International Forum on Pension Reform Bled, Slovenia June 7-9, 2007

1. Making Pension Reform Work:The Link to Labor and Financial Market ReformsRobert HolzmannWorld Bank International Forum on Pension Reform Bled, Slovenia June 7-9, 2007

2. Key messages • Pension reform under an aging population is a world-wide reform agenda • Without deep structural reforms expenditure for public pension (and health) risk to derail fiscal policy for decades to come • Solutions for pensions (compared to health) are relatively straightforward and limited • Yet to be successful, this requires parallel reforms in the labor and financial market, and beyond Enhancing Job Opportunities in ECA

3. Roadmap • Demography: Aging and fiscal implications • Public pensions: What are the reform drivers, options, and lessons? • Labor Market: Key to solution but how to keep the elderly employed? • Financial market: Funded pensions are gaining importance but need a ready market • Conclusions and next steps Enhancing Job Opportunities in ECA

4. I. Demography: Aging and fiscal implications • All the world will experience severe aging over the decades to come, including the low income countries • In Europe ageing is already well advanced and will continue due to fertility rates well below reproduction (around 1.4 compared to 2.1) and rising life expectance • Central and South-Eastern Europe is expected to age even faster due to negative net-migration, and labor force may shrink by almost 1% p.a. till 2050 • Without further reforms, in some countries of the region public pension expenditure would increase by 6+% of GDP by 2050 (compared to reform countries) Enhancing Job Opportunities in ECA

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6. II. Public Pensions: Reform Drivers • Fiscal Pressure • Short-term pressure and consequences of un-sustainability: macro instability and crowding-out of other social expenditure • Long-term pressure and aging of population (Annex table) • Need to align Systems with Socioeconomic Changes • Increase in life-expectancy and old-age pension • Increase in life-expectancy and disability pension • Female labor force participation, divorces and widow’s pensions • Challenges and Opportunities in Globalization • Reacting to shocks – the need of flexibility • Mobility across professions and countries • Financial Sector development – a crucial element to a absorb shocks and to diversify risks Enhancing Job Opportunities in ECA

7. Pension Reform Options • The reform options for fiscal balance are limited • Higher contributions (or budget transfers) • Lower benefits • Later retirement: Splitting the gain in life expectancy between more leisure and more work • Benefit design options, and trade-offs • Defined benefits (DB) or defined contribution (DC) schemes • Balancing equity and efficiency (incl. incentives) • Funding options, and intergenerational re-distribution • Pay-as-you-go (unfunded) or pre-funding • (Some) funding helps, but no panacea against aging Enhancing Job Opportunities in ECA

8. Re-defining the Dependency Ratio in EU25 …… to keep it constant Source: Eurostat 2005 Demographic Projections Enhancing Job Opportunities in ECA

9. Reform trends and lessons • Move toward multi-pillar scheme with • Zero pillar providing poverty alleviation for elderly • Reformed unfunded first pillar, with better contribution benefit link and higher retirement ages • Often new second funded pillar (see annex table) • New/revamped voluntary and funded pillar • Country innovations • Notional Defined Contribution System to reform first (unfunded and earnings-related) pillar (Sweden, Latvia, Poland, Italy) • Clearing house approach to reduce costs of funded schemes (Sweden, Poland, Argentina, Croatia, and soon Chile?) • Transforming severance benefits into funded combined unemployment/retirement benefits (Austria, Korea, Italy, Chile) • Introducing nation-wide voluntary schemes with opting-out option (NZ, UK) • Toward harmonization/coordination of schemes across occupations, sectors and countries (for equity and portability reasons) – challenge for European Union Enhancing Job Opportunities in ECA

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11. III. Labor Market Reforms • Number of jobs in an economy is not fixed • Fallacy of lump of labor • Withdrawing elderly from the labor market does not create sustainable jobs for younger cohorts • With increasing life expectancy elderly want to work longer, if they find a job • Job creation requires multi-sector approach – MILES to go • Incentives matter for both labor supply and retirement decisions, and labor demand by firms Enhancing Job Opportunities in ECA

12. Retirement Incentives Matter:Implicit tax on remaining in work Enhancing Job Opportunities in ECA Source: Gruber and Wise (1999) and Hofer and Koman (2001)

13. Retirement Incentives Matter:Net replacement rate at retirement Sources: Casey et al. (2003), and Burtless (2007) Enhancing Job Opportunities in ECA

14. Supply-side incentives to retire early • Insufficient (or non-actuarial) adjustment for early/delayed retirement • High net-benefit level (replacement rate) that are typical for unsustainable schemes • Earnings-test: Reduction in benefits while continue working • Low minimum retirement ages (and social pressure to retire) • Special early retirement programs, including for long-term unemployed and generous disability programs • Tax treatment of contributions and benefits Enhancing Job Opportunities in ECA

15. Keeping and creating demand for elderly workers • Addressing the productivity-wage gap for elderly • Moving the u-shaped productivity profile upward • Making wages more adjustable/reviewing the seniority principle • Strengthening life-long learning • Including training in wage negotiations • Creating flexibility across learning, working and (retirement) leisure • Creating mobility • Between sectors, countries and regions • Between different stages of family life and family structures (e.g. child bearing, divorce) • Between positions/status across the life-cycle Enhancing Job Opportunities in ECA

16. III. Financial Market Reforms • Trend toward multi-pillar scheme and hence funded pensions will continue • By design - introduction of second pillar (e.g. Bulgaria, Croatia, Macedonia, Slovakia, etc.) • By default/design – making the first pillar less generous and supporting voluntary schemes (Austria, Czech Republic, Germany, Slovenia?) • In Central, Eastern, and Southern Europe the savers-/dis-savers ratio will increase for the next decade providing conditions for funding • Yet the financial sector must be able to deliver adequate risk-adjusted rates of return and actuarially fair annuity products Enhancing Job Opportunities in ECA

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18. Readiness of the Financial Sector • General readiness indicators include • Macroeconomic stability • A sound financial infrastructure • An adequate regulatory and supervisory capacity • A government’ commitment for continue structural reforms • Countries in the region made main progress over last 15 years but more in banking than in non-banking areas (EBRD indicators in Annex) • Confirmed by more detailed readiness study for selected countries Enhancing Job Opportunities in ECA

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20. Scaling-up for more and more diversified pension fund portfolio • Pension fund portfolio in the region still largely dominated by government bonds • Diversification toward equity capital needed to deliver on return expectations • International diversification – but how much • Domestic share market – would it be able to absorb additional 1% of GDP p.a. • How to develop investment opportunities in equity capital in a bank-based environment Enhancing Job Opportunities in ECA

21. IV. Conclusions • The primary solution for pension and other social programs to address population aging is through higher labor force participation, in particular for elderly workers • This requires changes in worker’s incentives, such as benefit/contribution structure to stay in formal labor, and firm incentives to hire and keep elderly workers • Pension reforms will by default or design give more role to funded provisions. For pension funds to deliver the adequate rates of return will require major and sustained reforms in financial sector Enhancing Job Opportunities in ECA

22. References • Holzmann, R., Richard Hinz, and Bank Team, 2005. Old-Age Income Support in the Twenty-first Century: An International Perspective on Pension Systems and Reform, Washington, DC: World Bank. • Holzmann, R. R.N. Bebczuk, A. R. Musalem. 2007. Aging Populations and Financial Markets: Global Challenges and Regional Perspectives for Central, Eastern and Southern Europe, World Bank/ERSTE Foundation, in preparation. • Queisser, M. and E. Whitehouse. 2006. Neutral or Fair? Actuarial Concepts and Pension-System Design. OECD Social, Employment and Migration Working Papers, No. 4. Paris: OECD. • OECD. 2006. “Retirement Incentives”. Special Issue of “Pension at a Glance”. Paris: OECD. In print. • Whitehouse, ED. Pension Panorama: Retirement-Income Systems in 53 Countries. Washington, D.C. World Bank and OECD. • World Bank. 2005. Enhancing Job Opportunities in Eastern Europe and the Former Soviet Union. Washington, DC: World Bank. Enhancing Job Opportunities in ECA

23. Annex • Demographic Structure 2000 and 2050 (Source UN 2005) • Second Pillar Reforms in Transition Economies (Source: World Bank) • Public Pension Expenditure Projections for EU25 – 2004-2050 (Source: EU Commission) • Transition Indicator Score: Banking (Source: EBRD) • Transition Indicator Score: Non-Banking (Source: EBRD) Enhancing Job Opportunities in ECA

24. Enhancing Job Opportunities in ECA Source: UN Demographic Projections 2005

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