Human Capital Investment and the Sustainability of Public Transfer - PDF document

manuscript No. (will be inserted by the editor) Human Capital Investment and the Sustainability of Public Transfer Systems Across Europe An Evaluation based on National Transfer Accounts Bernhard Hammer · Alexia Prskawetz · R´ obert I. G´ al · Lili Vargha · Tanja Isteniˇ c · Received: date / Accepted: date Abstract We evaluate the sustainability of the public transfer systems in 24 EU countries using a new cohort-specific indicator, the Human Capital Investment Gap (HKIG). The indicator measures for a certain cohort the difference between the public benefits in old age and the public contributions of their children. Calculating the HKIG for the cohort born in 1950, we show that in none of the analyzed countries the contribution of the child generation will be sufficient to finance the old age benefits of the 1950 cohort, given the age- and employment-specific transfer pattern observed in 2010. This result holds for most of the countries even when assuming very optimistic employment scenarios. The decomposition of the HKIG into its components indicates that the cross-country differences in the HKIG are mainly driven by the level of This project has received funding from the European Unions Seventh Framework Pro- gramme for research, technological development and demonstration under grant agreement no 613247. Bernhard Hammer Wittgenstein Centre for Demography and Global Human Capital (IIASA, VID/¨ OAW, WU), Vienna, Austria Tel.: +43-1-313367728 E-mail: bernhard.hammer@oeaw.ac.at Alexia Prskawetz Wittgenstein Centre for Demography and Global Human Capital (IIASA, VID/¨ OAW, WU) and Institute of Statistics and Mathematical Methods in Economics, TU Wien, Vienna, Austria Lili Vargha Hungarian Demographic Research Institute, Budapest, Hungary and Doctoral School of Demography and Sociology, University of P´ ecs, P´ ecs, Hungary R´ obert I. G´ al Hungarian Demographic Research Institute, Budapest, Hungary Tanja Isteniˇ c Faculty of Economics, University of Ljubljana, Ljubljana, Slovenia

2 Bernhard Hammer et al. public contribution and benefits, while retirement age and employment rates play a comparably minor role. Keywords Public transfers · human capital · sustainability · National Transfer Accounts · generational contract 1 Introduction: Monitoring Public Transfers in Ageing Societies Population ageing goes hand in hand with fundamental changes in the life course and lifestyles of individuals. The most remarkable changes are higher levels of formal education, postponement of childbearing, a lower number of children, better health at all ages and a higher life expectancy. These changes affect the funding of the public transfer system, which constitutes largely a redistribution from the population in employment to the retired elderly. 1 In- creasing life expectancy together with pension systems that are tied to fixed age borders has led to an extensive period of retirement, which resulted, in combination with declining fertility, in an increase in the number of retired persons relative to the size of younger generations. As a consequence of these developments the population in employment has to finance longer periods of economic dependency for an increasing number of persons. It is of utmost importance for individuals and policy makers to gain in- formation how demographic changes and the associated changes in individual behavior affect the public transfer system. Expectations about the level of taxes and the access to public transfer benefits in the future influence im- portant current economic decisions of individuals, such as how to provide for old age. Inaccurate projections and unmet expectations can result in consid- erable economic hardship and loss of personal welfare. Policy makers in turn are concerned that the changing demographic structure and macro-economic conditions result in a large burden on the young generations and limit the ca- pacity of the state in other areas, such as education and infrastructure spend- ing. These concerns are intensified with the progression of population ageing. Several authors emphasize that it might be increasingly difficult to implement policy changes at the disadvantage of the large and growing group of elderly voters (e.g. Bovenberg, 2008; Sinn and Uebelmesser, 2003). The consequences of population ageing for the public transfer systems are therefore closely monitored. Remarkable efforts are made by the European Commission, which established the Working Group on Ageing Populations and Sustainability (AWG) to improve the quantitative assessment of the long- term sustainability of public finances and the economic consequences of ageing populations of the EU Member States. Results of the evaluation are published in the triannual Ageing Reports (e.g. European Commission, 2015). The eco- nomic and fiscal implications of ageing are also the topic of the Fiscal Sus- tainability Reports of the European Commission (e.g. European Commission, 1 Age-specific data on income, transfers, consumption and saving for 2010 are provided on http://www.wittgensteincentre.org/ntadata .

Human Capital and the Sustainability of Public Transfers 3 2016). Both, the Ageing Reports and the Fiscal Sustainability Reports include a range of indicators describing the consequences of ageing, in particular for the government budget. An important group of these indicators provides in- formation on the sustainability of the public transfer system, i.e. they measure the degree to which taxes and social contributions can finance public bene- fits in the future, given the expected demographic changes and the expected changes in age-specific public contributions and benefits. However, the commonly used sustainability indicators for the public trans- fer system do not account for the fundamental relation between transfers to children and the transfers to the retired elderly population over time. The gen- erosity of the public transfer system to the members of the elderly population relies on their investment in children when they themselves were in working age. These investments determine the ability of the generation of children to finance public pensions and health services for the elderly once they enter em- ployment. In this paper, we develop a sustainability indicator for the public transfer system using a framework that takes this fundamental relation be- tween transfers to children and the transfers to the elderly population into account. Our indicator contrasts the public net benefits that are expected by the members of a certain cohort in old age with the projected public transfers to the elderly population that are made by the children of this cohort. We find for the cohort born in 1950 that in all of the analyzed countries the projected old age benefits are considerably higher than the contributions of the chil- dren. The gap indicates insufficient investments in children, in terms of their number, their education and integration into the labour force. This finding motivated the name human capital investment gap (HKIG) for our indicator. The decomposition of the HKIG into its components allows us to identify several characteristics of transfer systems that influence the sustainability of public transfers and the size of the HKIG. We find that the cross-country dif- ferences in the size of the HKIG are mainly driven by the per capita levels of contributions and benefits and only to a very limited degree by the number of years an average person is net contributor, respectively net beneficiary. In Chapter 2 we develop a framework for analyzing intergenerational trans- fers using the concept of a generational contract. The framework accounts for the relation between transfers to children and the transfers to the elderly pop- ulation. Chapter 3 provides an overview of indicators that are commonly used for monitoring the sustainability of the public transfer system under demo- graphic change. We distinguish two groups of such indicators: indicators that are based on data from one period such as dependency ratios; indicators with a long-term time horizon that use data from several periods and take into account expected future tax payments and public expenditure. The chapter discusses advantages and shortcomings of these indicators and their relation- ship with the HKIG. Chapter 4 provides an overview of the intergenerational public transfer flows in 2010 using the European National Transfer Accounts data for 25 countries. These data serve as basis for calculating the HKIG for the cohort born in 1950, which is the topic of Chapter 5. The central elements of the HKIG are projections of the public old age benefits for the 1950 cohort