Pensions and labor supply in the OECD

From the National Center for Policy Analysis

February 12, 2014

The employment rate among the older segments of Organization for Economic Cooperation and Development (OECD) populations have decreased significantly over the last 50 years, says Gabriel Heller Sahlgren, a research fellow at the Institute of Economic Affairs (U.K.).

As employment rates for older generations have fallen, more pressure has been put on state pension systems to fund their retirement, leaving fewer people to fund larger groups of pensioners.

• The male employment rate for ages 55 to 59 in OECD countries decreased from above 90 percent to less than 70 percent between 1968 and the end of the 1900s. In 2008, that number was at 80 percent.
• By 2040, the ratio of dependency supporting pensions is expected to increase by 17 percent relative to 2008.

Evidence suggests that this drop in employment is tied directly to the financial incentives of state pension systems.

• One simulation found that delaying eligibility for pensions by just three years would increase labor force participation by 36 percent among men aged 56-65.
• Looking across countries, one study found that an increase in 10 percent in public pension wealth leads to a decrease in the average retirement age by 1.5 percent.
• Italy has such strong incentives in place that reaching pension eligibility increases a person's likelihood of retirement by 30 percentage points.
• Conversely, a Swiss study found that permanently reducing retirement benefits by 3.4 percent would result in a 50 percent decline in retirement probability.

Sahlgren suggests linking the pension age with life expectancy in order to encourage labor force participation. He also argues for a private pension system that gives workers more control over their own retirement savings and encourages them to bear the costs of their own retirement.

Lastly, evidence suggests that workers use unemployment benefits and disability insurance as "alternative" retirement plans. Those programs should be reformed to discourage such behavior. When the United Kingdom recently undertook such reforms and provided incentives for disability insurance recipients to return to work, the country saw a response in higher employment rates.

Source: Gabriel Heller Sahlgren, "Income From Work -- the Fourth Pillar of Income Provision in Old Age," Institute of Economic Affairs (U.K.), January 2014.