How we model the effects of pension reforms
Why have we built an entirely new model to test the resilience of Europe's pension systems? Usually, when economists want to project the future, they build models based on the past. They ask: How did people react to change in the past, how did they behave in crises? These assumptions are then used to simulate, for example, the effects of policy reforms.
But in a sense, the future has become more complicated. Why is that? People’s lives differ more from each other than before. Some people have children early, some later, some change careers many times, some never; some migrate, others stay in place. This makes the question “What will happen if…?” even more difficult to answer than it already was.
In short, our life courses have become more heterogeneous. In a more heterogeneous society, we cannot simply extrapolate from how people behaved in the past.
We need new models – models that are built around our societies as they are now, and around the real people living in them.
This is why one of the main contributions of FutuRes was to create such an economic model.
From the final report: "Households are heterogeneous with respect to innate characteristics like learning ability and schooling effort, which implies heterogeneous life cycle decisions. Moreover, households experience idiosyncratic shocks of fertility, unemployment, health and mortality depending on their socioeconomic status (SES). We calibrate our model for four European countries: Austria, Germany, Italy and Poland."
Our model is designed specifically to project the effects of pension reforms in Europe. The FutuRes team at TU Vienna worked on it during the three years of the funding period. What they were interested in is the tradeoff between sustainability of pension reforms on one hand, and fairness on the other. “Fairness” in terms of treating population groups in a way that they receive similar returns for what they pay in.
In a time where European countries are beginning to struggle with updating their pension systems to demographic change, the Vienna team did no less than setting up a bench framework that can be used to model, not just one national economy, but several countries with very different pension systems.
How does it work?
In short, the model is a calculation into which we can enter certain variables according to the country that we're interested in. We then simulate a pension reform by assuming that the government changes a few of these variables. Built into the calculation are “actors” whose reaction we measure: “households” and “firms”.
This is essential because the real life outcomes of a pension reform might at times be very different from what you would expect. An example of such an undesired outcome is when government reforms involuntarily drive up interest rates (“crowding out” of savings).
In our model we are taking into account such behavioral reactions continuously over time – down to the individual level and also differentiated by generations.
To do this, the model has to account for heterogeneity by distinguishing between different social groups – by education or income, but also by hours worked per week. We argue that this makes the model more practical for policymaking. It also makes it more resilient to future changes in societies, which are inevitable.
Find out more
Resilience analysis of current pension systems: Final report by the FutuRes team at TU Vienna.
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