Jukka Lassila

Uncertain demographics and fiscal sustainability

There is widespread acceptance that much of the developed world faces a potential pensions and welfare crisis as a result of declining birth rates and an ageing population. However, there is considerable uncertainty about the specifics of demographic forecasting and this has significant implications for public finances. Uncertain Demographics and Fiscal Sustainability addresses the economic consequences of uncertainty and, with particular reference to European economies, explores the impact of demographic risks on public finances, including pension systems, health care and old-age care expenditures. Covering a spectrum of theoretical and empirical approaches, different types of computational models are used to demonstrate not only the magnitudes of the uncertainties involved but also how these can be addressed through policy initiatives. The book is divided into four parts covering demographic, measurement, policy and methodological issues. Each part is followed by a discussion essay that draws out key elements and identifies common themes.

Short-term forecasting of industrial production with business survey data: experience from Finland's great depression 1990–1993☆

Abstract The severe Finnish recession in the early 90s provides an interesting testing ground for forecasting models specified and estimated before the recession. We use recent data to evaluate some short-term forecasting models for industrial production. The main explanatory variables are from business surveys and the models themselves are based on the use of the Kalman filter. The recession years present difficulties for forecasting especially in the textile industry and metal industry. In the food industry and to some extent in the forest industry the forecasting performance during the recession is actually better than in earlier periods. Mechanical re-estimation of the models yields better forecasting results in four out of six branches studied. The importance of business survey information, however, seems to have increased during the recession. The improvement in prediction accuracy after taking account of relevant business survey information is statistically significant in the forest industry and in manufacturing of non-metallic products when the precision of autoprojective forecasts is used as a baseline.

Controlling the effects of demographic risks: the role of pension indexation schemes

Within a model featuring demographic uncertainty, this paper studies a pension reform where public pension benefits are indexed to the total wage bill rather than to the average wage level. This implies a decline in the variability of contribution rates and an increase in the variability of replacement rates. While thus shifting some of the adjustment burden following demographic shocks to pensioners, the trade-off in risks is found to be fairly moderate.

Longevity Adjustment of Pension Benefits

In anticipation of future gains in life expectancy, several countries have passed laws that automatically adjust pensions, if life expectancy changes. In this paper we study the effects of longevity adjustment under demographic uncertainty in Finland. If longevity increases, the adjustment decreases the contribution rate, and the reduction is bigger the higher the rate would have been without the reform. On the other hand, longevity adjustment increases the uncertainty in replacement rates. The current middle-aged generations, whose pensions are reduced more than contributions, are likely to experience the largest losses. The full gains are observed far in future. The quantitative results depend on, besides demographic realisations, the specifics of the pension system. Longevity adjustment significantly weakens the defined-benefit nature of the Finnish pension system and brings in a strong defined-contribution flavour.

Population ageing and fiscal sustainability in Finland : a stochastic analysis

This study analyses the fiscal sustainability of the Finnish public sector using stochastic projections to describe uncertain future demographic trends and asset yields. While current tax rates are unlikely to yield sufficient tax revenue to finance public expenditure with an ageing population, if developments are as expected, the problem will not be very large. However, there is a small, but not negligible, probability that taxes will need to be raised dramatically, perhaps by over 5 percentage points. Such outcomes, if realised, could destabilise the entire welfare state. The study also analyses three policy options aimed at improving sustainability. Longevity adjustment of pension benefits and introduction of an NDC pension system would reduce the expected problem and narrow the sustainability gap distribution. Under the third option, pension funds would invest more in equities and expect to get higher returns. This policy also limits the sustainability problem, but only under precondition that policymakers in the future can live with substantially larger variation in the value of the funds without adjusting tax rules or benefits.

Reforming Social Security in a Transition Economy: The Case of Lithuania

This paper points out a number of problems associated with the existing pension system in Lithuania. Reforms are proposed, including (i) a substantial increase in the basic pension benefit rate, financed on a pay-as-you-go basis, provided universally, and regulated according to wage/price indexation; (ii) a significant cut in the tax contribution rate to the public pension system matched by a rise in the VAT; (iii) a rise in the retirement age to 65 for both men and women; and (iv) a gradual conversion to a private, funded, mandatory pension system to replace the earnings-related part of the current pension system.

Uncertain Demographics and Fiscal Sustainability: Demographic uncertainty and pension projections

Introduction With increasing understanding that populations are ageing and will continue to do so, long-term pension expenditure projections have become essential policy tools for all countries with pure pay-as-you-go or less than fully funded public pension systems. The most important background assumptions in these projections usually concern future demographics. It therefore seems particularly relevant to try to envision the uncertainty caused by future demographics in pension expenditure projections. We summarize quantitative estimates of the uncertainty in long-term pension expenditure projections caused by demographic factors for Belgium, Denmark, Finland, Germany, the Netherlands, Spain and the United Kingdom. The estimates are obtained from model-based country studies. The demographic uncertainties are quantified by stochastic population simulations. The results unequivocally show a great deal of uncertainty in pension projections. There are significant differences between the uncertainty estimates in these countries. The differences partly reflect demographic factors, partly differences in pension systems and partly the properties of the models that were used. We also relate the uncertainty estimates of the country studies to the uncertainty considerations in the recent projections by the Economic Policy Committee (EPC) of the European Commission (EPC, 2006). The EPC uses sensitivity analysis as a method to describe uncertainties. Not surprisingly, the resulting quantifications of deviations from the expected outcomes are small compared with those obtained in the country studies. Finally, we consider the implications of the country studies for the future development of the tools for analysis.

Pension Policies and International Capital Mobility

The effects of pension policies on households’ and firms’ behaviour depend on the international mobility of financial capital. We compare the policy effects between three regimes: a perfect capital mobility regime, a flow equilibrium regime where domestic interest rates react to current account developments, and a portfolio adjustment regime where the net foreign debt affects the domestic interest rate. We consider three different pension policies: an increase in the retirement age, a decrease in the pension benefit level and a temporary variation in the pension fund. The long-run policy effects are equal with perfect capital mobility and the flow equilibrium regime, but the short-run effects are different and the transition period is longer with the latter. In the portfolio adjustment regime even the long-run effects are different when the policy changes are permanent. Thus the degree of international capital mobility is important e.g. for the changes in intergenerational distribution. The effects on the pension contribution rate, on the other hand, are almost independent of the interest rate behaviour.

Bargaining on Pensions: The Finnish Pension Reform of 2001–2002

A major reform of the Finnish private-sector earnings-related pension system was negotiated in 2001–2002 between central organisations of employers and trade unions and representatives of the central government. This paper describes the reform, views it in the light of previous reforms, and analyses the effects of the reform on the welfare of different cohorts and different educational groups. The analysis of the reform showed that current old workers generally kept their positions, and even improved them. Younger workers lost somewhat. Future workers will gain. Early retirement in general was punished, which on average will hit low-educated employees harder than more educated groups. The reform process also showed that the relative positions of trade unions and between-union comparisons were important.

Tax Threats and Wage Formation

Abstract The government, concerned about employment, can threaten the trade unions: if wages exceed a certain limit, income taxes will be increased. A credibility problem arises because executing the tax increase, if the wage proposal is rejected, will deteriorate employment. We analyze these kinds of threats as an inverted Stackelberg game between the government and many trade unions. The credibility of the threat comes from costs related to cheating, and this limits the size of the threatened tax increase. The success of a tax threat policy requires that the conditions under which the threatened measures will be implemented are tailored to fit certain unions. For several reasons, the use of threats is likely to be restricted to temporary policy packages.