Age Related Pension Expenditure and Fiscal Space

Mukul G. Asher, Fauziah Zen, Mukul G. Asher, Fauziah Zen

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317371588
• Edition: 1
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

This book explores the linkages between age-related pension expenditures and the fiscal space needed to fund them, as well as to organize the mix of financing methods with different risk-sharing arrangements. After critically assessing the existing models projecting age-related expenditure in the literature, the book focuses on the case studies of these inter-linkages in four highly-populated East Asian countries, namely China, Indonesia, India, and Japan. Nearly two- fifths of the global population live in these countries. Therefore, how these inter-linkages manifest themselves and the initiatives in these countries for finding fiscal space will have an impact on how the ageing issues are addressed globally.

This book does several distinguishing characteristics, including exploration of inter-linkages between age-related expenditure and fiscal space, and application of country-specific methods to explore these linkages, rather than relying standard macroeconomic model. In the process, the studies also bring out the limitations of standardized model used in the literatures. Scholars and policy makers interested in the subject will definitely find the book of valuable use.

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Age related pension expenditure and fiscal space

An overview

Mukul G. Asher and Fauziah Zen

1. Introduction

This book constitutes the third publication arising from the project on Social Security Systems by the Economic Research Institute for ASEAN and East Asia (ERIA).¹ The primary motivation for this book arises from the need to better understand linkages between age related pension expenditures and the fiscal space needed to fund and finance them. In addressing growing anxiety concerning the credibility of pension promises among policymakers and populations in Asia, deeper understanding of these linkages is essential. This book, however, focuses on pension expenditure requirements intermediated through the fiscal system and not on total resources of the society to meet retirement income security.

After critically assessing the models commonly used by researchers in projecting age related expenditure in the literature, this book focuses on the case studies of age related pension expenditure and fiscal space in four highly populated East Asian countries, namely China, Indonesia, India, and Japan. These four countries account for nearly two-fifths of the global population. As these countries exhibit different per capita income levels and are at different stages in the demographic cycles – with Japan and China exhibiting much more rapid ageing than Indonesia and India – these case studies may be instructive for other middle- and high-income countries in Asia and elsewhere.

Among the four countries, only Japan is a high-income country, while the others are middle-income countries. Japan is also a member of the OECD² (Organization of Economic Co-operation and Development), which was set up in 1960. Japan’s policymakers face the challenge of declining population, whereas the other three countries will need to cope with rapid ageing and increasing share of aged population at relatively lower levels of income as they strive to move up from middle-income to high-income economies.

The United Nations (2013a) has projected a more rapid pace of ageing over the next several decades. To quote: “World population ageing is about to start a phase of acceleration. During the past 30 years, between 1980 and 2010, the proportion of the population that is aged 60 years or over increased by 2.4 percentage points in the world as a whole, from 8.6 per cent to 11 per cent. The absolute change in this proportion was much greater in the more developed regions (6.3 percentage points) than in the less developed regions (2.3 percentage points). But these changes pale in comparison to the 7.6 percentage-point increase that is about to occur on average in the next 30 years…. Both the less and the more developed regions will experience large changes, of 7.9 per cent and 8.8 per cent, respectively. By comparison, the least developed countries will experience a significant, though much smaller increase of 2.9 percentage points.” (p. 13).

Both the pace of ageing and the number of aged populations – particularly those above 80 years old, who require large support from society as their savings and other assets get depleted – represent policy challenges for these countries. The pace of ageing is relevant, as rapid ageing reduces the time available for all stakeholders to adjust to rapid ageing.

This book explores age related expenditure projections to finding avenues for fiscal space. The country studies in this volume demonstrate how characteristics of the fiscal system and institutional capabilities in each country impact the avenues that may be relevant. Thus, in both India and Indonesia reforming formal systems of pensions is essential for finding fiscal space. Enhancing capabilities to use non-conventional avenues, such as utilization of state assets to generate revenue, is also relevant for India and Indonesia. China has been using the National Social Security Fund (NSSF) and revenue from divestment of public enterprises as non-conventional avenues to help finance age related pension expenditure. One of the major issues in China, however, is to address the pension needs of the substantial number of migrants from rural to urban areas – an issue of not significant relevance to India and Indonesia. For Japan, improving the returns from the Government Pension Fund (GPF) has become essential, and so has the political management of rationalizing pension benefits and increasing the consumption taxes.

2. Funding and financing distinction

There is a distinction between funding age related expenditure and the mix of financing methods and instruments used to fund the expenditure needs of each cohort of population. The funding concerns the society’s resources that are devoted to the needs of the elderly. As the proportion of aged in a total population and the longevity of the successive population increases, a greater share of society’s resources – which may be drawn from both the public and private sectors – will be required to address the needs of the elderly population. This process is facilitated if a high core rate of economic growth, sustained over a longer period, is exhibited by a country and if appropriate consumption smoothing arrangements – such as increasing retirement savings and channelling them to productive growth-enhancing uses – are effectively implemented.³ Intergenerational smoothing of nation’s wealth through such instruments as Sovereign Wealth Funds (SWFs), commodity stabilization, and other such reserve funds, may also represent an avenue for funding age related pension expenditure.

The financing-mix on the other hand concerns various financing methods and instruments used for funding. A defined contribution (DC) method of retirement financing, whether mandatory or voluntary, specifies the contributions made by the members, employees, and governments; but leaves the monetary benefits to be generated from contributions and investment income during the retirement period undefined. In contrast, the defined benefit (DB) method specifies the benefits to be provided during retirement, but leaves contribution and investment income undefined. A distinction is also made in using the social insurance method, in which participation is compulsory and contributions rates are uniform up to the covered wages. In the commercial insurance method, in contrast, participation could be voluntary or mandatory, but insurance premiums may vary by age and, where not prohibited by law, by gender, as well as by other characteristics of the insured.

The financing-mix instruments may include in varying proportions tax or budgetary allocations for pensions; private saving, whether mandatory or voluntary for retirement; conversion of housing and other assets into retirement income streams; family and community support; and others. With increasing levels of income, growing urbanization, and a higher female labour force participation rate, the need for intermediation of retirement financing through formal state-intermediated institutions increases, while the role of family and community support diminishes.

The weight given to financing methods DB and DC may vary among countries. Their relative importance may also vary in the same country at different stages of economic development and pension objectives and structures. This is also the case with the financing-mix used by a country. This suggests that pension reform is a dynamic context-specific process, and therefore a quest for the ‘best’ pension structure system and financing method is unwarranted.

3. Demographic projections and their limitations

In estimating age related pension expenditure, demographic projections are essential. The standard internationally comparable data source for demographic projection is the Population Division of the Department of Economic and Social Affairs of the United Nations (UNDESA). The most recent projections available when the chapters in this volume were written (and this is still the case as of February 2015) were the UNDESA’s 2012 Revision of the World Population Prospects (UNDESA, 2013b).⁴

The UNDESA (2013b) projections are undertaken for low, medium, high, and constant fertility assumptions, with the medium variant most commonly used. According to the medium variant projections, the global population is projected to increase from 7.2 billion in mid-2013 to 8.1 billion in 2025, and to 9.6 billion in 2050. This represents a nearly one-third increase in only 37 years.

The differences in population projections between the fertility variants are significant. Under the high fertility variant,⁵ the projected global population in 2050 is 10.9 billion, 1.3 billion persons more than under the medium variant. At the other end, under the low fertility variant, the global population in 2050 will be 8.3 billion, lower by 2.6 billion as compared to the high variant. In 2050, the population is even higher if the constant rather than the declining fertility rate is assumed.

The UN projections, which focus on the chronological age of the population, are conventionally used for analysing ageing trends. Sanderson and Scherbov (2007), however, argue that as individuals live longer, both the traditional chronological concept of ageing, which they term ‘retrospective age’, and the forward-looking concept termed ‘prospective age’ should be used for policy formulation and analysis. While the traditional concept measures how many years a person has lived, the ‘prospective age’ measures the number of expected years an individual has left to live. With increasing longevity, a fifty-year-old person, who currently has a much longer life expectancy than a same aged person in 1990, may well make different saving, investment, labour force participation, and other relevant economic and personal decisions. The differing behavioural decisions in turn have different implications for public policies and social attitudes towards ageing. The data on ‘prospective age’ are, however, not published by the UN and other international agencies. The country studies therefore also use projections based on ‘retrospective age’.

The above discussion of demographic projections has at least three major implications for projections of age related expenditure for the country studies in this book. First, relatively small errors in fertility rate projections can lead to disproportionately large variations in population projections for a country, as well as for regions in a country. This would impact the projections of age related expenditure and the needed funding by the society and fiscal space. Regular monitoring of fertility and longevity trends and their implications for population projections are therefore essential.

The second implication is that in countries with large populations and land mass – such as China, India and, Indonesia – national and regional fertility variations would have significant implications for regional migration patterns and for the location of individuals and businesses. This in turn would differentially impact the fiscal capacities in different regions. Aggregate national fiscal space needed to manage age related expenditure may thus need to be complemented by the analysis of regional funding and fiscal capacities. This extension of national-level analysis has not been undertaken in the country studies in this book, as this would have significantly expanded the scope of the project. This issue has been deferred for future research. As devolving fiscal and other powers and responsibilities to lower levels of government progresses, such a disaggre-gated analysis will become even more essential.

The third implication is that projections based on ‘retrospective age’ used in the individual chapters in the book would alone be not sufficient to fully understand the economic and social behaviour of the elderly, as ‘prospective age’ considerations will also need to be taken into account. This is, however, left as an area of future research.

4. The concept of fiscal space

The country studies in this book strongly suggest that substantial fiscal space will be needed to fund age related pension expenditure. There is, however, considerable ambiguity in the manner in which fiscal space is defined in the literature. As a result, several definitions co-exist (Heller, 2005; World Bank Group, 2015; Roy et al., 2009).

Heller (2005) defined fiscal space as “the availability of budgetary room that allows government to provide resources for a desired purpose without any prejudice to the sustainability of government’s financial position” (p. 3). This is a broad and rather vague definition. The key elements emerging from the brief survey on fiscal space literature are that additional fiscal revenue or expenditure should not unduly hamper government’s financial or fiscal sustainability, usually measured by flow indicators, such as budget deficits, and by stock measures, such as public debt and an estimate of contingent liabilities on the government or constraints to broad-based growth. Both generation of additional fiscal space and its use are emphasized. Those focusing on short-term stabilization measures emphasize the sustainability aspects, involving gaps in available resources.

Thus, the World Bank Group (2015, Chapter 3), in their discussion of how to generate fiscal space and use it in the developing countries, adopts the definition of fiscal space of Ley (2009). Fiscal space is defined as the “availability of budgetary resources for a specific purpose … without jeopardizing the sustainability of the government’s financial position or sustainability of the economy” (p. 122). The focus of the World Bank Group (2015, Chapter 3) study is on fiscal space generation and is used among a cross-section of countries for short-term counter cyclical fiscal policy to cope with macro-economic shocks, such as those generated by the 1997–98 East Asian Financial Crisis and by the 2008 Global Crisis.

The above study identifies fiscal rules imposing specified numerical targets on budgetary aggregates; stabilization and reserve funds which involve setting aside revenue from commodity booms or fiscal balance of payments surpluses; and medium term expenditure frameworks (MTEFs) designed to link budgetary plans and allocations on the one hand, and growth and other strategic objectives on the other hand, in a multi-year flexible framework.

Analysts focusing on broader development issues, however, focus on how additional fiscal revenue and expenditure can be generated from such avenues as reprioritization and efficiency enhancing of and effectiveness of expenditures, domestic revenue mobilization, and budgetary deficits – and in selected countries in the short run, from development assistant. These analysts also emphasize how these additional resources are used for enhancing broad-based economic growth.

Thus, Roy et al. (2009) adopt the following definition of fiscal space: “Fiscal space is the financing that is available to government as a result of concrete policy actions for enhancing resource mobilization, and the reforms necessary to secure the enabling governance, institutional and economic environments for these policy actions to be effective, for a specified set of development objectives” (p. 2).

Some analysts, such as Asher (2005), have argued that greater competence and willingness in generating non-conventional revenue resources can help generate fiscal space. Such sources include using state assets, both physical and financial, more productively;⁶ revenue from state-created property rights in a transparent and economically desirable manner; and willingness to use non-tax revenue, including appropriate cost recovery and user charges, and surpluses of regulatory bodies.

In analysing fiscal space generated for use in any one area, such as age related expenditure, the opportunities foregone for using the space for other purposes should also be considered in public policy discussions. Tanzi (2006) has argued that addressing the curbing of activities that result in a collection of benefits from government programs by those not targeted by the government programs could also help improve fiscal space.

The above discussion suggests that specific instruments and avenues for generating and using fiscal space will vary among countries, and among regions within the same country. It also suggests that both government income and expenditure flows and its assets represented ...