by the Pension Fund constituted 9.6% of GDP. This level of expenditure is similar to many European and transition countries. 2013 BALTIC JOURNAL OF ECONOMICS 105 was the first year of the Pension Fund deficit in Belarus –the deficit was quite small, amounting to 0.08% of GDP; in 2015 the deficit grew to 0.39% of GDP. The replacement rate (the ratio of the average pension to average wage) in Belarus is not high compared to the Organisation for Economic Co-operation and Development (OECD) countries. The OECD average is 54.5%, while the Belarusian replacement rate was 42% in 2015. The average pension in Belarus in 2015 was 2.806 mln Belarusian roubles, or 177 USD. According to the law, public pensions are indexed to average wage. Given the demographic challenges ahead, Belarus needs to reform its pension system. These changes can be parametric –changing only the features of the current pay-as-you- go system –or structural. In this paper, we focus on the sustainability of the current system and the possible parametric reforms. 3. The model The model used in this paper is designed to analyse the long-term economic implications of demographic change in spirit of Auerbach and Kotlikoff (1987). The exogenous demographic process is superimposed on the model and provides the shock or driving force behind the simulation results. The model is calibrated on the Belarusian data. Below we describe the demographic structure of the model and outline the main features of the production, household and government sectors. 3.1. Demographic structure The population is divided into 21 generations or age groups (i.e. 0–4, 5–9, 10–14, 15–19, …, 100–104). Demographic variables, fertility, mortality and net-migration rates are Table 1. Statutory retirement age across countries as of 2011. Transition countries Developed countries Armenia 63 Australia 67 Azerbaijan 58/63 Austria 65 Belarus 55–58/60–63 Belgium 65 Bulgaria 60/63 Canada 65 Croatia 60/65 Denmark 67 Czech Republic 55–61/62.5 Finland 65 Estonia 60.5/63 France 65 Georgia 60/65 Germany 67 Hungary 62 Greece 65 Kazakhstan 58/63 Iceland 67 Kyrgyz Republic 58/63 Ireland 65/66 Latvia 62 Israel 67 Lithuania 60/62.5 Italy 60/65 Moldova 57/62 Japan 65 Poland 60/65 Netherlands 65 Romania 59/64 New Zealand 65 Russian Federation 55/60 Norway 67 Serbia 60/65 Portugal 65 Slovak Republic 59.5/62 Spain 65 Slovenia 56.3/63 Sweden 65 Turkmenistan 57/62 Switzerland 64/65 Ukraine 55–60/60 U.K. 68 Uzbekistan 55/60 U.S. 67 Source: Pallares-Miralles, Romero, and Whitehouse (2012). 106 K. LISENKOVA AND K. BORNUKOVA assumed to be exogenous. Every cohort is described by two indices. The first is t, which denotes time. The second is g, which denotes a specific generation or age group. The size of the cohort belonging to generation g+kin any period tis given by the following two laws of motion: Po pt,g+k= Po pt−1,g+k+5frt−1for k=0, Po pt−1,g+k−1(srt−1,g+k−1+mrt−1,g+k−1) for k[[1, 20]. (1) The first equation simply implies that the number of children born at time t(age group g+k=g, i.e. age group 0–4) is equal to the size of the first adult age group (g+k+5=g+5, i.e. age group 20–24) at time t−1 multiplied by the ‘fertility rate’, fr, in that period. 1 If every couple has two children on average, the fertility rate is approximately equal to 1 and the size of the youngest generation gat time tis approximately equal to the size of the first adult generation g+ 5 one year before. A period in the model corresponds to five years and a unit increment in the index krepresents both the next period, t+k, and, for an individual, and a shift to the next age group, g+k. The second law of motion gives the size at time tof any age group, g+k, beyond the first generation, as the size of this generation a year ago times the sum of the age-specific conditional survival rate, sr, and the net-migration rate, mr, at time t−1. In this model the fertility rates vary across time, while the survival and net-migration rates vary across time and age. For the final generation (i.e. the age group 100–104 (k= 20)), the conditional survival rate is zero. This means that everyone belonging to the oldest age group in any period dies with certainty at the end of the period. Time variable fertility and time/age-variable net-migration and conditional survival rates are calibrated based on exogenous population projections. This permits a precise modelling of the demographic scenarios of any configuration within the model. 3.2. Production At any time t, a representative firm hires labour and rents physical capital to produce a single good using a Cobb–Douglas technology. The production function thus reads: Yt=AtK a tL1− a t, (2) where Ydenotes output, Kis physical capital, Ldenotes effective units of labour, A is a scaling factor and αrepresents the share of physical capital in output. The market in which the representative firm operates is assumed to be perfectly competitive. Factor demands thus follow from the solution to the profit maximization problem: ret= a At Kt Lt  { a −1} , (3) wt=(1 − a )At Kt Lt  a , (4) where re and wdenote the rental rate of capital and the wage rate, respectively. BALTIC JOURNAL OF ECONOMICS 107 3.3. Household sector Household behaviour is captured by 21 representative households that interact in an Allais–Samuelson overlapping generations structure representing each of the age groups. Individuals enter the labour market at the age of 20, retire at the age of 65 and die at the latest by the age of 104. Younger generations (i.e. 0–4, 5–9, 10–14 and 15– 19) are fully dependent on their parents and play no active role in the model. However, they do influence the public expenditure. An exogenous age/time-variable survival rate determines life expectancy. Adult generations (i.e. age groups 20–24, 25–29, …, 100–104) optimize their consumption-saving patterns over time. The household’s optimization problem consists of choosing a profile of consumption over the life cycle that maximizes a constant elasticity of substitution inter-temporal utility function, subject to the lifetime budget constraint. The inter-temporal preferences of an individual born at time tare given by U=1 1− u  20 k=4 P k l=4 1 1+ r g+l  P k m=0srt+m,g+m((Cl+k,g+k)1+ u )  , (5) where Cdenotes consumption and u represents the inverse of the constant inter-temporal elasticity of substitution. Parameter r is the pure rate of time preference, and is age-vari- able. 2 Future consumption is also discounted at the unconditional survival rate, ksrt+k,g+k, which is the probability of survival up to the age g+kand period t+k. It is the product of the age/time-variable conditional survival rate, sr t+k,g +k , between periods t+kand t+k+ 1 and ages g+kand g+k+1. The household is not altruistic, i.e. it does not leave intentional bequests to children. It insures its future via a perfect annuity market, as described theoretically by Yaari (1965, case C) and implemented in an OLG context by Börsch-Supan, Ludwig, and Winter (2006). The household’s dynamic budget constraint takes the following form: HAt+1,g+1=1 srt,g ×[YL t,g(1 − t L t−Ctrl)+Penst,g+(1 +rt[1 − t K])HAt,g−[1 + t c]Ct,g], (6) where HA is the level of household assets, ris the rate of return on physical assets, τ K is the effective tax rate on capital, τ L the effective tax rate on labour, τ C the effective tax rate on consumption, Ctr is the contribution rate to the public pension system, Y L is the labour income, Pens is the level of pension benefits. The intuition behind the term 1/sr is that the assets of those who die during period tare distributed equally between their surviving peers. Therefore, if the survival rate at time tin age group gis less than one, then at time t+ 1 everyone in their group has more assets. This is the mathematical description of the perfect annuity market. Labour income is defined as YL t,g=wtEPt,gLSt,g, (7) where LS is the exogenously given supply of labour. It is assumed that labour income depends on the individual’s age-specific productivity. In turn, it is assumed that these age-specific productivity differences are captured in age-earnings profiles. These 108 K. LISENKOVA AND K. BORNUKOVA productivity profiles are quadratic functions of age: EPt,g= g +( l )g−( c )g2, g , l , c ≥0, (8) with parametric values estimated from micro data (as discussed in the calibration section). Differentiating the household utility function, subject to its lifetime budget constraint, with respect to consumption yields the following first-order condition for consumption, commonly known as Euler equation: Ct+1,g+1=[1 +[1 − t K]rt+1 (1 + r t)  1/ u Ct,g.(9) It is important to note that, since survival probabilities are present in both the utility function and the budget constraint, they cancel each other out and are not present in the Euler equation. 3.4. Investment and asset returns The law of motion for the capital stock, Kstock, is: Kstockt+1=Invt+(1 − d )Kstockt, (10) where Inv represents investment, δis the depreciation rate of capital. Capital markets are assumed to be fully integrated. This implies that financial capital is undifferentiated from physical capital, so that the no arbitrage condition holds: 1+rt=ret+(1 − d ), (11) where rand re denote the net and gross rates of return to physical capital, respectively. 3.5. Government sector The Government’s budget constraint reads:  g Popt,g{( t L t+Ctrl)wtEPt,gLSt,g+ t cCt,g+rtHAt,g}=Govt+ g Po pt,gPenst,g, (12) where Gov is public consumption. The left-hand side of the constraint contains the government revenues. The right-hand side represents different categories of government expenditure, including transfers to households and pension benefits. Note that the pension programme in our model is a part of the overall government budget, and transfers from the general government budget finance the Pension Fund deficits, which is defined as the difference between the total pension contributions collected and the total pension benefits paid out. Public expenditures per person (GEPC) are fixed per person and hence total expenditure (Gov) depends only on the size of the total population (TPop). Govt=TPo ptGEPC.(13) In the simulations presented in this paper, we use the wage tax rate, t L t, as the only endogenous policy variable that adjusts in every period to achieve a balanced government BALTIC JOURNAL OF ECONOMICS 109 their savings to compensate for that. Higher savings lead to higher level of capital and ultimately higher level of output and consumption. This option in a sense is equivalent to partial substitution of public pension for private defined contribution pensions, which is often discussed as an alternative pension reform option. Another interesting point about this policy scenario is that cohorts born before 1990, which already started their working career by the time the policy change is introduced, will face lower lifetime welfare. We cannot show them on this chart since we do not have their complete life cycles (period before 2010 is not modelled). The reason for this lower welfare is that their optimization choice (which they made before the new policy was introduced) becomes sub-optimal after the policy change. 6. Concluding remarks The process of population ageing presents a serious challenge for the Belarusian economy. Our estimates suggest that it will result in a 16% drop from potential per capita GDP by 2050. But one of the most urgent consequences of population ageing is the persistent deficit in the pension system. The Pension Fund has been in the deficit since 2013, but our results suggest that deficits will grow in the future and, under the current pension system, it will reach 9% of GDP annually by 2055. We estimate the possible effects of two parametric reforms: decreases in replacement rate and increases in retirement age. We find that retirement age increase would be very effective, as it works not only through the decrease in pension payments, but also via increases in the labour supply and GDP. If retirement age for both males and females is increased to 65 years, the Pension Fund deficit will not exceed 3% of GDP. Increasing the retirement age by three years, as currently planned, will keep the deficit below 7% of GDP. We did not look at the scenarios that involve an increase in pension contribution rate, because it is already one of the highest in the region. Without a substantial increase in retirement age or an increase in contributions, the replacement rate will have to decrease. This will result in 34% reduction in the living stands of retirees relative to workers by 2055. Notes 1. Most of the post-Soviet countries experience changes in the fertility behavior, with the first births happening later (see, e.g. Melihovs (2014) about the Latvian experience, or Shakhotska (2007) on Belarus). We are using existing population projections to calibrate a simplified ‘fertility rate’used in this model. It would be possible to disaggregate it and use age-specific fertility rates but this would not make any difference to the demographic shock and hence our results. 2. Several empirical studies show that individuals have the age-variable rate of time preference (Attanasio, Banks, Meghir, & Weber, 1999; Bishai, 2004; Trostel and Taylor, 2001). Introducing age-variable rate of time preference allows us to replicate observed bell-shaped consumption profile. For detailed discussion, see Georges, Lisenkova, Mérette, and Zhang (2016). 3. Since pensions are indexed to the growth of wages, the TFP growth does not affect the share of pension expenditure in GDP. Hence, the assumption on TFP growth does not affect the results regarding the financial stability of the Pension Fund. We made simulations with 1% growth as well, and the outcome was not significantly different. 116 K. LISENKOVA AND K. BORNUKOVA Disclosure statement No potential conflict of interest was reported by the authors. Notes on contributors Katerina Lisenkova is Head of Economic Modelling at the Fraser of Allander Institute since 2016. Her research interests are in the areas of population economics, demographic change, public finance, economics of migration, regional economics, economics of education and macroeconomic modelling. Previously, Katerina worked at the National Institute of Economic and Social Research (NIESR) where she was leading a team developing and using the National Institute General Equilibrium model of Ageing (NiAGE). Kateryna Bornukova is Academic Director at BEROC. Her research interests are macroeconomics of labour supply, female labour force participation, economic growth and transition. Kateryna has also been a consultant for the UN and the World Bank. ORCID Katerina Lisenkova http://orcid.org/0000-0003-0264-9797 Kateryna Bornukova http://orcid.org/0000-0001-9534-0953 References Adsera, A. (2004). Changing fertility rates in developed countries. The impact of labor market institutions. Journal of Population Economics,17(1), 17–43. Amialchuk, A., Lisenkova, K., Salnykov, M., & Yemelyanau, M. (2014). Economic determinants of fertility in Belarus. Economics of Transition,22(3), 577–604. Attanasio, O., Banks, J., Meghir, C., & Weber, G. (1999). Humps and bumps in lifetime consumption. 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