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Lfeyriskerfin Norurlndunum og snemmtekinn lfeyrir Tryggvi r Herbertsson Hagfristofnun Mlstofa hj Selabanka slands 4. febrar, 2002

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Introduction On the whole, labor force participation of older workers is declining in the industrialized countries due to changing age structures. In response to high unemployment, many countries expanded early retirement schemes in the 1980s. In the Nordic countries, substantial decreases in labor market participation have in particular occurred in Finland and, more recently, in Norway. Despite the common trend toward earlier retirement, however, labor market participation rates differ significantly across countries. This divergence indicates that participation depends on a wide variety of factors. Older workers in Iceland have among the highest participation rates in the world. Participation rates are also relatively high in Norway, despite the recent decline. However, Denmark and Finland have experienced low and falling participation rates, although there is some evidence that these rates may now be leveling out.

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Introduction This combination of earlier retirement and longer life expectancy results in a much longer span of inactivity. Regardless of its causes, the withdrawal of older workers from the labor force leads to an increase in unused production capacity, a reduced tax base, and a heavier load on pension and fiscal systems. If the trend toward earlier retirement were to continue far into the future, it would pose even larger fiscal threats to pension systems, especially those that do not include a penalty for early retirement. The trend toward earlier retirement and the related issue of disability raise substantial policy challenges. General outline of presentation: Demographics in the Nordic countries Pension arrangements Early retirement The costs

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Key Figures

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The Demographic Time Bomb?

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Demographics

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Proportion of population aged 65 and over Key features Low mortality High fertility Reasonably low migration

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Demographics

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Dependency ratio tends to plateau Costs are permanently, not temporarily, higher Old-age dependency ratio (65+ over 20- 64) in Sweden 1860-2100

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The Nordic Welfare State

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The Nordic Welfare Model Pensions have a long history in the Nordic countries. The generic Nordic pension system combines a public, means-tested minimum benefit; a public earnings-related component; and occupational-based private pension coverage. In 1998, pension spending amounted to: 8.8 per cent of GDP in Denmark, 5.7 per cent in Finland, 3.3 per cent in Iceland, 7.8 per cent in Norway, 10.7 per cent in Sweden. Demographic trends will increase pension costs significantly over time. Although the results vary somewhat from country to country, the trend is unambiguous: the elderly proportion in the population will exceed 15 per cent by 2030 in all the Nordic countries.

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Denmark Public old age pensions combine flat-rate pensions with a small earnings related pension, FP-pensions (pay-as-you-go financed) Flat-rate funded labour market supplementary plan (ATP-pensions) New funded supplementary plan (SP-pensions), paying a flat-rate 10- year annuity from the age of 67 Occupational DC pensions Private pensions schemes with insurance companies and banks

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Denmark Percentage Contributing to a Private Pension Scheme in Denmark in 1998 Private (occupational and personal schemes) coverage high in Denmark

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Finland Flat rate/very small earnings related Finnish National Pension (KELA) Mandatory TEL/related DB plans (partially funded) Third pillar insurance funds Male TEL Contributions 1999 in Finland

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Iceland

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Norway Flat rate + progressive earnings scheme DB occupational pensions Top up accounts

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Sweden Old PAYG system PPM Occupational schemes Insurance plans

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Sweden (Buffer funds)

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Minimum Pensions Table: Minimum pension in the Nordic pension systems Denmark Finland Iceland Norway Sweden Official retirement age 67 65 67 67 65 Minimum social security pension before tax for a single individual with no alternative income (basic pension and supplements). 12,855 5,071 - 5,298 11,844 10,362 9,368 Is minimum state security pension income tested? Not the basic amount, but the low- income supplement Yes Yes Not the basic amount, but the low- income supplement Not the basic amount, but the low- income supplement As of 4th of April 2000

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The Costs of Early Retirement

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Labor Force Participation In 17 OECD countries, for which data are available, the proportion of the 55-64 age cohort of employed males fell by an average of more than 10 percentage points between 1980 and 1996. For the Nordic countries the inactivity of those 55 years and older has increased substantially over the last four decades. Trends in the inactivity of males 55+ in the Nordic countries 1965-98 (weighted average)

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Early Retirement Labour force participation rates among 55-64 years old males in the Nordic countries, 1977-96

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Costs of Early Retirement Herbertsson and Orszag (2001) developed a framework to assess the economic costs of early retirement in the OECD. There are substantial differences among the countries in costs due to early retirement. In particular, Iceland has the lowest costs in the OECD. Costs of early retirement of 55-64 year-olds as a share of potential GDP in the Nordic countries and the OECD

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Why Early Retirement? Labor supply explanations: Incentives (pension wealth, accrual rate, earnings tests, tax considerations, etc.) Disability (morbidity increases with longevity) Transition from long-term unemployment into retirement Government policies (lump-of-labor fallacy) Labor demand explanations (possibly pseudo-theorems): Jobs get obsolete and older workers lack skills (education) to switch jobs Older workers less productive than younger workers

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Why Early Retirement? The UK Cabinet Office (2000) estimates that at most one-third of early retirees have planned their retirement. Labor force status of people not working between 50 and state pension in the UK: Voluntary inactive Retired (18 per cent) Taking care of family (14 per cent)? Involuntary inactive Long-term sick or disabled (44 per cent) Looking for work (10 per cent) Other reasons for inactiveness Dont need job (5 per cent) Other (10 per cent)

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Early Retirement: Denmark

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Early Retirement: Finland

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Early Retirement: Sweden

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Late Retirement: Only in Iceland Labor force participation rates for men over 65 in the OECD

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Disability: Morbidity on the Move Disability incidence among men and women age 55-59 in the Nordic countries

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Disability: Morbidity on the Move Percent of age-group with more than 75% disability pension in the Nordic countries

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Encouraging Work Important to recognise external costs of early retirement. Policy options: Voucher programs, Quantity restrictions, Special schemes (FlexJob in Denmark).

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Conclusion Despite the political unpopularity of reforming early retirement systems, several countries have already taken steps to tighten eligibility rules and strengthen incentives to retire later. However, even these additional incentives are often weak or clash with supplementary pension provision. Furthermore, in most countries, few incentives exist to retire late, as reflected in low labor force participation after the formal retirement age. Steps taken so far to challenge changing demographic structures: Denmark ATP, occupational pensions Finland prefunding of TEL, etc. Iceland voluntary individual accounts, mandatory occupational plans Norway the petroleum fund Sweden - PPM