This action might not be possible to undo. Are you sure you want to continue?
1 z 10
In a recent conversation with an economist colleague I asserted that the change to a private pension system without changes in the size of contributions to it couldn’t have an aggregate effect on the performance of the system. The essence of pensions is that claims arising with firms and their employees must be redirected to retirees who lack incomes arising from current productive activity. Whether that takes place by means of taxes (that is, contributions to a state system) and payment of benefits by the state, or through contributions to private pension funds, which then pay out benefits to their retiree clients, the same thing has to happen: firms and their employees must relinquish a part of their purchasing power in favor of retirees. The key data are the ratio between workers and retirees, and the productivity of those workers; the choice between a state system and a private one doesn’t change anything substantive. This observation seems obvious to me, but judging by the frequent occurrence of expressions about how in a private system everyone pays for his or her own pension and thus isn’t dependent on broader economic conditions, not everyone sees it the same way. (More on one such claim below.) My colleague’s answer was that, from a static perspective it was true, but that the move to a private system would raise economic growth. The idea is that the state is a bad manager, so as moneys previously under its control were freed up to go into private hands, the overall performance of the economy would improve. But that also seemed mistaken to me. The substantive issue here, after all, isn’t the oversight of flows from workers to retirees, but the amount of real investment. In our verbal discussion we were somehow talking past each other and it wasn’t clear whether we were talking about the same concepts. I would say that the widespread advocacy of privatized retirement systems is founded on at least one of these ideas: either by creating a private system we insulate individuals from unfavorable developments in the economy, or by removing pension funding from the incompetent hands of the state we accelerate economic growth. I will try here to show that both of these ideas are mistaken.
and so the aggregate size of those sources remains unchanged. rather. who for various reasons want to liquidate a part of their stock-market positions. So first of all about flows into financial markets. so long as they don’t lead to a higher level of real investment. It’s clear that the transfer of retirement contributions to a private system raises the gross flows. they go into the hands of previous private. that is. So if the reader doesn’t accept that assumption. I see two possible sources of this disagreement.. For the prices of shares on the stock market are a signal (at least in theory) of the market’s evaluation of the prospects of various firms and thereby influence the ease of borrowing—firms whose share prices are rising can borrow greater amounts with a lower interest rate.g. Another argument could be that even if a greater flow of savings into the stock market doesn’t change the scale of investment. new factories and machines. For the majority of inflows don’t go into the hands of private firms in order for them to undertake further real investment. there’s no point in bothering with the equations. I support the assumption immediately below with a verbal argument. which is the subject of the equations below.).132964353. To the extent that a greater inflow to stock markets caused by pension reform goes partly to the expansion of sources available to firms for investment. but my equations below assume that raising the gross flows in and of itself won’t accelerate growth. I don’t see any significance of greater flows into the stock market and flows out of it. I leave unchanged the size of those contributions and likewise governmental expenditures outside the retirement system and the levels of consumption of all groups in society. non-firm holders of the stocks. But this signal must be derived not from the . then with the equations I attempt to show that expenditures on real investment are unchanged.doc 2 z 10 I examine the possible impact of pure redirection of retirement contributions from a state system to a private one. it nonetheless improves the allocation of those investment expenditures among various possible purposes. arithmetically it must be balanced by a reduction of other sources. In contrast to general opinion I claim that such a change—the pure redirection—cannot have any effect. etc. We have to distinguish between gross flows into financial markets and net expenditures of private firms on real investments (e. R&D.
even though such changes may be necessary in the case of consumption and desirable in the case of government expenditures. and government expenditure (which. as usual. because index funds by design don’t act on the basis of some sort of opinions about future success of different firms. a G are as usual consumption. Narrowing the choice of depositing one’s pension savings into one or several previously designated index funds doesn’t help matters. I return to that point at the end of the note): Y=C+I+G where C. private investment. I begin with the normal equation for Gross Domestic Product. and Y is GDP. And that’s something I can hardly imagine. And so what matters is whether that signal will be better when new people brought into stock-market investing by pension reform participate in its formation. If we are in agreement thus far. whether those come from a state system or a private one . The current participants in the stock market are likely to be those who have the greatest interest in such activity and thus have the greatest willingness to engage in the research needed to determine which firms have the best prospects. I want to focus on reform in the manner of financing a pension system and not on the influence of other possible changes in the consumption by various parts of society or in government expenditures on non-pension matters.doc absolute share price of a given firm. but rather from its performance relative to the share 3 z 10 prices of other firms. This in effect weakens market signals about firms. I. then the next question is whether changed flows into financial markets can raise the level of real investments. doesn’t include transfers. The addition of less informed participants is more likely to make the signal worse rather than better. for a “closed” economy (without international trade.132964353. which means that it also doesn’t include pension benefits in a state pension system). I make this equation more specific by dividing consumption among: B: consumption of retirees on the basis of retirement benefits. they merely follow the opinions of others. and so I turn to the equations that show—at least I think they show—that they can’t.
a G remains unchanged. the whole point of any pension system. CS. which is. Put in simplified terms. Because you don’t eat money. but entirely analogously in a private system that would more or less correspond to a shortage of demand for the shares of retirees who need to sell them to have money for consumption. The intuition behind this assertion can be illustrated by looking at a typical reflection of what seems to me a fundamental misunderstanding of the whole matter. the future validity of your pension still depends on the number and productivity of workers in the future. This means that all expenditure in equation 1 must lie at the end of various paths from the two amounts in equation 2.132964353. 2. Hospodářské noviny. but already on this general level it’s clear that the amount of private investment can’t be increased so long as: 1. . where everyone who participates pays for his own pension.doc CS: consumption on the basis of savings outside of possible savings in a private pension system. It originally belongs to owners and employees and is divided according to labor contracts: Y=π+w (2) where π indicates the owners’ share (something like profit.” (“Coalition has agreed on pension reform. I trace those paths. the aggregate of the amounts Cw. but you don’t draw on it until the future. though of course not identical with it) and w is the workers’ share (derived from "wages"). B. In the material below. regardless of whether it’s a state system or a private one. 4 z 10 (1) All purchasing power for these expenditures arises from useful activity of the private sector. Y = Cw + CS + B + I + G. Of course the details diverge from this simplified picture. 2011) But how would that actually work? You pay for your pension now during your working years. February 18. but it nonetheless captures the essence of the matter. and Cw: consumption on the basis of wages. the size of GDP remains unchanged. in the state system there could be a shortage of people paying retirement contributions. Marek Hudema writes. after all. “In a [retirement] fund system. future retirees aren’t threatened by a shortage of workers in the future.
So we have π = tπ⋅π + dS + r.ty) w + Cw (of course we can rewrite this as in more familiar terms showing consumption as a share of disposable income: Cw = (1-sw)(1 .ty) w.τ . Cw: w = ty⋅ w + τ⋅ w + sw(1 . and from what’s left they save the portion sd.ty) dS + sw(1 .τ . they save the portion sw. Recipients of dividends pay the same income tax as wage earners. For instance.” that is.doc For the details. In the following equations the subscript “0” indicates the “original condition. And there are retained earnings r. The excess of deposits over withdrawals represents the amount available to firms for investment. They pay dividends to shareholders. Now we have to trace the deposits into savings (including those that go to the stock market) and also those in the other direction. withdrawals from savings. designated dS (the subscript “S” is to distinguish it from dB. 5 z 10 Owners pay a profit tax at a rate of tπ. Wage earners have to pay income tax ty⋅ w and also pay their contributions to the retirement system τ⋅ w. and what’s left is used for consumption.ty) w). which I will introduce later). for which I will use the subscript “1. but rather is paid to previous non-firm owners of the shares that were bought.τ . a state system for later comparison with a private system.” Flows into the stock market come in part from savings out of wages and in part out of savings from dividends. a significant part of the money “invested” in the stock market doesn’t go into the hands of firms for investment. let’s start by dividing up π a w and their paths to their final use. From what remains. So gross savings H [from the Czech “hrubý” for gross] H0 = sd(1 . .132964353.
The balance in the pension system is simply P0 = τ⋅ w – B.ty) dS + sw⋅ (1 .132964353. The other component is that part of dividends that shareholders didn’t save. and because those are by definition money not available for investment. So net savings of the private sector S are S0 = sd⋅ (1 . flows out of savings.τ . . in the general budget and also in the pension system. so we have CS = (1-sd)(1-ty)dS + Z0 or Z0 = CS – (1-sd)(1-ty)dS. and so we have to adjust net private saving by possible surplus or deficit in both parts of the government budget. Taxes other than retirement contributions are T0 = tπ + tydS + tyw so if we notate the balance in the general budget as GG. that is.doc 6 z 10 Withdrawals. they are a part of CS. consumption on the basis of earlier savings. More precisely. we can say that the general budget balance is GG0 = tπ + tydS + tyw – G (in the case of a deficit. But what interests us is the amount available to firms. we can say that they are used for consumption. we designate Z.ty) w – Z0. this amount is negative).
Le me first note that dividends in the setting of the retirement system are a new element in the equations. it follows that dB = -(∆dS + ∆r). A part of share ownership wouldn’t be here under the state system and so we must make room for dividends to these shareholders. and in the original state they are R0 = r so the final sum of means available for investment is I0 = H0 – Z0 + GG0 + P0 + R0 or I0 = sd⋅ (1 . B) remain unchanged. If we denote these changes.τ . then some combination of retained earnings and dividends to other shareholders must make way for these new dividends.ty) w – CS + (tπ + tydS + tyw – G) + (τ⋅ w – B) + r. but will be substituted by a combination of dividends and withdrawals from financial markets.τ . so long as we don’t change the aggregate amount of pension benefits B. where ∆dS ≤ 0 and ∆r ≤ 0. Further. as do retirement contributions (τ⋅ w). as ∆dS and ∆r. (4) (3) So there’s the state system.doc 7 z 10 The final source of means for investment are retained earnings. The amount B will no longer be paid by the state. and if we assume that the owners’ share π remains unchanged.ty) dS + sw(1 .132964353. the supplemental amount of withdrawals from the financial market must be (B – dB) or (B + ∆dS + ∆r). CS. .ty) w – (CS – (1-sd)(1-ty)dS) + (tπ + tydS + tyw – G) + (τ⋅ w – B) + r or I0 = (1 .ty) dS + sw(1 . If we denote these dividends in the context of the retirement system dB. For comparison with the private system let’s assume that all parts of consumption (Cw.
they had less for consumption.ty)⋅∆ dS. So we have Z1 – Z0 = -(1 . First. and that has to be replaced by increased withdrawals. which flow now into private accounts. Withdrawals from financial markets will have to change. so the state no longer receives retirement contributions. but it also no longer pays benefits. Gross flows into financial markets change by the pension contributions of current workers τ⋅ w. since recipients of dividends have less from which to save. The state loses part of its tax revenue because of the diminished dividends. and thus GG1 – GG0 = ty⋅∆ dS And finally. The state system is eliminated.doc 8 z 10 And so in turn the changes in individual parts of equation 3. that is.sd)⋅ (1 . by -(1 . . when shareholders outside the retirement system lost -∆dS. in order to have unchanged consumption CS. retained earnings are reduced by ∆r. which means that the balance in the state pension system is zero: P1 = 0 and P1 – P0 = –(τ⋅ w – B). So we have H1 – H0 = τ⋅ w + sd⋅ (1 . but also change by sd⋅ (1 .ty) ∆dS.ty)⋅∆ dS + (B + ∆dS + ∆r). (B + ∆dS + ∆r).ty)⋅∆ dS. Second. withdrawals have to provide that part of retirement benefits which are not covered by dividends in the context of the retirement system dB. so R1 – R0 = ∆r.132964353.sd)⋅ (1 .
In this way Czechs.sd)⋅ (1 . could insure themselves against unfavorable domestic trends.ty)⋅∆ dS + (B + ∆dS + ∆r)] + ty⋅∆ dS – (τ⋅ w – B) + ∆r. The redirection of τ⋅ w from the state system not into the domestic stock market but into livelier foreign stock exchanges seemingly . Cw. The fact that retirement contributions flow to private accounts rather than into a state system cannot. but I see the outlines and I think that a similar principle is at work in this case as well.ty)⋅∆ dS + ty⋅∆ dS – ∆dS – ∆r + ∆r – B + B = (1 . It’s true that participants in a private system have the option of buying shares of firms in other economies where there are more favorable demographic trends or faster economic growth.doc 9 z 10 We now have all the components for the comparison of the level of investment under the state pension system and the private one.ty)⋅∆ dS + (1 . It also seems that the entire economy in aggregate could escape from the strict limitations embodied in the foregoing equations. I1 – I0 = (H1 – H0) – (Z1 – Z0) + (GG1 – GG0) + (P1 – P0) + (R1 – R0) = [τ⋅ w + sd⋅ (1 . Rearranging terms we have I1 – I0 = τ⋅ w – τ⋅ w + sd⋅ (1 .sd)⋅ (1 . paying into their pension funds. under the condition that there is no change in CS. and it’s high time for that.ty)⋅∆ dS] – [-(1 . B. I don’t have it worked out in similar detail as with the closed economy.132964353. in and of itself.ty)⋅∆ dS + ty⋅∆ dS – ∆dS = 0. increase the quantity of real investment. I said I would return to the question of an open economy. and G.
Put slightly differently. lower government expenditures. But in making any of those changes we would not maintain the condition that we are examining only redirection of financial flows. plus the net gain from the ownership of foreign shares F (payments to Czechs owning foreign shares minus payments from the Czech Republic to foreign owners of Czech shares): C2035 = Y2035 – I2035 – G2035 + F2035. And these reduced purchases will later show up as reduced consumption on the basis of savings (held abroad). which also requires other changes in the present: lower consumption. lower investments. And a greater aggregate size of F in the future means larger purchases of foreign shares in the present. or that we can support unchanged future benefits with smaller contributions today. . But this is deceptive. in some future year—let’s say 2035—the amount the Czech Republic will have available for consumption will be its own GDP.132964353. Some actors are already making use of that surplus and buying some foreign shares. If participants in a privatized pension system want to buy foreign shares. minus investment I. exports minus imports.doc 10 z 10 holds out the possibility that with pension contributions of the same size as today we can allow ourselves larger pension benefits in the future. that necessarily means that people who were already buying those shares will have to buy less than they would have. For the purchase of foreign shares. or higher GDP. had we stayed with a state-run pension system. minus government expenditures G. the Czech economy as a whole has roughly its foreign trade surplus. A greater share of F2035 for some individuals means a smaller share for others.
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue listening from where you left off, or restart the preview.