Topic 1: The Swedish Pensionssystem and the challenge from an aging population

Sweden among many other countries are facing an aging population in the sense that longevity,
i.e. average life span expected, are increasing, which put pressure on the social insurance
system – the public pension system. Analyze using relevant microeconomic theory this problem
and discuss potential solutions.

According to the annual report of the swedish pension system, the orange report, total income
earned by workers in Sweden in 2016 amounted to about sek 1,709 billion. Out of the total
income, 471 billion was set aside for pension purposes of which 297 billion was for the national
pension. The swedish agency paid out 289 billion in income and premium pension.

Pension pay out ratio = pension paid out/ pension contribution collected *100%
=97.3%

This chapter is broadly divided into fivesections. First section discusses the future of capitalism
on the basis of the classical writer’s theories. In the second section, ‘perennial gale of creative
destruction’ is explained. The third section provides alternative definition of competition. These
three sections actually pave the way for fourth section; which is Schumpeter’s defense of
monopoly capitalism. In the last section, Baran’s arguments are advanced which criticizes
monopoly form of capitalism for there are in built mechanisms in monopoly capitalism that
impede progress.
The kingdom of sweden has always been considered as one of the nations with the oldest
populations in the world. According to statistics from SCB, the national agency responsible for
maintaining relevant data concerning sweden, swedish citizens above the age 65 years currently
represent 19.8% of it’s current population of 10.1 million. The labour force represents the highest
bulk of it’s population with a percentage of 59.2%. Among the labour force, swedish citizen above
the age of 40 years represent over fifty percent of the labour force. This, coupled with the
projected growing life expectancy of swedish citizen is likely to produce a resultant effect of an
ageing population.

An ageing population poses different social and economic implications for the society such as
reduced labour force, increased health cost for the elderly, increased pressure on the pension
system, reduced tax revenue among others. Key among these implications is the expected
increase in pressure on social insurance institutions such as the pension system. The swedish
pension reform in the 1990s restructured the old pension system in such a way that 16% of the
contributions of the labour force to the pension system is expended on current pensioniers, in
exchange for a promise of contribution upon retirement of the labour force.
This poses a challenge in the sense that pension funding for the elderly is expected to grow as
the ageing population grows and the reduced labour force may not be sufficient to cater to the
needs of large aged population posing a potential possibility of market failure. Short term
solutions to increase pension contribution make backfire on the government, if citizens are
discouraged to work less due to the pressure of the tax system. It is therefore clear that
government needs to intervene in the situation to prevent a less than desirable result for the
pension system which could set off a chain of events in the economy.

This paper aims to examine the problem of the increased pressure on the swedish pension system
caused by an ageing population using relevant microeconomic theory.
Theoretical framework

According to Nicholas barr, pension systems can be classified into different types based on 2
major subject focuses:
 The way the pension system is organised
 The relationship between individuals contribution and the benefits received.
There are three major ways of organising a pension system. It could be a fully funded, partially
funded and pay as you go (PAYG) . A fully funded pension system is one which consist of a fund
that has built from contributions over the years, inclusive of interest earned from financial assets
invested in, with the contributions. A PAYG on the otherhand is one which relies on current
pension contributions to pay out pension benefit. In otherwords the working labour force in the
current time, funds the pension benefit of the old. When the working force members retires,
their pension funds will in turn be funded by the next labour force. This essentially implies that a
generations benefit is not limited to the contributions made by the generation.
When looking at the relationship between contributions and benefits, pension systems can be
classified as either defined contribution schemes, defined benefit schemes or notional defined
contribution schemes. Defined contribution schemes relates to pension schemes where the
benefit of the individual is a factor of his contributions. Defined benefit schemes on the other
hand, the benefit is determined by the wage history and number of years the pensioner had
worked. The Notional defined contribution scheme is similar to a defined contribution scheme,
in that contributions are monitored and serve as the base for pension benefits. However the
contributions may not be invested in any financial assets and interest earned on the contribution
is determined by the government.
The swedish pension system
In 1913, Sweden became the first country to institute what is known as a universal pension
system. This was in response to the problem of increased social pressure on the muncipalities
due to the aged populace. Large numbers of swedish citizens migrated close to the turn of the
century to seek greener pastures during the industrial revolution, living the older citizens behind
in the care of the local authorities. This coupled with the low fertility rates compounded the
problem of the aging populace. As a response to the problem presented, a reform took place to
institute a pension system which covered the entire populace, the universal pension system. The
pension system instiuted was a defined contributory pension system funded mainly by individual
contributions. However, it was plagued with a problem common to most newly instituted funded
system, the pensions system needed a lot of time to make any meaningful impact on the
populace. As such another reform was well underway given, the general discontent from the
public.

In the early, 1940s a commision was set up and charged with the responsibility of providing
solutions to challenges faced by the swedish society, key among this was the matter of the
inadequate pension system. Proposals in response to the challenge of the pension system where
examined by the commission until a particular proposal ganered lots of favour from the populace.
It was a proposal to institute a flat pension rate known as the folkpension where everyone was
entitled to a more equitable pension sum than the previous contributory pension system. In
1946, the folkpension sytem was voted by the parliament to replace the then existing pension
system. Following the introduction of the folkpnsion, there was a noted improvement in the
standard of living for the elderly. However pension sums to the old were still relatively below
average income levels. High income earners unsatisfied with the provisions of the pension system
began to negotiate arrangements for pension in consideration of employments. Low income
earners on the otherhand had very low bargaining power and as such could not negotiate for
pension arrangements in their terms of employment. The implication of this situation was that
low income pensioners were left only to the means of their basic pension fees in the face of rising
price levels and a decline in real income. There was once again a growing disconcertment in the
eyes of the general populace.

Once again a commision was launched and charged with the responsibility of finding a solution
to the identified problem of sustainaning living standards among old pensioners. This led to the
third and possibly the most controversial reform in the Swedish nation. The year 1960 saw the
introduction of the pension system known as the ATP. The ATP was a Pay as you go pension
system with sort to reconcile the pension sum received by pensioners with their level of income
prior to retirement. Pension sum received were based on the 15 highest earning years of the
pensioner and required a minimum of 30 years of pension contribution to qualify for the full
pension benefits of the ATP system. This system gave gross advantanges to some generations
while leaving other generations disadvantaged. ”These features taken together made the ATP-
system both unsustainable and unfair, both between and within generations. Furthermore, the
15- and 30-year rules, apart from redistributing from workers with many years in the labour
market and flat life earnings profiles (usually blue-collar workers) to people with fewer
working years and steeper earnings profiles (white-collar workers), subsidised leisure, which
undermines a pay-as-you-go system.” A. Kruse

in response to the unfairness of the ATP, pension commissions where charged with the
investiagtion of more acceptable solutions to the challenges of the pension system. In 1999, a
reform was introduced and this reform has since been adopted till date with slight modifications
to the system. The current swedish pension system shall be examined in details in the subsection
below

Curent statististics
Ratio of pensioners from age 61, to ratio of labour force
Table showing the ration in the next 30 to 40 years
The current swedish pension system

The current pension system was designed as a 3 tier pension system:

 The Guaranteed pension
 The inkomstpension
 The premium pension

The guaranteed pension served as a safety net for low income earners. It was designed to keep
the most disadvantaged pensioners out of poverty and funded from government taxes. The
individual contribution rate is 18.5%, out of which 16% goes to the inkomstpension and 2.5%
goes to the premium pension. The individual is free to invest the amount that goes to the
premium pension in any fund of his/her choice. As a result growth in the premium pension is
subject to the annual performance and returns of the funds invested in. The inkomstpension on
the otherhand is managed by the state. The set up of the inkomstpension is such that each
indiviual seemingly has a notional account which is topped up with a notional interest rate
annually. The monthly pension sum is then adjusted for life expectancy upon retirement

In sweden, an individual has the choice to decide on the manner in which the persons pension
funds can be drawn. He/she can begin withdrawing from their pension funds at the age of 61 and
can decide whether to draw part or the whole pension fund at once.

The major part of the Swedish system is a pay-as-you-go system. Such systems
build on trust, trust between generations. The working generation paying contributions
that are used for disbursement of benefits to contemporary pensioners does so
in the hope that (being convinced) future generations will do the same when they
are pensioners. A first prerequisite for this implicit social contract between generations
to hold up is financial stability, discussed in the previous section. A second
one is political sustainability.

Data

The theory of demographic transition staed that every country goes through three stages of
demographic transaitions. The first stage is a population where death rates and birthrates are
relatively high. This stage is typical of underdeveloped countries which are yet to have
developed their health insurance industries along with other social infrastructure that may be
pertinent for the reduction of birth rate and death rate. The second stage postulates that after
going through the first stage, death rates decline while the birth rates are still relatively high.
The theory postulates that in the final stage of a country, where development has been
achieved, the birth rates begin to fall while the death rates remain. This is driven mainly by the
disregard of traditional familiy beliefs by the educated populace. At this stage population
growth begins to slack

The graph below shows the expected growth in life expectancy in Sweden due to advancement
in health care systems and other social institutions. The projections expect a steady and
positive increase in life expectancy of swedish citizens
The second graph below illiustrates the fertility rate projections for sweden over the next 60
years. From the graph we can deduce there is an expected rise in birth rates over the next
deceade. However as the decade comes to an end, the country is expected to witness steeper
and steeper growth until the eventually halt in growth. From the theory aforementioned, we can
see that the nation of sweden is fast approaching the thrid stage of demographic transition.

Fertility
1.90

1.85

1.80

1.75

1.70

1.65

1.60

1.55
2038
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036

2040
2042
2044
2046
2048
2050
2052
2054
2056
2058
2060
2062
2064
2066
2068
2070
It is clear from the analysis of the above graphs that with increasein life expectancy and yhe
decrease in fertility rate growth, the population would tend to an ageing population. What
exactly is the implication of this population statistics. By just amount does this aging population
affect the pension system being examine? We look at the third graph for further details.
Source : RAMS (Register-based labour market statistics), Statistics Sweden and the
Forecast Institute, Statistics Sweden (for the forecast). Note: Time series breaks in 1993
and 2004.
The graph above shows projections on the dependency ratio in sweden. From the graph we can
deduce that the dependency ratio is expected to tend upwards at an increasing rate. This
statistics would tend upwards in consideration of the other factors illustrated graphically abive.
With life expectancy tending to increase and fertility rate slowing to a constant, the
consequences are definitely increased social burden on the pension system.

As mentioned in section 3, we note that a payg pension system is one which relies on the
contribution of the current labour force to finance the benefit of the current pensioneers. In
other words it is based on the principle of continuity and trust. Continuity in the sense that the
labour force is expected to be available till perpetuity to finance the benefit of the old, and trust
in the sense that, workers have to hold on the promise that when they eventually retire, they will
receive their benefits from the existing labour force.

The current swedish pension system is predomminantly a payg system as such is subjected to the
payg assumptions. Although the lauour force is expected to remain, the most likely scenario from
the dependecy statistics analysed above indicate that the current contributions will not be able
to sustain the pensiioneers in the future years in the face of increasing life expectancy. This
presents a delicate situation in that the most obvious action to increase pension contributions to
caver the rising costs would most likely have indirect effects, such as a change in behaviour. The
labourers would be discouraged to work hard to avoid higher taxes. If such behaviour is exhibited
this would only amplify the situation. We therefore face a basic problem of public finance which
asks how should the goverment intervene.

Recommendations
An obvious solution is to increase the retirement age, but this would have only a short term effect
and would not be sustainable in the long run, since there is a limit to the amount of age increase
that could be made without having a trade off in decling health of the old. This solution does not
adequately tackle the problem at hand
One solution to this problem addresses the problem of the ageing population rather than the
design of the pension system. This is for the country to increase immigration into the country
while simultaneously increasing the quality of assimilation programs in order to mitigate the
negative effects of increase immigration. An increase in immigration rate, would provide the
labour force the much neededd man power to reduce the burden on the labour force.

Another solution is to increase the expenditure on the social system without increasing the
contribution rates of the workers. This can be acheived by the privatization of certain services
provided by the government in order to lower government expenditure on the sector and divert
funds to keep up with the rising cost of pension benefits. Increase private participation in
education and energy among others should be encouraged, as there are instances of private
sector provision in these sectors in other countries. Taking advantage of decrease interests in a
public sector spending should be done, the entire budgets should be reviewed and structured to
withstand cuts and diversion in areas without making any significant damage
The government should also look to expanding its role in the international market to provide
alternative sources of revenue. Take for instance china and its numerous trade deals that provide
alternative sources of revenue. This serves to fund public expenditure on pension system.

The emphasis on these solutions proferred is on curbing the problem of the aging population and
not on the pension system, this is because the sewdish pension system is a well designed pension,
which serves as best practice, it is designed to mitigate risk against Problems. The last solution
is to increase the premium pension rate and reduce the income pension to an optimal rate that
allows individuals invest more with the chance of earning more returns. This strategy requires
slow implementation so the effect of the change does not negatively impact pensioneers with
reduce funding

One or more these recommendations can be combined to achieve optimal effects on the problem
of the aging population on the pension system

Glossory
Aging populace definition
References
https://www.justlanded.com/english/Sweden/Sweden-Guide/Jobs/Old-age-pensions-in-
Sweden
http://www.economicsdiscussion.net/theory-of-population/top-3-theories-of-population-with-
diagram/18461
http://www.scb.se/en/finding-statistics/search/?query=public+expenditure&lang=en