Who cares about the day after tomorrow? Pension issues when households are myopic or time inconsistent

• Author: Axel Börsch‐Supan,Klaus Härtl,Duarte Nuno Leite
• Published date: 01 August 2018
• DOI: http://doi.org/10.1111/rode.12372
• Date: 01 August 2018

SPECIAL ISSUE ARTICLE

Who cares about the day after tomorrow? Pension

issues when households are myopic or time

inconsistent

Axel B€

orsch-Supan

1,2,3

|

Klaus H€

artl

1,2

|

Duarte Nuno Leite

1,4

1

Munich Center for the Economics of

Aging (MEA) at the Max Planck

Institute for Social Law and Social

Policy (MPISOC), M€

unchen, Germany

2

Technical University of Munich (TUM),

M€

unchen,Germany

3

National Bureau of Economic Research

(NBER), Cambridge, MA

4

Center for Economics and Finance at

University of Porto (CEF-UP), Porto,

Portugal

Correspondence

Duarte Nuno Leite, Munich Center for the

Economics of Aging (MEA) at the Max

Planck Institute for Social Law and Social

Policy (MPISOC), Amalienstrasse 33,

D-80799 M€

unchen, Germany

Email: semedo-leite@mea.mpisoc.mpg.de

Abstract

Pension economics has traditionally guided pension policy

with the help of formal models based on individuals who

think in a life-cycle context with perfect foresight, full infor-

mation, and in a time-consistent manner. Associated macro

models were mostly based on a single country. This paper

sheds light on several aspects of pension economics when

these assumptions do not hold using—to our knowled ge—

the first multi-country model of procrastinating households.

Our focus is on the interaction between the share of procrasti-

nators in a country, the speed and extent of population aging,

and the size of an existing PAYG-DB pension system. Start-

ing from the insight that procrastination reduces the volume

of savings, we focus on three questions that are particularly

relevant for the quickly aging Asian economies: What are the

consequences for the balance between pay-as-you-go and

fully funded pension systems? Where will retirement savings

be invested in a globally linked world with very different

pension systems and demographics? How large are global

spillover effects of pension reforms in one region for the

other regionsin the world?

1

|

INTRODUCTION

The uncertain future of public and private pension systems is a topic of high priority and large

controversy. The pressures on pension systems are particularly pronounced in Europe and Asia—

in Europe, because the number of retirees per number of workers is already very high and still

DOI: 10.1111/rode.12372

Rev Dev Econ. 2018;22:953–989. wileyonlinelibrary.com/journal/rode ©2018 John Wiley & Sons Ltd

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953

increasing until about 2050, and in Asia, because the speed of population aging is so fast. This

strain will affect all types of pension systems, whether they are pay-as-you-go (PAYG), full y

funded (FF), defined benefit (DB), or defined contribution (DC), albeit to a different extent.

Figure 1 shows the demographic pressure, expressed by the support ratio—the number of work-

ing age individuals, defined as ages 15 to 64, divided by total population size—for the four coun-

tries/country groups that will be the focus of this paper.

Japan features the most progressed aging process in the world and it has a large PAYG-

financed public pension system. EU3 represents the three largest countries of Continental Europe

—France, Germany, and Italy. These countries have also substantially aged and have similarly

large public PAYG pension systems as Japan. In contrast, the United States has a much smaller

social security system and a much less pronounced population aging process. Finally, Asia2

denotes the two countries with the largest population in Asia, China and India, which have very

small pension systems and are still young, but will face a very fast aging process in the future.

After 2050, the Asia2 countries will actually have a lower support ratio than the United States (as

shown in Figure 1). These international differences in the demographic development have impor-

tant economic implications as they may induce capital and labor movements between faster and

slower aging countries (e.g., Brooks, 2003; Fehr, Jokisch, & Kotlikoff, 2003; Domeij & Floden,

2006, Attanasio, Kitao, & Violante, 2007; B€

orsch-Supan, Ludwig, & Winter, 2007), which in turn

have implications for national pension systems.

A large number of older individuals per working age population in a country exerts pressures

on the economy of a country since pension expenditures demand a high share of GDP. The align-

ment between the extent of population aging and pension expenditures, however, is far from per-

fect (Figure 2). Most European countries have pension expenditures significantly above the

regression line (Italy, Austria, France, and Poland), while most Asian countries have much smaller

pension systems relative to their demographic status (Japan, Korea, Australia, and New Zealand).

This is mainly due to the many design differences between national pension systems. When study-

ing the impact of population aging on pension expenditures, particularly in an internationally com-

parative context, it is therefore important to take account not only of international differences in

demography but also these design differences.

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

Support rao (in %)

Year

Asia2

US

EU3

Japan

FIGURE 1 Support ratio in the United States, European Union and Asia [Color figure can be viewed at

wileyonlinelibrary.com]

Source. EU3 and United States: Human Mortality Database (2008). Japan and Asia2: United Nations (2012)

Population Trends. Support ratio is population aged 15 to 64 divided by total population size.

954

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B€

ORSCH-SUPAN ET AL.

In order to do so, pension economics has traditionally employed formal models based on indi-

viduals in overlapping generations who think in a life-cycle context with perfect foresight, full infor-

mation and in a time-consistent manner (e.g., Auerbach & Kotlikoff, 1987; Feldstein & Samwick,

1998). There is, however, a large body of evidence indicating that individuals fail to make decisions

in a time-consistent manner, lack full information and are much more present-oriented than assumed

in the perfect foresight life-cycle model. Opinions among citizens range from complete ignorance

about how serious the challenges are to the equally faulty belief that pension systems are doomed to

a complete failure (Boeri, B€

orsch-Supan, & Tabellini, 2001, 2002; Walker, Reno, & Bethell, 2014).

In many countries, one can also observe the widespread failure to provide sufficiently early and

consistently for retirement income in the sense that such saving is sufficient to offset actual and

future benefit cuts (B€

orsch-Supan, Bucher-Koenen, Coppola, & Lamla, 2015, B€

orsch-Supan,

Bucher-Koenen, Ferrari, Kutlu Koc, & Rausch, 2016, for Germany; Knoef et al. (2016), for

Netherlands; and Crawford & O’Dea, 2012, for the United Kingdom). In the United States, such

undersaving for retirement has received widespread attention (Poterba, Venti, & Wise, 2012;

Repetto, Laibson, & Tobacman, 1998; Madrian and Shea, 2001).

Individuals seem to realize these failures—but too late. B€

orsch-Supan, Hurd, and Rohwedder

(2016) conducted an Internet survey among individuals aged 60 and older. The results of the sur-

vey show a substantial prevalence of regret over previous saving decisions. Sixty percent of the

respondents wished that they had saved more when they were younger. High demand for commit-

ment devices, even when they are costly, provides more evidence to this finding (Rabin, 2013a,b;

Ashraf, Karlan, & Yin, 2006; Beshears, Choi, Laibson, Madrian, & Sakong, 2011).

In order to tackle this evidence, several strands in the literature emerged. A first strand enriches

the neoclassical textbook model of time-consistent households by elements that justify the

Australia

Austria

Belgium

Canada

Chile

Czech Republic Denmark

Estonia

Finland

France

Germany

Greece

Hungary

Iceland

Ireland

Israel

Italy

Japan

Korea

Luxembourg

Mexico

Netherlands

New Zealand

Norway

Poland

Portugal

Slovak Republic

Slovenia

Spain

Sweden

Switzerland

Turkey

United Kingdom

United States

OECD R² = 0.5869

0

5

10

15

20

5.04.03.02.

0

1.0

Pension expenditures

Dependency rao

FIGURE 2 Pension expenditures (percent of GDP) by old-age dependency ratio [Color figure can be viewed at

wileyonlinelibrary.com]

Source. Pensions at a glance (OECD, 2015). Old-age dependency ratio is population age 65+ divided by population

of age 15 to 64 (2013 data). Public and private pension expenditures are share of GDP (2012 data).

B€

ORSCH-SUPAN ET AL.

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955