The Effect of the Demographic Change on Inequality and the Role of the Pension System: Evidence from Social Security Data and a Dynamic Structural Life-Cycle Model

The demographic change poses numerous challenges to societies in developed countries. In particular, the increasing longevity and the related ageing of societies affect the organization and the financing of the welfare state. Therefore, most governments have introduced or are about to design reforms of the welfare state, most important of the pension system. At the same time the increasing longevity has important distributional effects and consequences for the inequality of a society. First, there exists clear evidence that life expectancy and the increase in longevity strongly differs between individuals and is related amongst others to health, income, education, working history and occupations. Therefore, while some individuals will enjoy a longer life and might be able to extend their working life to accumulate more lifetime income or wealth, other individuals do not benefit from this overall trend or experience longer periods in bad health. Second, the labor market effects and the distributional consequences of pension reforms related to the demographic change, strongly differ between individuals. Some individuals can easily adjust their employment behavior or increase old age savings as a response to these reforms. In contrast other individuals might have problems to extend their working life or might face constraints to accumulate additional private savings. For these individuals, the increase in retirement age might lead to negative employment effects and longer periods of unemployment and thus to a sizable reduction of net income and pensions.
It is the objective of this project to study the effect of the increase in longevity and of pension reforms related to increasing longevity on income inequality and welfare and based on these results we will discuss implications for the optimal design of the pension system.  In more detail, we combine evidence from social security data with longitudinal household survey data to study the interplay between heterogeneous life expectancy, pension reforms and income inequality. In the center of the project we develop a structural model of labor supply, retirement and savings with heterogeneous life expectancy that allows to study the consequences of increasing longevity on inequality and to analyze the fiscal and distributional effects of various pension reforms. We complement the structural analysis with new descriptive evidence about the increase in the heterogeneity in life expectancy between cohorts and how this increase is related to the cohort specific increase in income inequality. Moreover, we provide causal evidence about the heterogeneous effects of pension reforms; we analyze how firm- and occupation-specific characteristics as well as individual and household variables affect individual responses to pension reforms. The different projects of this proposal are strongly linked. In particular, we plan to exploit the new evidence about the heterogeneity in life expectancy in the structural model and, for the identification of the structural model we exploit the variation induced by the pension reforms.

Prof. Dr. Peter Haan (DIW Berlin)

Dr. Anna Hammerschmid (DIW Berlin)
Dr. Daniel Klemptner (DIW Berlin)