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4

Private Wealth and Income Security: International Comparisons

Income security during retirement is a primary social achievement of the 20th century. As individuals retired from work at younger ages and life spans increased, the period between the formal end of work and death became one of the most significant stages of life. This enormous accomplishment, however, was accompanied by fundamental public policy challenges associated with the risks posed by population aging. The two most basic challenges were (1) that individuals would have sufficient income security during their retirement years so that retirement did not necessarily imply a substantial decline in living standards and (2) that individuals would have protection against the increasing risks of falling into poor health.

During the last century, industrialized nations responded to the problem of having sufficient income to achieve a decent standard of living during retirement by developing the now-familiar three-tiered system: the primary role of the public tier is to guarantee through governmental transfers at least a minimum income standard during retirement; the second tier is based on employer-provided pensions; and the third tier consists of wealth accumulation through private household savings (see also Chapter 3). As discussed below, individual countries in North America, Europe, and Asia have placed differing emphasis on these three tiers in devising their own unique schemes. Yet despite this cross-country diversity in policy, it is generally recognized that collectively, people in all of these countries are much better able now than they were 50 or even 25 years ago to enjoy reasonable income security during their old age.

At the same time, it is also widely acknowledged that whatever their past successes, the systems currently in place must eventually be substan-



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Page 102 4 Private Wealth and Income Security: International Comparisons Income security during retirement is a primary social achievement of the 20th century. As individuals retired from work at younger ages and life spans increased, the period between the formal end of work and death became one of the most significant stages of life. This enormous accomplishment, however, was accompanied by fundamental public policy challenges associated with the risks posed by population aging. The two most basic challenges were (1) that individuals would have sufficient income security during their retirement years so that retirement did not necessarily imply a substantial decline in living standards and (2) that individuals would have protection against the increasing risks of falling into poor health. During the last century, industrialized nations responded to the problem of having sufficient income to achieve a decent standard of living during retirement by developing the now-familiar three-tiered system: the primary role of the public tier is to guarantee through governmental transfers at least a minimum income standard during retirement; the second tier is based on employer-provided pensions; and the third tier consists of wealth accumulation through private household savings (see also Chapter 3). As discussed below, individual countries in North America, Europe, and Asia have placed differing emphasis on these three tiers in devising their own unique schemes. Yet despite this cross-country diversity in policy, it is generally recognized that collectively, people in all of these countries are much better able now than they were 50 or even 25 years ago to enjoy reasonable income security during their old age. At the same time, it is also widely acknowledged that whatever their past successes, the systems currently in place must eventually be substan-

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Page 103tially revised if the goal of adequate income security is to continue to be met in this century. Some of the challenges to the current systems stem from the demographic forces discussed in Chapter 2. First, the large baby boom cohorts born after World War II in various countries will be entering their retirement years during the first few decades of the 21st century. Issues associated with the sheer size of these cohorts are compounded by large increases in older-age life expectancy throughout Asia, Europe, and North America, which now face the new demographic reality of a constantly declining ratio of workers to retirees. This new demography implies that the financial costs of maintaining the existing income benefits of the old pay-as-you-go public-tier systems are not sustainable. The major domestic political challenge of the 21st century concerns how countries will adapt their old-age income security and health insurance systems to meet this challenge. In this chapter we do not advocate any particular system over others. However, one option that most countries are likely to consider involves relying on individual private savings and wealth accumulation to offset any reductions that may take place in the level of public-tier support. How realistic is it to assume that individuals will save sufficiently over their lifetime to contribute significantly to their own income needs during retirement? To answer this question, one must first understand the basic motivations for household wealth accumulation. Why do some households save so little while others—even those with similar incomes—appear to accumulate so much wealth? Do individuals save primarily to leave bequests to their heirs; to reconcile differences in the timing of income and consumption over the life cycle; or to insure against future uncertainty regarding income, unemployment, or health? What role do financial inheritances play in perpetuating wealth inequalities across generations? These are basic and important research questions that require good theoretical and empirical scholarship, as well as high-quality data on household savings and wealth. A central question regarding income security for the aged is whether individuals and families will assume greater responsibility for their own retirement if current government programs are scaled back because of budgetary pressures. In particular, will households accumulate more private wealth during their working years to finance their retirement years? A promising research strategy for answering this question is based on international comparisons. As suggested above, there is a great deal of variation in the way different countries finance the retirement of their older populations, placing differing weights on publicly provided pensions, private or employer-provided pensions, and private savings. For example, as a general rule the countries of continental Europe place much more emphasis than the United States on income security through a public-tier system. Yet some European countries rely almost exclusively on

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Page 104an integrated public tier, while others, such as the United Kingdom, use a combination of private- and public-sector resources. These combinations may produce quite different rates of income replacement during retirement, and therefore have differing implications for the incentives for private savings. For example, a public-sector benefit that provided almost complete income replacement would reduce and possibly even eliminate incentives for private retirement savings. To address these basic questions, the panel pursued the following strategy. Because there exists much less research in Europe than in the United States on these issues, we commissioned papers from four European countries, selected on the basis of the following criteria: (1) they currently had wealth data from household surveys that were of sufficient quality to allow something useful to be learned about patterns of household wealth accumulation in the country; (2) differences in household savings across these countries span most of the variation that exists within Europe; and (3) distinguished researchers with impressive backgrounds on these topics were available to write the papers. The four countries selected were the Netherlands (Alessie and Kapteyn, 1999), Italy (Jappelli and Pistaferri, 1999), Germany (Börsch-Supan, 1999), and the United Kingdom (Banks and Tanner, 1999). To extend the comparisons beyond Europe, we also commissioned a paper on Japan (Kitamura and Takayama, 2000), a country with relatively high rates of household wealth accumulation that is experiencing population aging at a very rapid rate. The remainder of this chapter is organized as follows. The first section highlights the main theoretical issues that arise with household savings and wealth accumulation. As we demonstrate, these theoretical questions transcend national boundaries. The second section describes the most important wealth surveys now in place in the United States, the above four European countries, and Japan and reviews the relevant data quality and measurement issues. The third section documents the most salient patterns of household wealth accumulation in the United States, Europe, and Japan, based on the data from these surveys. The final section presents the panel's recommendations regarding the policy and research questions in the domain of wealth accumulation that should be of highest priority, as well as the steps necessary to establish the research infrastructure required to address them. WEALTH ACCUMULATION: RESEARCH FRAMEWORK AND KEY QUESTIONS A number of questions must be addressed in examining aggregate rates of savings across countries. For example, are the reasons for savings

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Page 105unique to nations, or do some motivations transcend national boundaries? Are the citizens of some countries savers, while those of others are spenders? Do institutions and national policies matter for aggregate national savings? An immense literature now exists on motives for wealth accumulation and savings (for an excellent survey, see Browning and Lusardi, 1996). The starting point for a wealth accumulation framework is typically the life-cycle model (or life-cycle hypothesis), which emphasizes savings (and dissavings) to deal with timing issues surrounding non-coincidence in income and consumption (see Box 4-1). According to this theory, individuals will tend to want to smooth consumption (to keep the marginal utility of consumption constant across periods), so that they will save when income is high and dissave when income is low. Browning BOX 4-1 Difficulties with Data on Consumption Given the importance attached to consumption in various models, the reader might expect this chapter to emphasize the value of collecting consumption data. However, while consumption is an important variable for measuring well-being and for understanding the dynamics of asset change, this report focuses on the measurement of income and assets, partly on grounds of practicality. The problem is that the collection of reliable consumption data typically takes several hours of survey time; is subject to substantial bias (the consumption level is usually underestimated); and effectively precludes adequate attention to such critical areas as health status, labor force participation, detailed measurement of income and assets, and measurement of family structure and transfers. Thus while we recognize that consumption is a useful indicator of well-being, we do not think it feasible to include a direct measure of consumption in a dataset designed to provide the most useful, policy-relevant data on aging. There is a method of collecting consumption data that does not use up all the available survey space. This method has been used on an experimental basis, with results that can fairly be described as promising. The idea is to collect consumption data indirectly, by measuring income level, asset change from one period to the next, and capital gains over the same period. Consumption is measured as the difference between income and savings, and savings is measured as the change in net worth plus (or minus) capital losses (gains). The problem with this indirect method of measuring consumption is that, while it appears to provide an unbiased measure of consumption, it is subject to extremely large measurement errors. The first difference in net worth is a highly noisy variable, net worth in each period has a substantial measurement error, and the difference in net worth has an even larger measurement error.

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Page 106 and Lusardi (1996) provide a concise summary of some of the major implications of the theory in its purest form (the certainty-equivalence model): the path of consumption should be independent of the path of income, the elderly should run down their assets, and anticipated changes in income should have no effect on consumption. All three of these fundamental implications have been disputed empirically: consumption appears to be too sensitive to income, the elderly may not dissave since wealth profiles appear not to turn down (perhaps), and much work has been done in an attempt to separate anticipated from unanticipated income changes. These failures of the life-cycle model have led to a number of attempts to extend or enrich the theory so these facts can be explained. A good deal of this recent work has incorporated uncertainty into the model, adding risk aversion (or precautionary savings) as a primary savings motive. At least under some conditions, uncertainty causes individuals to discount future incomes more heavily and to place a high value on social insurance schemes (such as public pension annuities) that reduce risk. Uncertainty about future income will tend to increase current savings, and, at least in earlier portions of the life cycle, consumption will tend to follow income. In one important variant of this model, impatience for the present duels with prudence as individuals attempt to maintain a “buffer stock” of a small amount of wealth to deal with future uncertainty. The buffer stock remains small because of impatience. Another avenue explored in recent work involves liquidity constraints, i.e., the idea that individuals cannot borrow and lend at the same interest rate. Given these constraints, individuals will not be able to borrow as much as they might want to finance their current consumption. Once again in this case, consumption will tend to follow income more closely. Another motive for saving involves bequests. Tests of a bequest motive are of three types. The first is based on the main prediction of the lifecycle hypothesis: that in the absence of a bequest motive, bequeathable wealth should decline at sufficiently advanced ages. The second type of test is based on variation in the rate of wealth change as a function of covariates that are assumed to be related to the strength of a bequest motive. An example is provided by comparing the rates among those with and without children; a consistent finding is that there is little difference. One difficulty in testing for the importance of bequest motives relates to the distinct possibility that some considerable proportion of bequests are “accidents” (see Yaari, 1965). Since individuals cannot foresee with certainty the time of their deaths, they may run the risk of dying too late, having run out of resources to finance their consumption. To guard against this risk, they will accumulate wealth; thus those who die early will leave bequests even though they do not have a bequest motive

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Page 107per se. As a practical empirical matter, however, it has proven difficult to distinguish between altruistic and accidental bequests. A third type of test is based on direct questions about savings motives. For example, Alessie et al. (1995) found that people who say they have thought about leaving a bequest save more than others. A related but somewhat different aspect of bequests involves the extent to which past inheritances can explain the diversity in current wealth holdings by households. It turns out that financial inheritances received represent but a fraction of total net worth, so that levels and distributions of wealth would be largely the same even if the maximum contribution of financial inheritances were taken into account. For example, in the U.S. Panel Study of Income Dynamics (PSID), it was found that only one in five households had received any financial inheritances as of 1984. Smith (1999b) estimates that inheritances would account for only 13 percent of PSID 1984 wealth values, as well as 13 percent of the increment in wealth between 1984 and 1994. Another branch of the recent literature rejects rationality in its traditional form as applied to savings behavior. Some of this literature stems from a discouragement with our ability to explain the wide diversity in savings and wealth among individuals. The nonrational theories take a number of forms, including separate mental accounts (e.g., Thaler and Shefrin, 1981) and hyperbolic discounting (Laibson, 1997). In the context of this summary of the theory, a number of key research questions arise that could be addressed by cross-national analysis. These questions include the following: 1. Do the elderly dissave (a key prediction of the life-cycle model)? The lifecycle model does not imply that in the presence of uncertainty, one should start running down assets immediately after retirement, as has been stressed, for instance, by Hurd (1998). If and when individuals start depleting their wealth holdings depends on family composition, mortality risks, utility parameters, and the possible presence of a bequest motive. Thus in a formal sense, simply looking at whether the elderly dissave after retirement is not sufficient to determine the validity of the life-cycle hypothesis. However, absent a bequest motive, the hypothesis does imply that wealth should start declining sooner or later. The evidence on this matter is mixed. Hurd (1987) and Alessie et al. (1999) present evidence that this is indeed the case. Others, however—most notably Börsch-Supan and Stahl (1991) and Börsch-Supan (1992)—find no evidence for dissaving at all. Börsch-Supan and Stahl offer as an explanation that at some point, the elderly are simply no longer able to consume as much as they had originally planned because of physical (and perhaps mental) restrictions. In terms of economic theory, this would represent an unanticipated

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Page 108 change in tastes. 1 More generally, unanticipated shocks (e.g., a runup of the stock market) may throw consumers off their planned consumption paths. To shed further light on this research question, one would clearly need accurate knowledge of the actual assets and liabilities of households over time. In addition, however, one would need information about the state of physical and mental health of individuals within those households and the extent to which this state was anticipated. Similarly, one would need to know the extent to which households' capital gains or losses were anticipated. There is a clear role for cross-country comparisons here, since stock markets and housing markets are certainly not perfectly correlated across countries; thus differences in movement may be exploited to identify different types of (anticipated or unanticipated) shocks. 2. Is there an important bequest motive for savings? One would like to know more about the various potential beneficiaries of bequests—not just relatives, but also charities. A particularly important heir is likely to be the spouse, if present. Given differential mortality between men and women, it is important to know the extent to which household planning of consumption takes into account the needs of the longest-living spouse (usually the woman) (Hurd, 1998). Cross-country comparisons are important here as well in view of the vastly different tax treatments of bequests in different countries and the variations in living arrangements that exist across countries. 3. Do social insurance programs for retirement income have the effect of reducing household savings and wealth? What is the effect on national savings? This is a research subject with a lengthy history (see, e.g., Feldstein, 1974; Browning and Lusardi, 1996). The main problem in investigating this issue is how to deal with individual unobserved heterogeneity. In many countries, public pension benefits are related to an individual's earnings history. Thus people who have spent much of their lives in the labor force will generally receive higher benefits than those with a less consistent labor market history. The former individuals may also be the ones who, by personality or habit, save more. They may, for instance, be more risk averse than people whose labor force attachment is looser. The result is a spurious positive correlation between savings and public pension benefits, whereas the life-cycle hypothesis would suggest a negative relationship. The use of panel data (as by Alessie et al., 1997) may circumvent this problem to some extent, as one can allow for fixed individual effects. However, use of these data leads to inaccurate results, since the remain 1Even if consumption constraints are fully anticipated, it is conceivable that wealth will increase in old age. This may occur if one cannot borrow against future annuity income and if annuity income is higher than the upper limit on consumption.

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Page 109 ing variation in public pension entitlements across individuals is too limited to allow for statistically significant conclusions. A more promising approach may be that taken by Kapteyn et al. (1999), who exploit the fact that different cohorts have lived (and are living) under different expectations about their retirement provisions. According to the life-cycle hypothesis, this variation in expectations should translate into different wealth accumulation patterns across generations. The results obtained by Kapteyn et al. suggest that this is indeed the case. Also here, one would like to exploit differences in institutional arrangements across countries to obtain more reliable estimates of the effect of public pension provisions on national savings rates. The effect of survivor provisions in public pension programs on savings rates of multiperson households warrants special attention. 4. What is the interaction between private pensions on the one hand and private savings and wealth accumulation on the other? The issues under this question are similar to those with public pensions, except that there is generally greater individual freedom in the choice of private versus public pension arrangements. Thus the possibility of spurious positive correlations between individual wealth accumulation and pension rights is even stronger: people who save a great deal also tend to have more generous pension arrangements. Comparisons across countries open up additional identification possibilities. For instance, in the Netherlands most private pensions are tied to one's occupation, thereby severely limiting individual freedom of choice, whereas in the United States individual choice is much greater. Comparison of savings rates across such institutional arrangements would provide insight into the interrelationships between institutions and savings. For both this and the previous research question, it is of paramount importance to collect adequate (possibly administrative) data on individual work histories, characteristics of pension plans, fiscal treatment of such plans, and the like. 5. Is consumption smooth before and after retirement? On the one hand, the answer to this question is a crucial test of the life-cycle hypothesis, since retirement is generally fully anticipated; hence according to the lifecycle hypothesis, consumption should not be affected by retirement except for the effects of the new way of life (more leisure and possibly fewer work-related expenses). Yet empirical evidence appears to suggest that consumption declines considerably after retirement (see, e.g., Hamermesh, 1984; Banks et al., 1998). The fact that, for example, Health and Retirement Survey (HRS) data indicate that about a quarter of U.S. households arrive at (or close to) retirement with only modest amounts of wealth (less than $30,000; see Lusardi, 1999) in itself suggests that many households do not plan adequately for retirement. Generally, tests of income smoothing around retirement are hampered by the fact that hardly any reliable

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Page 110panel dataset exists that would allow one to follow consumption patterns before and after retirement closely. The collection of such data is of clear importance. 6. What is the effect of capital gains on active savings? If capital gains were fully anticipated, posing this research question would amount to asking what is the marginal propensity to consume out of wealth. Estimates of this marginal propensity are large enough to entail substantial risk of an economic recession if, for instance, the stock market were to suffer a major setback. Conceivably, the uncertainty involved in the value of stock holdings may reduce the tendency to consume out of capital gains. Nevertheless, Juster et al. (1999) find that $1.00 of capital gains in stocks reduces active saving by about 0.17 (see also Poterba, 2000). They also find that this effect is large enough to explain the dramatic decline in active saving in the United States since the 1980s. In view of the obvious importance of active saving to provide for old age in the future, more detailed analysis of the relationship between capital gains and active savings in different countries is required. Next to the availability of excellent wealth data, the first priority would be to have data on the extent to which capital gains are anticipated and how certain individuals feel about the value of their stock holdings. As indicated with respect to research question 1, movements in stock market prices and real estate values show enough variation across countries that these differences can be exploited to learn more about the effect of capital gains on savings. 7. What are the effects of health shocks on wealth accumulation and vice versa? The robust positive relationship between health and wealth is a much-studied phenomenon, but a single comprehensive explanation for this relationship appears to be lacking (see, e.g., Smith, 1999a). The effects of health shocks on wealth accumulation may be quite different across countries. In countries where individuals are generally fully insured against any major adverse health event, out-of-pocket health-related expenditures cannot be an important mechanism for the translation of adverse health shocks into lower wealth accumulation. Under those circumstances, health shocks would instead have an indirect effect, for instance through a less successful labor market history. Here as before, one runs into the problem of disentangling unobservable individual traits and observable factors. For example, people with potentially poor health may generally have less energy; hence even before a major illness occurred, they would already have earned less (and accumulated less) than other observationally equivalent individuals. Thus to shed light on the exact mechanisms involved, accurate earnings and illness histories are necessary. Cross-country comparisons can then help in identifying the exact role played by institutions. Regarding the effect of wealth, or more generally socioeconomic status, Hurd et al. (1998) find only weak evi-

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Page 111dence for a causal link between socioeconomic status and changes in health over a 2-year period, controlling for various health status measures at the beginning of the period. On the other hand, they do establish a statistically quite significant effect of health status on wealth changes over the same period. Their findings suggest that at least at older ages, differential access to health care is not a major factor in explaining the correlation between health and wealth. As Hurd et al. suggest, the fact that one does see a strong relationship between socioeconomic status and morbidity and mortality in a cross section of the elderly population may point to unobserved genetic and behavioral factors that influence both socioeconomic status and health at later ages. Clearly, one would like to be able to identify these factors, for which one would again need accurate earnings and illness histories. Further, the effect of health and wealth is likely to interact with living arrangements and family situations, which again points to the need for a multidisciplinary approach to data collection. 8. What is the effect of tax-preferred savings vehicles on household savings? This is a research question with a long history, especially in the United States (see, e.g., Venti and Wise, 1989, 1990, 1991; Gale and Scholz, 1994). The importance of the issue hardly requires amplification. Tax subsidies on savings may easily involve very substantial amounts; hence the effectiveness of these instruments must be evaluated carefully. To this end, one would need household panel data (among other things, to be able to correct for unobserved individual heterogeneity). A related issue has to do with the composition of household portfolios (see Poterba, 1999). In many cases, income (positive or negative) from different assets (or liabilities) is taxed differently. Examples include whether capital gains are taxed and whether mortgage and other interest payments are deductible. The differential tax treatment of income relative to different assets and liabilities has significant effects on the composition of household portfolios (see, e.g., Hochguertel et al., 1997; King and Leape, 1998; Poterba and Samwick, 1999). It may be difficult to disentangle the effects of household income and taxes through empirical work, given the systematic relationship between marginal tax rates and income. Since understanding the role of institutions is even more crucial here than is the case for some of the other research questions, it would be desirable for the data to span time periods covering (several) policy changes and/or countries with different policies regarding the fiscal treatment of saving. 9. Do the elderly consume their housing wealth? Despite considerable research into this issue (e.g., Venti and Wise, 1989, 1990, 1991; Sheiner and Weil, 1992), the evidence appears to be mixed. Although there are some indications that the elderly may consume their housing wealth, a great majority may not do so. Reverse mortgage schemes have met with mixed success, and the factors that determine the success of such schemes are as

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Page 112yet incompletely understood. Beyond the collection of data on actual behavior, an obvious approach is to ask elderly individuals directly why (or why not) they would consider consuming their housing wealth. 10. How does household wealth interact with labor market (retirement) decisions? Such interaction occurs in at least two ways. Those who have accumulated significant amounts of wealth may be expected to retire earlier than others, simply because they can afford to. In economic terms, they are consuming part of their wealth in the form of leisure. Conversely, those arriving at retirement age without significant wealth holdings may decide to return to the labor market at least part time to supplement the annuity income they are drawing from public and/or other pensions. Modeling of the interplay between wealth accumulation and labor force participation is technically complex (see, e.g., Blundell et al., 1997). The technical complications of estimating a theory-consistent model usually force researchers to estimate models that are rather loosely related to theory. Here there appears to be considerable scope for the use of subjective information, obtained, for example, by asking individuals directly about preferences and constraints (e.g., whether a job would be available if they wanted one). 11. Are there demographic effects in the stock market? One of the explanations sometimes given for the sharply increasing stock market prices over recent years is that demographic demand is high. Put simply, the baby boomers have reached a stage in their life cycle at which they have both the resources and the need to save for old age. They invest their money in part in the stock market, thus driving prices up (e.g., Bergantino, 1997). If this explanation is quantitatively important, one may expect the opposite stock movement in prices once the baby boom generation starts retiring. As a result, the value of an individual's stock may be much lower in retirement than is currently anticipated. Apart from studying long-term movements in stock market prices (as does Bergantino, 1997), an obvious way of learning more about the potential importance of this phenomenon is by studying household portfolios on the basis of microdata and interviewing households about their investment motives and expectations for the future. Cross-national variation in stock market performance should be useful in identifying the salience of demographic effects. DATA SOURCES There has been renewed interest in the United States, Europe, and Asia in the measurement of and motives for household wealth accumulation and savings behavior. Recently, wealth data have proliferated in these three regions as some prominent surveys have incorporated wealth

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Page 144 ~ enlarge ~ FIGURE 4-4 Measures of net worth by age of household head and cohort in Italy: 1989 to 1995. NOTES: These figures plot wealth by age of 13 cohorts: cohort 1 includes all households whose head was born between 1905 and 1909, cohort 2 those born between 1910 and 1914, and so on up to cohort 13, those born between 1965 and 1969. Each cohort is observed at four different times, one for each cross section. The line in each graph is obtained by regressing wealth on a fourth-order polynomial, a full set of dummies, and a set of restricted time dummies. The data are drawn from the 1989-1995 SHIW. Values are converted in thousands of 1995 Euros. SOURCE: Jappelli and Pistaferri (1999).

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Page 145 ~ enlarge ~ FIGURE 4-5 Net worth and net financial assets by birth year of household head in Japan: 1979 to 1994. SOURCE: Kitamura and Takayama (2000).

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Page 146 TABLE 4-9 Replacement Rates for the Retired Population Country All Disposable Income Public Transfers Only France 80 61 Germany 85 63 Italy 80 25 Japan 76 42 Netherlands 78 50 Sweden 78 75 United Kingdom 68 35 SOURCE: Organization for Economic Co-operation and Development (1998). Table 4-9, based on a recent OECD study, lists rates of income replacement during retirement for six European countries and Japan. In each country, these numbers were computed in a cross section as the ratio of the after-tax incomes of individuals at age 67 to the after-tax incomes of individuals at age 55. In addition to total income replacement rates, the table shows retirement income replacement based only on the public-tier program. Throughout Europe, total income replacement rates are about .8 and are similar across countries. If anything, retirement income replacement is understated in these tables since income growth across cohorts implies that the incomes of those currently age 55 are higher than the incomes of those currently age 67 when they were age 55. Just 1 percent income growth per year would lead to essentially complete income replacement in virtually all European countries. Even without taking work-related costs into account, on average many European workers are better off when they retire than when they are working. The similarity across European countries in total retirement income replacement rates disappears when we examine public transfers only—a reflection of differences in the way the various countries have designed their old-age pension systems. Since the portion of the system that lies formally outside the public tier is usually heavily controlled (or at least influenced) by the respective governments as well, it generally makes sense to examine the total retirement system, not just the public transfer portion. Retirement Income Security An important policy issue across all Western countries is the extent to which government social insurance programs during retirement substitute for or crowd out private savings (see Smith and Smeeding, 1998, and

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Page 147 TABLE 4-10 Retirement Income Security Systems Poverty Rate as % of GDP (circa 1992) Guaranteed Minimum as % of Median National Income Social Retirement Pensions as % of GDP Country 40% 50% 1995 2030 Diff United States 13.4 22.7 34 4.1 6.6 2.5 Germany 4.5 8.1 52 11.1 16.5 5.4 United Kingdom 10.9 30.5 43 4.5 5.5 1.0 Canada 1.5 7.1 56 5.2 9.0 3.8 Australia 7.1 28.6 51 2.6 2.9 0.3 The Netherlands 3.0 4.4 66 6.0 11.2 5.2 Sweden 1.5 6.4 63 11.8 15.0 3.2 SOURCE: Smith and Smeeding (1998). the discussion in Chapter 3 of this report). Most modern nations face challenges of an aging population that are similar to that in the United States. Nearly every country has a pay-as-you-go social retirement scheme that will be put to the financial and political test over the next 30 years. Each nation also has some mix of employer-provided pensions, own savings, earnings, and targeted benefits for the poor that helps them meet income security goals. Income security policy goals include preventing poverty in old age, encouraging private savings, encouraging work at older ages, and ensuring desired rates of income replacement in retirement. What differs across countries is the extent to which each of these goals is pursued and the costs incurred. Table 4-10 summarizes several salient features of retirement income security systems for seven modern nations. Poverty rates in old age vary substantially across nations. The first two columns of Table 4-10 show the percentage of persons aged 65 and over with disposable incomes (adjusted for differences in family size) of less than 40 or 50 percent of the overall national median disposable income. The table also shows the minimum guaranteed income for a single, older person as a percentage of the same adjusted national median income for each nation. 9 Nations with relatively low minimum benefits 9These minimum income systems usually involve two items: a flat old-age security benefit within the social retirement system, and some type of income or income and asset means-tested general revenue-financed “welfare” benefit for older persons. In the United States, the system involves the result of combining Old-Age and Survivor's Insurance (OASI), Supplemental Security Income (SSI), and food stamps. In many other nations, the flat old-age security benefit (minimum social security benefit) is higher, and the income-tested benefit is higher still. In Sweden, the policy goal is to have a guarantee at or above 60 percent of the median.

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Page 148(United States, United Kingdom) have relatively higher poverty rates. Other nations with well-targeted, high-participation-rate welfare systems (e.g., Canada) or those with relatively high lower-tier social retirement benefit levels (the Netherlands, Sweden, Germany) have lower overall poverty rates. Australia is unique in that it has no social security system, only a means-tested income support system, financed by general revenues to prevent old-age poverty. While this system produces only a 7 percent poverty rate at 40 percent of the median income, it results in a 29 percent rate at half of the median. These data also raise the question of what is meant by the generosity of a program. In the United States, for example, if social security is evaluated on the basis of replacement of income before retirement, it is a generous program indeed. Another definition of generosity is how much income is received relative to the median income of the society. On this basis, the U.S. system appears far less generous than those of other nations. 10 Table 4-10 also summarizes the OECD forecast for the financial cost of the social retirement system alone (as a percentage of GDP) if it were to continue its current level of benefits and participation rates over the next 30 years. Most American analysts are concerned about the future of the U.S. social security system, which would consume 6.6 percent of GDP in the year 2030. The gap between this figure and that for 1995, which must be made up by either benefit reductions or tax increases, is 2.5 percent of GDP. In contrast, the nations with high social retirement benefits—Germany, the Netherlands, and Sweden—are confronting much larger gaps while also starting from much higher bases; Canada faces a larger gap while starting from a slightly higher base. Each of these nations relies heavily on its social retirement system to finance old-age income support. For the median elderly person, German, Dutch, and Swedish social retirement benefits make up 84, 73, and 90 percent of disposable income, respectively. These figures compare with about 60 to 63 percent in the United States and Canada (Smeeding, 1997). According to most analyses, including those of the OECD (1998) and the World Bank (1994), these benefit levels cannot be sustained. Two nations—the United Kingdom and Australia—face a lesser problem. As mentioned earlier, Australia has no social security system, so it faces no explicit age-driven social security deficit problem. The United 10As discussed above, earnings and income inequality in the United States is much higher than in European countries at all ages. For the American system to achieve the same retirement-age poverty rates as other countries, it would have to have replacement rates that were well in excess of 1 for a large subgroup of the elderly. These levels of replacement would raise serious questions about such a system's effect on work effort and savings.

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Page 149Kingdom has reduced its future outlays by designing a two-tier system: a low (roughly 40 percent of median income) flat-tier benefit supplemented by welfare benefits, and an upper tier that allows participants to invest their contributions in private assets, not government securities. Sweden also recently privatized a portion of its social retirement system, but it still faces high expected outlays resulting from the generosity of the current system and the cost of converting to a privately financed system. Concepts of Wealth One limitation of many household surveys is that they do not measure a large source of wealth—annuities paid during retirement—that is especially relevant just before and during retirement. This is an especially important issue for international comparisons given the differing extent to which countries rely on government annuities during retirement and on employer-provided pensions. For example, the two important annuities in the U.S. system are social security and private pensions. Social security is an almost universal public-sector retirement annuity wherein the benefit is tied to past earnings through a progressive formula. Employer-provided pensions typically also are related to salary, but they are far from universal and are much more common in larger private firms. For example, 53 percent of HRS respondents report that they are covered by a pension. Fortunately, HRS has made a determined effort to measure both social security and pension wealth. 11 Table 4-11 lists wealth-income ratios for the subcomponents of wealth across schooling groups in the United States. This table documents some stark contrasts in the relative progressivity of these components. Financial assets are by far the most unequally distributed component; relative to household income, financial assets are 3.3 times larger among college graduates as compared with those who did not graduate from high school. Pensions are also regressive in their distribution, reflecting the greater prevalence of employer-provided pensions among high-wage workers. In contrast, social security is quite progressive, with social security wealth-income ratios being three times larger among high school dropouts than among college graduates. The final row in Table 4-11 combines all forms of household wealth. Compared with household wealth alone, total wealth is distributed relatively uniformly across schooling groups. The other European countries for which wealth data are available (along with Japan) have not yet developed integrated datasets that can 11The numbers reported here were derived from respondents' reports of their future expected Social Security and pension annuities. See Smith (1995) for the details of this calculation.

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Page 150 TABLE 4-11 Wealth-Income Ratios by Components of Wealth in the United States Education of Household Head Type of Assets All No High School Diploma High School Diploma Some College College Financial Assets 1.47 0.63 1.15 1.46 2.07 Household Assets 4.84 3.69 4.18 5.00 5.74 Social Security 2.12 3.28 2.65 1.96 1.33 Pensions 1.85 1.25 1.74 1.69 2.26 Total Wealth 8.81 8.22 8.57 8.65 9.33 NOTE: Data are from wave 1 of The Health and Retirement Survey, conducted in 1992. SOURCE: Juster et al. (1999). simultaneously inform us about levels of household wealth and wealth in the form of employer-provided and government-supported pensions. Such data are a high priority since they could go a long way toward reconciling cross-country differences in levels of private household wealth. For example, the fact that many of the continental European countries rely much more heavily on government-financed than employer-provided pensions may explain their relatively low levels of private wealth accumulation. RECOMMENDATIONS 4-1. Countries should address the pressing need for longitudinal microdata comprising extensive measures of economic status that can illuminate the relationship between income and wealth on the one hand, and financial incentives to retire, various dimensions of health status, and intergenerational transfers on the other. In most countries, the requisite data on economic status pertinent to policy making simply do not exist. A number of recent surveys have demonstrated that relatively short wealth modules can capture most of the salient attributes of the household wealth distribution. Countries should build upon and extend existing survey models (such as the Health and Retirement Survey in the United States) that have been shown to provide high-quality data on wealth and savings in addition to information on interrelated realms of life. 4-2. Given the overarching need for longitudinal microdata on economic status, researchers and policy makers should pay close attention to novel and potentially revolutionary ways of collecting such data. Several recent innova

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Page 151tions in collecting household wealth and income data have been found to greatly improve the quality of such information and should be further developed. These include the use of unfolding brackets to reduce item nonresponse and produce more accurate estimates of household wealth, the integration of income and asset questions, and the use of randomly varying anchor points. One particular high-priority research question is how to use the panel nature of repeated questions on household wealth to reduce across-wave measurement error. The fact that a vast majority of households in developed countries will soon be connected to the Internet opens up promising new means of data collection, such as those used in the Dutch CentER Savings Survey. Rather than computer-assisted person-to-person interviewing or computer-assisted telephone interviewing, one can use computers or equivalent media (e.g., set-top boxes) not only to ask questions directly, but also to present questions in novel ways and perform cross-wave checking on line. 4-3. Similarly defined microdata should be collected in different countries to exploit institutional differences and advance our understanding of the effects of policies on individual-level wealth accumulation. One issue that could be illuminated by comparative cross-national research is the extent to which public income provisions discourage or drive out private savings. To assess institutional and policy effects, it is essential that data collection efforts in different countries be well coordinated, that similar information be collected, and that procedures (e.g., sampling and quality control) be synchronized to the extent possible. Such synchronization can be achieved largely through the exchange of information among various scientific groups involved in new data collection efforts. The goal is not necessarily to have standardized instruments and identical survey design protocols in all countries. Each country has unique institutional features and policy priorities that should help shape survey implementation. REFERENCES Alessie, R., S. Hochguertel, and A. Van Soest 1999 Household Portfolios in The Netherlands. Paper prepared for the Conference on Household Portfolios, European University Institute , Florence . Alessie, R., and A. Kapteyn 1999 Wealth and Savings: Data and Trends in The Netherlands. Paper prepared for the Panel on a Research Agenda and New Data for an Aging World, Committee on Population, National Research Council . Alessie, R., A. Kapteyn, and F. Klijn 1997 Mandatory pensions and personal savings in The Netherlands. De Economist 145: 291-324 . Alessie, R., A. Lusardi, and A. Kapteyn 1995 Saving and wealth holdings of the elderly. Ricerche Economiche 49: 293-315 .

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