Paths and Forks or Chutes and Ladders?: Negative Feedbacks and the Dynamics of Pension Regime Change

Kent Weaver

Georgetown University

and the Brookings Institution

Policy Regimes, defined:• A system of organizing, financing and

delivering policy that:– Has a distinctive distribution of costs and

benefits– Is relatively stable over time

• The German pension system• The U.S. health care system• Cheap energy policies• “Socialism market economy” in China

Examples:

The Questions:

1. How frequent is a major change in policy regimes?

2. How much do past choices constrain the range of future regime options? Do policymakers have significant discretion in shifting policy regimes?

Is the best metaphor for policy regime transitions…

Paths and Forks?

103

Old

Path Choice at Some Times and Not at Others?

Cul-de-sac or “No Exit”?

Boomerang or policy reversal?

..or Driving off a Cliff?

Cul-de-sac:Regime Type Regime

Type at t1 at t2

Regime Type 1

Regime Type 2

Regime Type 3

Regime Type 4

Regime Type 5

Regime Type 6

Regime Type 7

Unconstrained choice:Regime Type Regime

Type at t1 at t2

Regime Type 1

Regime Type 2

Regime Type 3

Regime Type 4

Regime Type 5

Regime Type 6

Regime Type 7

Paths and Forks:Regime Type Regime

Type at t1 at t2

Regime Type 1

Regime Type 2

Regime Type 3

Regime Type 4

Regime Type 5

Regime Type 6

Regime Type 7

Chutes and Ladders:Regime Type Regime

Type at t1 at t2

Regime Type 1

Regime Type 2

Regime Type 3

Regime Type 4

Regime Type 5

Regime Type 6

Regime Type 7

Mixed Patterns Across Regimes:Regime Type Regime

Type at t1 at t2

Regime Type 1

Regime Type 2

Regime Type 3

Regime Type 4

Regime Type 5

Regime Type 6

Regime Type 7

More choice at t1:Regime Type Regime Type Regime

Type at t1 at t2 at t3

Regime Type 1

Regime Type 2

Regime Type 3

Regime Type 4

Regime Type 5

Regime Type 6

Regime Type 7

More choice at t2:Regime Type Regime Type Regime

Type at t1 at t2 at t3

Regime Type 1

Regime Type 2

Regime Type 3

Regime Type 4

Regime Type 5

Regime Type 6

Regime Type 7

Boomerang:Regime Type Regime Type Regime

Type at t1 at t2 at t3

Regime Type 1

Regime Type 2

Regime Type 3

Regime Type 4

Regime Type 5

Regime Type 6

Regime Type 7

3. What factors determine whether policy regime change occurs?

The Conventional (Piersonian) Wisdom:• Once policies are in place they are

generally reinforced by:– Adaptive expectations and sunk costs (lock-in

effects)– Political support coalitions that grow up around

the policies– Multiple veto points in political systems

• So policy regime change mostly results from exogenous shocks

A Framework for Explaining Policy Regime Change:

Much policy regime change has endogenousroots, and depends on:• Balance between positive and negative

feedbacks from existing policy• Incremental reform options available to

policymakers—and whether they have been exhausted

• Regime transition opportunities available to policymakers

A Quick Overview of Pension Policy in Wealthy Countries

OECD countries vary substantially in what theyspend on pensions

Pension systems vary substantially across countries in their impact on poverty

Most western countries face a severe decline in

the ratio of workers to retirees….

….that gets worse the further out projections are made

And many countries have experienced falls in labor force participation for older men….

Source: Social Security Administration, An Aging World, 2001. The initial year is 1981 for Canada and New Zealand, 1982 for France. The final year is 1996 for France.

Male Labor Force Participation Ratesage 60 to 64 c. 1980 and 1999 (approx.)

68.8

39.144.2

29.1

45.7

65.9

86.4

60.4

46.6

16.4

30.3 31.7

57.4 55.552.2

54.8

0

10

20

30

40

50

60

70

80

90

100

Canada France Germany Italy NewZealand

Sweden UnitedKingdom

UnitedStates

1980 1999

…while levels for older women are lower and show more uneven trends

Source: Social Security Administration, An Aging World, 2001. The initial year is 1981 for Canada and New Zealand, 1982 for France. The final year is 1996 for France.

Female Labor Force Participation Ratesage 60 to 64 c. 1980 and 1999 (approx.)

28.3

22.3

138

11.7

41.4

27.8

34

26

15.212.7

8.1

32.5

46.5

24.7

38.8

0

10

20

30

40

50

60

70

80

90

100

Canada France Germany Italy NewZealand

Sweden UnitedKingdom

UnitedStates

1980 1999

A variety of incremental policy responses have been tried to address pension funding issues:

• Refinancing– Increase payroll tax base and rates– Add dedicated revenue sources or increase

general revenue subsidies

• Retrenchment– Change indexation formulas– Punish early retirement– Increase retirement ages

But what about more fundamental reforms―shifts in pension regimes?

The Questions on Pension Regime Change:

• How frequent is a major change in pension policy regimes?

• How much do past choices constrain the range of future pension regime options? Do policymakers have significant discretion in shifting pension policy paths?

• What are the forces that determine whether pension regime changes occur?

The Convention Wisdom on Pension Regime Change

Categorizing Pension Regimes:

• Welfare states can be divided into three categories– Universal/citizenship regimes

(Scandinavia)– Social insurance “Bismarckian” regimes

(continental Europe)– Residual regimes (U.K., Canada, United

States, Australia)

Esping-Andersen, The Three Worlds of Welfare Capitalism

The Frequency of Pension Regime Restructuring:

• Welfare states have survived recent economic and demographic pressures relatively intact

• Pension reform has been largely incremental rather than fundamental “regime change”

Myles and Pierson, The New Politics of the Welfare State

Explaining Patterns of Pension Restructuring:• “Positive policy feedbacks” limit the

pension reform options of policymakers:– Constrain choice sets– Create constituencies who resist any

change that would make them worse off

• Age and maturity of pension regime matter (e.g., “double payment problem”)

A Revised Approach

Categorizing Pension Regimes:• Esping-Andersen’s tripartite categories

are overly broad and misleading, e.g.:– Residual category is overly broad mixture of

• means-tested• “Bismarckian Lite”• mixed regimeswith distinctive challenges and regime

transition opportunities– New “Notional Defined Contribution” (NDC)

pension has different challenges and transition opportunities from continental/Bismarckian regimes

Recategorizing Pension Regimes:

– Universal/citizenship regimes (New Zealand)

– Social insurance “Bismarckian” regimes (continental Europe)

– “Bismarckian Lite” regimes (U.S.,Canada)– NDC regimes (Sweden, Italy)– Residual regimes (formerly Australia)– Mixed regimes (U.K., Netherlands,

Switzerland, Denmark)– Privatized regimes (none among rich

countries)

1950 1974 1985 1995 2009

NDC

Bismarckian

Bismarckian Lite

Universal

Mixed

Residual

Asterisk indicates that a country has added a small mandatory or quasi-mandatory defined contribution individual account tier.

Italy *Sweden *

Germany *AustriaFrance

U.S.Canada

Denmark

Australia

Ireland

Neth.

Switz.

N.Z.*

U.K.

Pension Regime Transitions

Available regime transition options depend on your starting point…

1950 1974 1985 1995 2009

NDC

Bismarckian

Bismarckian Lite

Universal

Mixed

Residual

Canada

Denmark

Australia

Residual (Means-Tested) Pension Regime Transitions

1950 1974 1985 1995 2009

NDC

Bismarckian

Bismarckian Lite

Universal

Mixed

Residual

Asterisk indicates that a country has added a small mandatory or quasi-mandatory defined contribution individual account tier.

Sweden *

Canada

DenmarkIreland

Switz.

N.Z.*

U.K.

Universal Pension Regime Transitions: Early exits and multiple destinations

1950 1974 1985 1995 2009

NDC

Bismarckian

Bismarckian Lite

Universal

Mixed

Residual

Asterisk indicates that a country has added a small mandatory or quasi-mandatory defined contribution individual account tier.

Italy *Sweden *

Germany *AustriaFrance

Bismarckian Pension Regime Transitions: Very late exits and only 1 destination (plus*)

1950 1974 1985 1995 2009

NDC

Bismarckian

Bismarckian Lite

Universal

Mixed

Residual

U.S.Canada

“Bismarckian Lite” Pension Regime Transitions: High durability

1950 1974 1985 1995 2009

NDC

Bismarckian

Bismarckian Lite

Universal

Mixed

Residual

Asterisk indicates that a country has added a small mandatory or quasi-mandatory defined contribution individual account tier.

Italy *Sweden *

Germany *

Denmark

AustraliaNeth.

Switz.

N.Z.*

U.K.

Mixed Pension Regime Transitions:Multiple Precursors, No Exits, and **

The Frequency of Pension Regime Restructuring:• Pension regime change is fairly frequent

– 9 of 14 countries in sample have at least one – Only four (Sweden, Canada, Denmark and New

Zealand) have more than one– Regime reversals (“Boomerangs”) are very rare

• Bismarckian systems are beginning to “thaw” with shifts to NDC regimes and addition of small DC tiers

• The U.S. is an outlier in having virtually no incremental or regime changes since 1983

Pension Regimes differ substantially in their durability:

• “Bismarckian Lite” and mixed regimes are highly durable (cul-de-sac) in post WW II period

• Universal and residual regimes virtually disappeared after World War II, with multiple destinations (paths and forks)

• Bismarckian regimes were very durable until mid-1990s when shift to NDC began (precursor to “Chutes and Ladders?”)

Pension Regime Restructuring—Timing:• Different types of regime transitions are

concentrated in different periods:– Shifts to Bismarckian regimes stop pre-

1973– Shifts to mixed regimes concentrated

post-1973– Shifts from Bismarckian to NDC regimes

post-1994 (after incremental reform options exhausted)

– Individual account account “add-ons” to dominant DB regimes grow beginning in 1990s

Argument: Prospects for pension regime change depend on:• The balance of positive and negative

feedbacks• The availability and efficacy of

incremental reforms to address those challenges

• The availability and political acceptability of regime transition options

which vary across specific pension regimes

Challenge and Change in Bismarckian Pension

Regimes

Challenges for Bismarckian social insurance systems are severe:• Severe sustainability issues with agingSevere sustainability issues with aging• Need to address problems of low labor Need to address problems of low labor

market participation in 55-64 age groupmarket participation in 55-64 age groupMale Labor Force Participation Rates

age 60 to 64 c. 1980 and 1999 (approx.)

39.144.2

29.1

60.4

65.9

32.3

16.4

30.3 31.7

54.8 55.5

18.6

0

10

20

30

40

50

60

70

80

90

100

France Germany Italy US Sweden Belgium

1980 1999

Incremental reform options for Bismarckian social insurance systems are limited:

Social Security Contributions as % of GDP in 2000

5.1

16.414.8

11.9

16.1

12.4

14.115

6.16.9

0

2

4

6

8

10

12

14

16

18

Belgium

Canad

a

Franc

e

Germ

any

Italy

Nethe

rland

s

Spain

Sweden UK US

%

• Payroll taxes perceived to hurt competitiveness• Less visible incremental benefit cuts mostly

exhausted, leaving only painful options (e.g. retirement age increase)

Transition Opportunities for Bismarckian regimes are highly constrained:

• Shift to mixed regime regimes unlikely due to double payment problem (only small DC “add-on” possible)

• Can’t shift to universal, residual, or Bismarckian Lite regimes because of adequacy concerns

• NDC regime is only remaining regime transition option (“single chute”)– and it is a recent innovation

Sweden in the 1990s—Policy Feedbacks in a Bismarckian System

• Universal pension

• Earnings-related pension on top

• Generous income-tested pension removes almost all seniors from poverty

Sweden--

Strong Negative Feedback Effects• Very serious fiscal challenge in both short run

and long run as population ages• Very high payroll taxes and overall tax burden

spark competition concerns

Exhausted Incremental reform options• Strong resistance to payroll tax increases• Strong union resistance to visible benefit cuts

Limited Regime Transition Opportunities:• Shift to a Mixed System very difficult given high

current commitments and payroll tax• Shift to NDC system compatible with existing

earnings-related system

Sweden Today—An NDC System with an Individual Account Add-On:

• NDC tier financed by 16% contribution rate-- risk of poor economic performance and increased longevity shifted from state to workers

• Individual account tier financed by 2.5% contribution rate

Challenge and Change in “Bismarckian Lite” Pension

Regimes

Challenges for “Bismarckian Lite” social insurance systems include:

• Developing adequate mechanisms to Developing adequate mechanisms to deal with senior povertydeal with senior poverty

• Adapting to changes in Adapting to changes in supplementary occupational and supplementary occupational and personal pension sectorspersonal pension sectors

• Addressing long-term pension Addressing long-term pension funding problems in the absence of funding problems in the absence of an immediate funding crisisan immediate funding crisis

“Bismarckian Lite” pension regimes contain room for refinancing without restructuring

Social Security Contributions as % of GDP in 2000

5.1

16.414.8

11.9

16.1

12.4

14.115

6.16.9

0

2

4

6

8

10

12

14

16

18

Belgium

Canad

a

Franc

e

Germ

any

Italy

Nethe

rland

s

Spain

Sweden UK US

%

“Bismarckian Lite” pension regimes have multiple transition opportunities:

• Can shift to Bismarckian regime only before demographic crisis hits

• Can shift to mixed regime as “add-on” with higher contributions

• Can shift to NDC regime

But also have less need to shift because of availability of incremental reform options

United States:

Negative Feedbacks• Moderate fiscal challenge in short run and

relatively modest in longer run• Adequacy: High senior poverty rates

especially very old single women

Incremental reform options• Benefit cuts (e.g., retirement age

increases and increased income-testing at upper end)

• payroll tax increases off the table because of Republican opposition

United States:

Regime Transition Opportunities• Shift to mixed system inhibited by

financing constraints unless new revenues added

• NDC system possible but inhibited by internal cross-subsidies unless new revenues added

United States Today— “Bismarckian Lite” Stability :

Social Security in the U.S.:

• Incremental reform in 1977 and 1983 including benefit cuts and increases in standard retirement age

• Virtually no policy change since then

• Efforts by Bush II to get opt-out individual account reform on the agenda failed

Concluding Thoughts

1. How much pension regime change?:

• How much regime change you see depends on how you categorize regimes

• Tri-partite conceptualization of pension regimes is inadequate

• Amount of pension regime change over last fifty years has been substantial in OECD countries

2. Amount and direction of pension policy regime change depends in large part on:

• Balance between positive and negative policy feedbacks– Negative policy feedbacks can be strongly

transition-encouraging (e.g., affordability of Bismarckian regimes)

• Incremental reform options available to policymakers—and whether they have been exhausted

• Regime transition opportunities available to policymakers– Only available after invented (e.g., NDC)– Adoption depends in part on political resources

3. Prospects for specific pension regime transitions vary over time

(Most common timing of pension regime transitions is shown next time to the corresponding arrow. Pension regimes with a low probability of regime exit in the current “late” period of public pension development are shown with a shaded background)

No public

pensions

“Bismarckian Lite”regime

Universal regime

Residualregime

Mixed regime

Bismarckian regime

NDC regime

late

earlymiddle

middleor late

middle

middleor late

earlymiddle

middle

early

middle

4. Negative feedback effects are a necessary but not sufficient explanation of pension regime transitions, e.g., why:

• Some Bismarckian systems (e.g., Sweden, Italy) shift to NDC while others (e.g., France) do not

• New Zealand and Ireland remain outliers as residual systems

• Timing differs in regime transitions

5. A broader set of explanations of pension policy regime change includes:

Political Environments and

strategies (e.g.,macro- institutions, coalitions,

corporatism

Policy feedbacks (e.g., policy

regimes, program maturity, “micro”

rules)

Economic-demographic

variables (e.g., aging, competitiveness,

fiscal crisis

The Problem stream

Policy Implementation

Policy survival

Agenda-setting

The Politics stream

Policy Adoption

The Policy stream

But examining negative feedbacks is a good place to start!

6. A framework focused on negative feedbacks and reform options has wide applicability—e.g., where Marx and Engels went wrong:Balance of positive and negative feedback effects• Anticipated near-universal immiseration did not occur

Incremental Reform Options• Many incremental patches available (e.g., welfare state

programs, better regulation of business cycles)• Patches became more politically feasible as voting

franchise was expanded

Regime Transition Options• High costs of transition• Major opposition from entrenched interests • Socialist and communist alternatives proved to have

substantial negative impacts in practice• Redistributive welfare state (with great variations) proved

“easier regime transition option

The End– Finally!