The forrnation of retirernent incorne
3.7 Conclusion: an optimal mix of flat-rate and earnings related benefits? and earnings related benefits?
In this chapter I have investigated the theoretical reasoning needed to support the main hypothesis of this thesis, that the presence of earnings related social insurance pensions can, under specific circumstances, help dampen the level of income inequality among the retired. If we were simply discussing the distributive impact of social insurance pensions in contrast with a hypothetical situation without public pensions, there would be little doubt about the answer, but the practical and theoretical relevance would be equally small. Comparisons with alternative models of public retirement provision, in particular a reliance on flat-rate or means-tested benefits, are much more relevant. Hence, the pertinent question is whether a mixture of flat-rate and earnings related benefits can be more conducive 'to equality than systems bas ed purely on flat-rate or means-tested benefits.
In Section 3.2 I pointed to four conditions or mechanisms that play a crucial role in the overall argument in favor of such a claim:
1 Private sources of retirement income must have an inherent tendency to be very strongly concentrated - relative to the pre-retirement income distribution.
2 Total expenditure on public pensions should be allowed to expand as sodal insurance is introduced.
3 The presence of sodal insurance pensions must be assumed to reduce the scope of private retirement provision (more effectively than flat-rate benefits and with a more favorable profile).
4 The distributive profile of private pensions must not turn significantly towards a higher level of inequality as they become more marginal-ized in the income package of retired households.
In the following sections I have tried to evaluate whether a plausible the-oretical argument can be deve10ped in support of these assumptions In the main, the answer is affirmative. However, on a number of points plausible counter-arguments can be deve10ped as well, and the overrid-ing impression from the discussion is one of theoretical indeterminacy and contingency of important mechanisms that control the formation of retirement income. I have found good reasons to support the expectation that private income components tend to be highly concentrated as com-pared to the pre-retirement income distribution, and that there is like1y to be a trade-off between benefit equality and benefit generosity in public pension provision. However, I have also stressed how these two claims must be conditioned on the structural and institutional context in different countries. The degree and pattern of labor market stratification is among the pertinent factors that are like1y to cause significant variation in the dis-tributive profile of occupational pensions.
The last two conditions, concerning the scope and nature of behavio-raI responses to public provision, are even more difficult to assess a pri-ori. I have argued that the scope of private income sources, and in partic-ular of occupational pensions, is like1y to be subject to a demand-side logic. However, the presence of unstable and re1ativistic preferences for retirement income might on occasion prevent a clear crowding-out effect of public pensions.
Let me conclude this section witrh a graphical illustration of the idea that an optimal mix of flat-rate and earnings related pensions might exist.
The panels in Graphs 3.2 and 3.3 are extensions of Graph 3.1 in Sec-tion 3.3. The X-axis measures the benefit structure of public pensions, going from a complete reliance on flat-rate benefits at the right-hand ("Beveridge") pole to a complete reliance on earnings related, sodal insurance benefits at the left-hand ("Bismarckian") pole. The Y-axis meas-ures, once again, the average benefit leve1 of public pensions, and the
thick convex lines in each of the panels are the possibility frontiers, based on the assumption of a trade-off between benent equality and benefit level, discussed in Section 3.3 above.
The new feature of these graphs is the addition of a kind of indiffer-ence curves that refer to the level of Gini inequality in total income to be expected among the retired. More precisely, these curves could be called
"iso-Gini" curves, and they provide a mapping of the distributive outcome associated with different combinations of benent level and benefit struc-ture of public pensions. They have been drawn using the Gini decompo-sition tools presented in Section 3.2. The lowest level of inequality is found in the upper right hand side corner of the graphs with the combina-tion of very generous and flat-rate benefits, while the highest level of ine-quality is found in the bottom left-hand corner with the combination of low and earnings related benefits from the public pension system.
The top panel in Graph 3.2 shows a hypothetical country with a rela-tively large potential for solidaristic retirement provision (C3), implying that the possibility frontier is relatively high and only moderately down-ward-sloping. The second panel represents a country with a low potential for solidaristic retirement provision, and hence the possibility frontier is lower and much more steeply sloping downward from left to right (Cl).
In order to draw the "iso-Gini" curves in the two panels of Graph 3.2 I have employed the method of gini-decomposition presented in Section 3.2,151 based on the following assumptions:
Gini inequality for the pre-retirement distribution is 0.2 for the first and 0.3 for the second of the two country cases. This means that if public pension provision is based fully on social insurance benefits (is situ-ated at the "Bismarckian" pole), the Gini inequality for public pensions will reach a maximum of 0.2 and 0.3, respectively. The difference in the concentration of public pension benefits decreases as one moves right along the X-axis, and at the "Beveridge" pole the Gini inequality for public pension is in both cases equal to zero.
The absolute size of the private income component is constant, and so is its concentration among the retired. In other words, no behaviorai
151 The curves are calculated on the basis of the forrnula for the Gini inequalityin total income shown in Section 3.2. For a given fixed level of inequality in total income, the formula can be rearranged to express the absolute level of public pension benefits as a function of the benefit structure of public pensions. For the sake of convenience I have discarded the r-terms, i.e., I have assumed the private income component is always perfectly rank-correlated with social insurance beneflts.
(3
-G=0.18
- G =0.20
- G =0.22
- G =0.24
- G =0.26
- G =0.28
._" Possibility frontier
"Bismarck"
Benefit structure "Beveridge"
(1
- G =0.30
- G =0.33
- G =0.36
- G =0.39
- G =0.42
- G =0.45
- Possibility frontier
"Bismarck"
Benefit structure "Beveridge"
Grapb 3.2 Possibility frontiers and iso-Gin i curoes witbout bebavioral responses. Two by-potbetical country cases.
respons es are allowed. The private income component in the first of the two countries is only 3/4 the size of the private income component in the second country, and the Gini inequality for the private compo-nent is assumed to be 0.6 and 0.8, respectively. In other words, it is assumed that the demand for private retire ment income is higher and more concentrated in the country with a more in-egalitarian distribu-tion of pre-retire ment incomes.
Under these assumptions we obtain downward sloping and concave "iso-Gini" curves in both cases. However, since private income is in both cases assumed to be highly concentrated as compared to the pre-retire-ment income distribution, the leve1 of public pension benefits has a posi-tive impact on total inequality in combination with the structure of bene-fits. If the structure of public pensions is changed in favor of more earnings related benefits, a constant leve1 of inequality in total retirement income can be maintained by increasing the total leve1 of public pension provision. The doser one appoaches the earnings related pole, the bigger the increase in benefits leve1s is needed to offset an inerease in the ine-quality of public pensions.
The optimal structure of public pensions can now in each case be found as the point on the possibility frontier that is associated with the highest "iso-Gini" curve (the curve representing the lowest Gini coeffi-dent). Of course, the position of the optimum depends on the shape of the possibility frontier as weU as on the shape of the "iso-Gini" curves.
In the first of the two country cases the optimal point is found at the
"Beveridge" pole, since the slope of the "iso-Gini" curves is everywhere steeper than the slope of the possibility frontier. In the country with more in-egalitarian predispositions, the two curves touch somewhere to the left of the "Beveridge" pole, and hence the optimum is characterized by a combination of flat-rate and earnings re1ated benefits. The main reason behind the different result for the two hypothetical examples lies with the slope of the possibility frontier, which is much steeper for the second country. However, the "iso-Gini" curves als o differ significantly. For a cer-tain leve1 and structure of public pensions, inequality in retirement income is substantiaUy higher in the second than in the first of the two country cases.
Note how the position of the optimum depends on two of the four conditions invoked above: The slope of the "iso-Gini" curves depends on the assumptions made about the concentration and size of the private
income components. The bigger the scope of private income provision and the stronger its concentratiori, the flatter the "iso-Gini" curves will be, and the chances increase that inequality in retirement income will be minirnized by moving somewhat away from the "Beveridge" pole. Simi-larly, the assumptions about the slope of the possibility frontiers are cru-cial. If the possibility frontiers were horizontal, in line with an assumption about fixed budgetary constraints, the optimum would invariably be found at the "Beveridge" pole, since the "iso-Gini" curves must always be downward sloping.
It is now time to add the last two conditions, concerned with the nature of behavioral responses.
The "iso-Gini" curves in Graph 3.2 were based on the assumption that the size and the structure of the private income component is unaffected by the leve! and structure of public pensions. The unbroken curves in Graph 3.3 represent the optimum inequality leve! that can be obtained in the absence of behavioral responses - i.e., these curves are based on the same assumptions as in Graph 3.2. The dotted lines, however, represent a new set of "iso-Gini" curves inwhich I have attempted to build in some highly stylized assumptions about behavioral responses to public pensions:
1) The absolute size of private income components is assumed to decrease with the leve! of public pension benefits; and 2) the concentration of pri-vate income components is assumed to decrease somewhat when public pensions are allowed to reflect pre-retirement income differentials. In other words, I have built in exactly the kind of assumption that would be favora-ble to the overall hypothesis about a positive role for social insurance pen-sions. It is not surprising, therefore, that they cause the "iso-Gini" curves to become flatter, and the optimum to move closer towards the social insur-ance pole, in both of the hypothetical country cases.
Even in the first, more egalitarian country with a relative!y modest share of private income components and a rather flat profile for the trade-off between leve! and structure of public pensions, the possibility line now touches an "iso-gini" curve at a point to the left of the "Beveridge"
pole, and hence the optimum now involves a combination of flat-rate and earnings related pensions.
The graphs provide a specification of the claim that social insurance pensions might have a positive role to play in combination with a certain minimum protection in attempts to keep inequality low among the retired. But of course they are not more than heuristic devices. Logical plausibility does not imply empirical truth.
\
\
\
"Bismarck"
"Bismarck"
"
"
(3
Benefit structure (1
Benefit structure
- G=0.22 - - G = 0.17*
-""" Possibility frontier
"Beveridge"
- G = 0.41 - - G = 0.32*
- Possibility frontier
"Beveridge"
Graph 3.3 Possibility frontiers and iso-Gin i curves. With (*) and without behavioral re-sponses. Two hypothetical country cases.
Nevertheless, despite their stylized and heuristic nature, these graphs allow enough complexity to highlight an important methodological point, one which will be addressed in the following chapter: Any attempt to test the overall hypothesis about a systematic relationship between the institu-tional set-up of pension systems and the degree of income inequality in retirement, using cross-national data, must take account of variation in the societal context in which the different national pension systems operate.